The U.S. housing market has officially entered a strange world.
The law of supply and demand is a fundamental principle of any free market, but it is currently being upended by strange events in the real estate market.
Demand for housing is declining while the supply of homes for sale is increasing, yet home prices continue to reach record highs.
“When it comes to the housing market, the laws of supply and demand no longer appear to apply,” economist David Rosenberg said in a note this week.
Existing home sales in May fell to a four-month low of 4.11 million units, down 2.8% from a year earlier, while the number of existing homes available for sale in May increased 18.5% from a year earlier.
“Unsold inventory increased from 2.9 months' worth in February to 3.2 months' worth in March, 3.5 months' worth in April and 3.7 months' worth in May, the highest level since June 2020,” Rosenberg said.
But despite declining demand, as measured by falling existing home sales and rising supply, the median home price rose 5.8% year-over-year in May to a record high of $419,300.
“This is a really worrying situation – demand is at a four-month low, supply is at a four-year high and prices are unprecedented highs,” Rosenberg said.
The disconnect is also due to the fact that real estate markets are highly regional and localized, with some areas doing better than others. In Texas and Florida, for example, home prices are falling even as the supply of homes for sale soars.
Another factor is mortgage rates, which are hovering around 7%, the highest in decades, locking out many would-be homebuyers and trapping sellers who don't want to refinance at higher rates to buy their next home, essentially freezing the market.
But this situation of declining demand, increasing supply and rising home prices can’t continue forever.
“At some point, either interest rates or prices are going to collapse,” Rosenberg said.
Some market experts believe home prices could fall sharply.
Market strategist Chris Vermeulen highlighted sluggish activity from homebuilders as a reason he believes the housing market could experience a big “downturn.”
“The reality is, I think we're going to see this collapse,” Vermeulen said.
But some expect home prices to continue to rise if the Federal Reserve cuts interest rates. According to the CME FedWatch tool, the market is expecting the central bank to make its first rate cut at its September policy meeting.
Lower mortgage rates will help lower borrowing costs but will also boost demand as more borrowers return to the market.
Renowned investor Barbara Corcoran says lower mortgage rates will drive home prices even higher.
“If real interest rates went down another percentage point, everyone would jump into the market and pay a lot more for homes,” Corcoran said.
