Home price growth headed for gradual correction

Slowing home price appreciation is not an indication that the U.S. housing market is facing a bubble that will burst as it had during the financial crisis of the late 2000s, a Standard & Poor's report said.

Home price growth is expected to gradually normalize, rather than suddenly correct itself.

"There are similarities between the current pattern of home price appreciation and the 2004–2006 experience," S&P said. "However, differences in the fundamental drivers of home price appreciation then and now suggest the current environment is a healthier one than the housing bubble that preceded the Great Financial Crisis."

Back in September 2005, S&P CoreLogic Case-Shiller National Home Price Index had a then-record year-over-year increase of 14.4%. It was surpassed this April when the annual change was 15%.

Every month since, the year-over-year change increased, peaking in August at 19.9%, before declining in September to 19.5%, which could be the first sign of a softening market, the report said.

However, the mortgage industry has changed since the financial crisis. Most loans today are originated to Fannie Mae and Freddie Mac standards. At the same time, the ability to repay and investor risk retention requirements apply to the non-qualified mortgage segment, which is much smaller in comparison to the pre-Great-Recession era.

Also, adjustable rate mortgages, which made up around 40% of originations in 2005 — many with teaser rates that were used to qualify subprime borrowers — now make up less than 5% of total volume, not just because of changes in underwriting standards but also because interest rates remain low.
Furthermore, the housing market is now demand-driven, because of the inventory shortage, versus the oversupply in the years around the financial crisis.

Still, prices will eventually decline, the report said. In the most benign scenario, price appreciation will turn negative by the fourth quarter of 2024 and reach a 9% year-over-year drop by the third quarter of 2026.

On the other hand, in S&P's more extreme scenario, prices start to decline after the first quarter of 2023, with a 14% year-over-year drop in the first quarter of 2026.

"Interestingly, even under the more extreme stress that we considered, home price appreciation hits -3.7% quarter-over-quarter only in 2026, which is shy of the -3.8% reading in first-quarter 2009 during the Great Financial Crisis," the report noted. "This is not necessarily surprising given the current trajectory of home prices."

But S&P added the analysis does not take into account population behavior characteristics, including the fear of missing out, which could be the greatest source of error, albeit one the rating agency tried to mitigate by keeping the period from the first quarter of 2020 to this year's third quarter out of its regression analysis.

"The regression analysis and associated downside forecasts suggest that relatively adverse movements in predictors of home price appreciation are unlikely to cause prices to fall in the near term," the report concludes. "Nevertheless, if prices were to fall dramatically, our analysis suggests that the impact on certain non-agency residential mortgage-backed securities transactions would likely be limited to two rating category movements (e.g., 'AAA' to 'A')."