Housing Market Positioned for a Gentler Slowdown Than in 2007

The U.S. experienced the worst shortage of homes for sale in at least three decades, driving up prices even more and locking first-time buyers out of the market.

The U.S. experienced the worst shortage of homes for sale in at least three decades, driving up prices even more and locking first-time buyers out of the market.


Daniel Acker/Bloomberg News

The U.S. housing market is running out of steam, but its slowdown looks nothing like the historic collapse that took down the whole economy in 2007.

Home-price growth has slowed for the last several months and is expected to continue slowing as mortgage rates rise. The volume of existing home sales has fallen compared to a year earlier for six straight months. In August, the three-month moving average of new single-family homes built was just over 860,000, down from nearly 900,000 at the beginning of the year.

There are a number of reasons to believe this shift will persist. Mortgage rates have risen about a percentage point over the past year, pinching demand for homes. Rising prices have squeezed affordability. In addition, the tax law passed in December reduced homeownership incentives, foreign buyers have pulled back, and ample supply of rental apartments has made buying less urgent for many.

“The rise in [mortgage] rates paired with this very strong price appreciation absolutely is slowing housing,” said Fannie Mae Chief Economist Doug Duncan.

The good news is compared to a decade ago the housing market doesn’t have far to fall. As frenzied as the market has felt in recent years, with bidding wars and double-digit price increases, it never came close to the level of the last boom by most measures. That positions it for a much gentler slowdown, economists say.

“Everybody, including me, is concerned about saying this time is different,” says Mr. Duncan.

The last cycle in fact was different because it was so extreme.

During the last bust, prices fell 25% and single-family housing starts plummeted to just over 430,000 in 2011 from a peak of more than 1.7 million.

The scars from those unusual swings still haven’t fully healed, even with a housing recovery in its sixth year. That is giving the current slowdown its own very unusual shape.

In a typical housing cycle, the forces of rising prices and rising building lead to oversupply, then slowdowns or declines in both. The cycle is driven in part by interest rates—low rates push prices and building higher and then higher rates drive them down.

This cycle is much different in part because building never really took off in this expansion, even though prices recovered in many markets.

Construction workers, land developers and home builders left the industry after the last crash, stymying new-home construction, which remains even now around the same level as in some prior recessions. In addition to labor shortages, higher materials costs and increased land-use regulations also held back construction.

Instead of oversupply, the U.S. experienced the worst shortage of homes for sale in at least three decades, driving up prices even more and locking first-time buyers out of the market.

Some argue that a recession might be good for the housing market because it will slow home-price appreciation and improve affordability.

Unlike the last downturn, average home prices don’t usually fall nationally, even during recessions. The next slowdown is likely to mark a return to that historical pattern.

Ralph McLaughlin, chief economist at Veritas Urbis, analyzed data from the recession in the early 1990s, early 2000s and 2007 through 2009 and forecast the likely effect of the next recession on current home-price growth. If the next recession resembles either the bursting of the dot-com bubble in the early 2000s or the mild early 1990s recession, home prices will likely stagnate for a year or more but not fall.

The high end of the housing market, where the majority of new construction did take place, could be more significantly impacted, as rising interest rates push buyers toward lower price points.

Some local markets also are at risk.

Prices in Dallas grew nearly 10% in August compared with a year earlier, nearly four times the 2.8% they were up in August 2005, according to Zillow. Prices in Denver are growing more than 6% compared to just under 3% during the last boom.

Prices in Seattle have grown about 25% over the last two years. In recent months, Seattle price growth has slowed as the number of homes on the market rose and buyers weighed their options more carefully. The number of homes for sale in Seattle was up 50% in August compared with a year ago, according to Redfin, a Seattle-based national brokerage.

That could be an example of housing supply catching up with demand. However, in much of the rest of the nation, the two are still out of whack. With interest rates rising and the market undersupplied, getting them realigned won’t come smoothly, but it also likely won’t lead to a crash.

Write to Laura Kusisto at laura.kusisto@wsj.com