A slowdown in home price appreciation is not an indication that the US housing market is poised to enter a bubble that will burst as it did during the financial crisis in the late 2000s, according to a report by Standard & Poor.
Home price growth is expected to gradually normalize rather than suddenly correcting itself.
"There are similarities between the current pattern of home price appreciation and the 2004-06 experience," S&P said. "However, differences in the fundamental drivers behind the appreciation of home prices then and now suggest that the current environment is healthier than the housing bubble prior to the Great Financial Crisis."
In September 2005, the S&P CoreLogic Case-Shiller National Home Price Index posted a record 14.4% year-over-year increase. It was exceeded in April of this year when the annual change was 15%.
Since then, the year-over-year change has increased every month, peaking at 19.9% in August before declining to 19.5% in September, which could be the first sign of the market weakening, the report said.
However, the mortgage industry has changed since the financial crisis. Most loans today are made according to Fannie Mae and Freddie Mac standards. At the same time, the unqualified mortgage segment, which is much smaller in comparison to the pre-Great Recession era, is subject to investor repayment and risk retention requirements.
Also, variable rate mortgages, which accounted for around 40% of new borrowings in 2005 – many with teaser rates used to qualify subprime borrowers – now account for less than 5% of total volume, not just due to changes in underwriting standards, but also because interest rates remain low.
In addition, due to the shortage of inventory, the housing market is now demand-driven compared to the oversupply in the years around the financial crisis.
Still, prices will eventually go down, the report said. In the best-case scenario, the price appreciation will turn negative by the fourth quarter of 2024 and drop by 9% year-on-year by the third quarter of 2026.
On the flip side, in S & P's more extreme scenario, prices begin to decline after the first quarter of 2023, with a year-over-year decline of 14% in the first quarter of 2026.
“Interestingly enough, even under the more extreme stress we were considering, the rise in home prices reached -3.7% QoQ only in 2026, which is less than the -3.8% level seen in Q1 2009 during the Great Financial Crisis. ”the report notes. "This is not necessarily surprising given the current trend in home prices."
However, S&P added that the analysis fails to take into account behavioral characteristics of the population, including the fear of missing out on something that could be the biggest source of error, although the rating agency has tried to tone it down by measuring the period from Q1 2020 to this one retains third quarter of the year from its regression analysis.
"The regression analysis and the associated downward projections suggest that relatively unfavorable moves in predictors of home price appreciation are unlikely to lead to a price decline in the near future," the report concludes. "However, our analysis suggests that if prices were to fall dramatically, the impact on certain unofficial mortgage-backed securities transactions would likely be limited to two rating category movements (e.g., 'AAA' to 'A')."