As a homeowner or would-be homeowner, news of housing market conditions can feel stressful – especially when you haven’t endured those conditions in the past.
While a housing price correction or housing market correction describes a drop in home prices, it’s not necessarily bad for homeowners – and can help homebuyers who are struggling to afford a home purchase. Sometimes a housing market correction is necessary to restore balance and level the playing field for those who are buying a home for the first time.
Here's a breakdown of what a housing market price correction is, and whether current housing market activity is indicative of a price correction.
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A housing market correction occurs when home prices drop slightly. There is no formal threshold that determines a correction, but a drop of 10% or less is commonly used.
The use of the term “correction” indicates that prices have in some way become unsustainable, so the market is correcting itself to better fit with affordability, demand and supply.
“When we talk about a price correction what we’re really looking at is prices that have been appreciating really aggressively and all of a sudden that slows down rapidly,” says Nicole Bachaud, senior economist at Zillow.
There is no defined timeline for a market correction. “A price correction is not a thing that happens and you can expect it to go away after a period of time,” Bachaud says.
A price correction can be as short as a couple of months or be drawn out over a year or more. Bachaud points to a relatively brief market correction that occurred in the latter part of 2018 and early 2019. When interest rates rose slightly, combined with high home prices, many homebuyers in coastal markets stopped making offers because they had concluded the market was too expensive. The market corrected with a downward shift in interest rates and a deceleration in home price increases.
When home prices in a local market decline slightly and never pick back up again, it’s likely an indicator of greater decline in housing demand – people may have stopped moving to the area and the population is declining, for example.
Other economic conditions can extend the duration of a correction. In 2018 and 2019 the economy was fairly strong. On the other hand, “if you’re in a recession period, it might be a really, really long time,” Bachaud says.
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The short answer is never quite what you want to hear: maybe. It’s often difficult to make a declarative statement about current conditions until they have been evident for some time.
There are a few indicators that point to a national housing market correction occurring either now or in the near future:
First, there’s the history of price appreciation since the pandemic. While this can vary from market to market and can be discussed at levels from neighborhood-by-neighborhood to national, for the purposes of this article, national will be the most useful.
According to Redfin data, the median sales price of a home in the United States was $290,807 in January 2020, just 6.6% growth over the year prior. Everybody knows what happened after that. In January 2021, the year over year appreciation rate had more than doubled to 13.8%, with a median sales price of $330,876. Another year, another alarming trend: 14.2% growth and $377,933 median sales price in January 2022.
That’s when the brakes were applied, as the Federal Reserve raised interest rates . January 2023 still showed appreciation, but just 1.2% year over year; January 2024 came back more toward what was normal pre-pandemic levels, at 5.1%,but that still leaves homes with a median sales price of $402,242, according to Redfin. So, is a housing correction even an option given this?
“It is possible – we have seen a really sharp run-up in home prices. So it is possible,” says Danielle Hale, chief economist at Realtor.com. “It is also possible that prices just move sideways.”
A sideways movement of home prices would be more of a plateau than a correction. Rather than seeing prices decline to reset the market, “we may just see fewer transactions,” Hale says.
Another vital factor that allows housing market price corrections to occur is having enough houses for everyone who wants to buy. Generally speaking, a balanced market has about six months of inventory, but that hasn’t been the case for some time. Housing inventory is the total number of active listings plus pending sales at the end of the month. If inventory is rising, there is less pressure for home prices to increase, according to the National Association of Realtors.
Nationally, even pre-pandemic, Redfin shows the highest level of national inventory in the last five years was in January 2019, and it was just over four months. May 2020 was the last month of more consistent inventory, but it still only had three months of homes available. Until January 2023, inventory was below three months consistently, which, even with rising interest rates, has kept prices high. Although that interest rate shock definitely slowed down buyers, it didn't change the reality of the market.
“Even though we’re seeing demand fall back, the supply is not there,” Bachaud says.
As of January 2024, supply is still sitting at three months, the highest point since February 2023.
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Rising interest rates ultimately lower affordability, which then can make it harder to buy a home, and can have a cooling effect on prices. Interest rates started seriously climbing in April 2022, with a national average of 5.0% for a 30-year fixed rate mortgage for the month, and peaked in October 2023 at 7.6% for the same product.
The average rate for January 2024 was 6.6%, so there has been some decline, but rates are still much higher than they were in January 2021 (2.7%) and January 2022 (3.4%), when there was a jump in housing prices. The problem is the lack of inventory is driving large-scale home appreciation despite these higher rates.
On Wednesday, in the first of two appearances this week on Capitol Hill, Federal Reserve Chairman Jerome Powell stuck to his script that it is not yet time to begin cutting interest rates.
At a press conference in late January, following a meeting of the Federal Reserve, Powell made it plain that he doesn’t expect rates to change in the immediate future, and that if the economy continues on the trajectory it’s on, rates may well go down.
“We believe that our policy rate is likely at its peak for this tightening cycle and that, if the economy evolves broadly as expected, it will likely be appropriate to begin dialing back policy restraint at some point this year,” said Powell.
This may sound like terrible news, but remember, a falling rate could translate to rising real estate prices. A rate that remains stable might lead to, at the very least, stable prices.
Bachaud, like Powell, notes that the future is hard to see right now, but she expects the housing market to start turning toward a normal growth path in 2024 – but not a correction. “We will probably not get back to the levels of affordability we are used to any time soon.”
If home prices drop more dramatically, a housing crash could occur – and it would be more obvious than a correction. During the housing crash that went hand-in-hand with the Great Recession, home prices fell by more than 30% in many markets.
Based on current housing market conditions, such an accelerated drop in home prices seems unlikely. A factor that makes a housing correction more likely than a housing crash is the relative financial stability of homeowners today compared with during the Great Recession. Homeowners today are less likely to default on their homes in the current economic environment.
Powell and other Fed officials have repeatedly said they will judge whether to begin lowering interest rates on the state of incoming economic data. Officials are fearful of cutting rates too soon. Meanwhile, the economy and financial markets are performing strongly, undercutting the argument that the Fed’s interest rate policy is too restrictive.
Patrick S. DuffyJan. 23, 2024
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