Back in 2007, economist Edward Leamer published the now infamous research paper “Housing Is the Business Cycle.” It calculated that in the post–World War II era, eight recessions (out of 10) came after the U.S. housing market had entered into a “substantial” slowdown.
Since then, we’ve had two more recessions: the Great Recession—which was set off by the bursting aughts housing bubble—and the COVID-19 recession, which did not come after a housing slowdown. So by the latest count, a housing slowdown has preceded nine out of the past 12 recessions.
That explains why so many economists are concerned: The U.S. housing market—a leading indicator of the broader U.S. economy—is slowing. Slowing fast.
Spiked mortgage rates, which have climbed from 3.1% to 5.7% over the past six months, have pushed the U.S. housing market into what Moody’s Analytics chief economist Mark Zandi calls a “housing correction.” In Zandi’s eyes, this “housing correction” is very different from a full-blown housing bust. Instead of crashing, Zandi says, we’ve entered into a period where home sales will fall significantly and housing inventory will rise significantly. Nationally, he projects that this “housing correction” will see year-over-year home price growth decelerate to 0% by this time next year.
But that’s Zandi’s national outlook. The Federal Reserve’s inflation fighting plan, he says, has pushed some markets into the early innings of a price decline.
Every quarter, Moody’s Analytics assesses whether local fundamentals, including local income levels, can support local home prices. At the latest reading, Moody’s Analytics finds 183 of the nation’s 413 largest regional housing markets are “overvalued” by more than 25%. In some of those overvalued markets, Zandi says, buyers and sellers can expect to watch home prices fall by 5% to 10% amid this housing correction.
Those 5% to 10% home price declines could quickly worsen if cooling in rate-sensitive sectors, like real estate, ultimately pushes the U.S. economy into recession. If a recession hits, Zandi tells Fortune he expects national home prices to decline by around 5%. However, in America’s most overvalued housing markets, Zandi predicts a 15% to 20% home price decline.
Earlier this month, Fortune published a list of the 40 regional housing markets most likely to see a 15% to 20% home price decline amid a recession. At the top of the list, Zandi says, are Boise; Colorado Springs; Las Vegas; Coeur d’Alene, Idaho; Tampa; Atlanta; Fort Collins, Colo.; Sherman, Texas; Jacksonville; and Idaho Falls, Idaho.
This week, we’re diving deeper into the data. Fortune reached out to Moody’s Analytics to see if the financial intelligence company would provide us with historical data for the 40 markets they deem as being at risk of a 15% to 20% home price decline.
The finding? Among these 40 overvalued housing markets most at risk of a significant decline, 33 are overvalued by a higher degree now than in 2006. Among those 40 regional housing markets, the average was overvalued by 45% as of the first quarter of 2022. Among those same markets, the average was overvalued by 19% in the first quarter of 2006.
Let’s be clear: Just because a market like Boise is overvalued by 72% doesn’t mean home prices there will fall by 72%. It’s historically normal for a growth market to see home prices, statistically speaking, trading higher than local incomes would normally support. However, once a market gets too overvalued, a price correction often becomes warranted. That’s where Zandi says things now stand in those 40 significantly overvalued housing markets.
The vast majority of these at-risk markets are concentrated in fast-growing areas of the Mountain West and Sunbelt that benefited the most from the pandemic’s work-from-home boom. Renters in high-cost cities like Seattle and Boston simply couldn’t pass up the affordability of markets like Austin and Tampa. The ensuing pandemic housing boom saw markets like Austin and Tampa become overvalued by 61% and 45%, respectively.
In places like Austin, which was overvalued by just 7% in the first quarter of 2006, this feels very new. In other places, it looks eerily similar to 2006. Look no farther than Las Vegas and Phoenix, which Moody’s Analytics rates as being overvalued by 53% and 54% in the first quarter of 2006. Now, Phoenix and Las Vegas are overvalued by 51% and 54%. That’s not something that real estate professionals in those cities—two of the hardest-hit in the 2008 housing bust—want to hear.
While the pandemic housing boom has taken some regional housing markets to historically unaffordable levels, we shouldn’t anticipate a 2008-style crash. That bust was underpinned by a credit boom of subprime mortgages. As the market and economy slowed, those bad mortgages began to go belly-up. Ultimately, it set off a foreclosure crisis that lingered well past 2010.
This time around, Zandi says we don’t need to worry about bad loans. The Dodd–Frank Wall Street Reform and Consumer Protection Act passed in 2010 outlawed those shady mortgages. The pandemic housing boom, in his mind, wasn’t a credit-fueled boom. Instead, it was a mismatch between elevated demand (i.e., an influx of WFH, investor, and millennial buyers) and low inventory levels. When inventory levels in 2021 sank to a 40-year low, Zandi says homebuyers had little choice but to bid up prices.
Already, we’re starting to see many of these significantly overvalued housing markets slow. That ongoing slowdown is particularly swift in Western markets like Boise, Denver, and Phoenix.
“Many markets in the West are landlocked for one reason or another, whether the ocean, mountains, national parks, or growth boundaries. As a result, building is more limited in these markets compared to parts of the country with less regulation and more developable land. The strong demand over the past two years drove up home prices across the country, and it appears the West hit the pricing ceiling quicker than other markets, given the particular supply constraints,” Ali Wolf, chief economist at Zonda, tells Fortune.
While Wolf doesn’t think this is 2008 all over again, she says we can’t ignore that the market has shifted.
“I don’t think the market will face a Great Financial Crisis–like bust, given the different dynamics today around mortgage lending standards and strong builder balance sheets,” Wolf says. “We can’t ignore, however, that the market is already correcting. Higher home prices and higher mortgage rates rose to the point that demand seized up in many parts of the country. Home prices are already adjusting down, and we could see that continue until consumer confidence and affordability resets.”