First, the good news: The United States hasn’t plunged into a recession. Despite more than a year of high interest rates, the economy has shown resilience beyond most economists’ predictions.

But the Federal Reserve (Fed) still hasn’t beaten down inflation completely, and the economy’s strength could be more long-term than a phase of the economic cycle.¹ Many market participants now believe interest rates will stay higher for longer. And this is prolonging a set of tough challenges in the housing market that have almost put it into a state of suspended animation. The difficulties:

• U.S. home prices are currently at all-time highs, and less affordable (relative to income and mortgage rates) than at the height of the 2006 housing bubble. That’s after prices skyrocketed by about 40% during the pandemic.²
• Sales of existing homes are very depressed, as bad as after the global financial crisis.
• While buyers wait for prices to fall, sellers won’t list their homes because they don’t want to sacrifice the low mortgage rates they locked in before the fastest, most aggressive rate hiking cycle in 40 years.
• Prices aren’t falling because the market is stuck. Demand has been reduced by high mortgage rates, but supply is even more restricted because of severe underbuilding in the 2010s, relative to population growth.³

High prices, high mortgage rates and a shortage of homes: combined, they’ve created today’s crisis of affordability.

How do these issues get resolved – and when?

Rising incomes can restore affordability – given enough time

First, here’s how we don’t think the crisis will be resolved: through a crash in home prices.

The (perhaps natural) assumption is that the housing market can only return to a more “normal” state of affordability and predictable price appreciation after a drop in home prices effectively “clears” the market, and it begins a new cycle. This is certainly not an impossibility, but that would likely require a U.S. recession and a spike in job losses across the economy, neither of which are our base case for the coming years.

Nor do we think lower mortgage rates are the solution to clearing the logjam. Indeed, surveys of homebuyers find consistently that financing rates aren’t their main motivators when they make a purchase.⁴ Life stages are: People buy homes when they get married, or when they need to move as they find employment, have children or retire.

We see another pathway that doesn’t involve punishing price declines or a sizeable drop in mortgage rates. It hinges on home affordability.⁵

Housing affordability could be restored by incomes continuing to rise at a robust rate. We think the path to affordability, for starter homes as well as the luxury market, is that wages rise to catch up to and meet the higher costs.

When will homes be affordable again?

How long might it take to restore average levels of affordability – based on historical ratios of home prices to income and factoring in mortgage rates – if incomes were to keep growing at their recent pace, and if mortgage rates didn’t decline and home values stayed at all-time highs?

Our answer: about 3.5 years.

Our analysis of the timing is notably sensitive to mortgage rates. If the market’s pricing of mortgage rates were to fall by just one percentage point, U.S. homes could be affordable again in just two years.

The takeaway: If you are looking to buy a house in the United States, don’t wait for – or expect – a home price crash. We don’t foresee one coming (thankfully), nor do we think one is necessary to restore affordability at the national level. We think time and continued robust income growth can cure the problem on their own.

Home prices vary by metro area

So far, we’ve talked about the national U.S. housing market. At the city level, it’s a more complicated story. Since the pandemic began, metro areas have experienced stark divergences in home price trends. That’s not typical, but it’s a unique feature of the current housing cycle.

We’ve organized these price trends by noting price behavior during the COVID-19 pandemic, and from the pandemic’s end (and each city’s price peak) until now. Four categories emerge:

• Boom-bust – Mostly in the Southwest, cities such as Austin saw pandemic-era booms and have since crashed. (Home prices in Austin are down about 15% from their peak.) Supply and demand are playing roles, but especially supply. Austin housing inventories are currently 67% above December 2019.⁶
• No boom-but still a bust – Only San Francisco didn’t see much of a pandemic boom, yet it still has seen deflation of more than 10% from its peak. In our view, weak demand explains it: Tech sector layoffs and rising remote work patterns have slashed housing demand in the Bay Area.
• Boom-no bust – Mainly in the South, cities such as Miami saw home prices boom during the pandemic and have held their value. Prices in Miami are up 54% since June 2020. Major supply constraints are responsible in these markets. Miami’s inventory levels are currently 40% below December 2019.
• No boom-no bust – These metros, among them New York, Washington, DC, and Chicago, didn’t see much of a pandemic housing boom (after all, New York and Chicago suffered sizeable population outflows during COVID-19) and have held steady since.

Paths to restored affordability differ by city

We did the same affordability analysis for large metro areas as we did for the national market, again assuming mortgage rates and home prices remain unchanged, mapping each city’s path to affordability based on recent trends in income growth.

There are a few interesting observations here.

First, while our analysis finds affordability restored in an average 3.5 years nationally, the average time is 5.3 years for large metro areas. This is not surprising, as the large cities are where America’s housing affordability problems are concentrated. (Affordability is less challenged in rural areas where land is more abundant and zoning restrictions on new development are less onerous.⁷)

Second, the years-to-affordability calculation for cities diverges widely, ranging from zero years for Cleveland/Detroit to more than 10 years for Miami.

Miami’s currently high housing valuations are driving this result. While the national median home price-to-income ratio currently stands at 3.95, for Miami the ratio is 6.6. (This is not altogether new, but the valuation gap has increased further in recent years: Prior to the pandemic, the national ratio was 3.74 versus 5.25 for Miami.⁸)

Where does new construction fit in?

So far, we’ve discussed existing homes, where the affordability crisis and the seizing up of activity have been most extreme. The story is quite different for sales of new homes, which have remained resilient and have risen strongly year-to-date (by more than 20%).⁹

In the market for new homes, affordability challenges are less intense due to more price deflation¹⁰ and because homebuilders are offering attractive incentives, including below-market mortgage rates (called “buy downs”) that make new construction more affordable.

New construction activity has also been, and continues to be, concentrated in lower-cost-of-living metro areas where younger generations, particularly millennials, have been flocking.

A robust new construction market is a positive development. It could be the way out of America’s severe national housing shortage. Builders, however, cannot fix the shortage overnight. Indeed, new housing unit completions make up just 1% of the nation’s housing stock annually.¹¹

Declining interest rates could speed up the home building, but they could also reignite inflation – that’s the delicate balance the Fed is trying to strike. For now, we don’t expect the Fed to begin cutting interest rates until the second half of next year. At that point, and especially by 2025, we think the U.S. housing market will be well on the path toward normalcy and better affordability.

Let’s talk about your city

Are you thinking of buying, selling or building a home? Reach out to a J.P. Morgan professional. They can work with you and your realtor to provide our analysis and expectations for housing markets in major metro areas.