Goldman Sachs’ 2023 Report on the Global Housing Market Crash

After two consecutive years of rapid home sales and soaring home-price appreciation, the housing market is cooling down in some places while growing in others. This disconnect has led many to question whether the housing market will crash, but Goldman Sachs’ report for 2023 shows it has taken the bearish side of the debate. The latest prediction from Goldman Sachs implies a significant decline in metropolitan cities in the US. Since this report is one of the staples economists and pundits turn to, I wanted to review it for you to provide a nuanced perspective. This article was submitted by Nirav Shah, M.D.  

Goldman Sachs’ Market Crash Predictions

According to the Goldman Sachs report, mortgage rates will continue to skyrocket. As a result, the sales and prices will remain under pressure in most of the G10 economies. After a historic surge in housing activity during the pandemic, housing prices sharply declined in the second half of 2022. Thanks to interest rate spikes by the Central Bank and the corresponding rise in mortage rates, a downfall in housing sales, starts, and prices will continue, deterring homebuyers from investing in this highly-uncertain market. Goldman Sachs has also notified its clients that their S&P CoreLogic Case-Shiller Index has predicted a sharp decline in housing prices. The index predicted a decline of 6.1% by the end of 2023, a significant increase from their previous predictions of 4.1%. That said, some heated markets will experience a double-digit decline. Austin, San Jose, San Diego, and Phoenix, in particular, are more likely to experience a peak-to-trough decline of more than 25%. According to Redfin, Phoenix, and San Diego are popular markets for seller concessions where homeowners sell homes at below-average prices, offer mortgage-rate buydowns, and provide money for home repairs.    

Impact of Higher Mortgage Rates on Housing Affordability

Mortgage rates will continue to unbalance supply and demand. High borrowing costs are increasingly limiting affordability in the housing market, which in turn weakens housing demand. The consistent increase in mortgage rates, coupled with less demand and overwhelming supply, leads to an overall decline in housing prices. According to Goldman Sachs’s researchers, “Goldman Sachs’ strategists state that their revised 2023 forecast is mainly influenced by their expectation of prolonged high-interest rates, which they believe will persist beyond current market expectations.” They anticipate that 10-year Treasury yields will reach their peak in the third quarter of 2023. Consequently, Goldman Sachs is increasing their forecast for the 30-year fixed mortgage rate, projecting it to reach 6.5% by the end of 2023, representing a 30 basis point (0.3 percentage point) increase from their previous expectation. According to Goldman Sachs’ research team, “A 100-basis-point increase (equivalent to 1 percentage point) in mortgage rates is estimated to result in a 6% decline in residential fixed investment within three to four quarters. Additionally, house prices are expected to experience a 2.5% decrease after 10 quarters following the rate increase.” Mortgage rates are a significant determinant of the housing market, but the timing and scope of their impact are not uniform in all countries. Differences in mortgage rates across different countries lead to different levels of impact on housing prices. For instance, countries with a significant share of fixed-rate mortgages tend to experience a delayed impact on the housing market once borrowers are forced to refinance. Conversely, countries with a significant share of variable-rate mortgages feel the impact of rising rates immediately.  

Other Factors Influencing The Global Housing Market Outlook

Of course, mortgage rates are not the sole factor in determining the global housing market. In fact, the report claims that interest rates’ impact on forecast variance is less than half in most countries. Housing market tightness, characterized by a scant supply of homes available for sale, is another major determinant and can limit the downside of housing prices. Nevertheless, taking all these factors into account, the GS Research team’s G10 housing model has predicted a sharp decline in housing pricing by the end of 2023.  

Housing Market International Analysis

On an international basis there are predicted to be significant declines in the following countries:

• Canada (-19%).
• New Zealand (-19%).
• Australia (-15%).
• Sweden (-17%).

On the other hand, a more modest downturn will occur across a few European countries:

• Italy (-2%).
• Switzerland (-6%).
• France (-4%).

This modest decline would be a result of the greater affordability that these areas have maintained in the past few years.  

Will The Housing Market Crash?

In response to Goldman Sachs’ downgraded outlook on the US housing market, can we expect a market crash similar to the 2008 housing collapse? So far, the housing market has shown a tremendous response to increasing interest rates throughout the Federal Reserve’s efforts to tighten monetary policy and slow down economic growth. Policymakers are continuing with additional rate increases to fight inflation and that will negatively affect the housing market. Mortgage rates will continue to soar, further threatening the affordability and demand of houses. That said, the decline in housing prices would be limited to prevent broad mortgage credit stress and a repeat of 2008. Though the report predicts a double-digit decline in some parts of the US, it would be balanced by other parts of the country. There is a positive outlook for certain markets as well. According to Goldman Sachs, home prices in cities like Baltimore are projected to increase by 0.5%, while in Miami, they are expected to rise by 0.8%. Overall, the national decline in home prices will be small enough to prevent the widespread foreclosure that was a part of the Great Recession. The investment bank states three reasons behind the not-so-steep correction, as expected by KPMG.

1. The rapid growth of unused home equity in recent years ensures that even if home prices drop more than anticipated, only a small portion of mortgage borrowers will end up owing more than their home is worth.
2. More than 90% of mortgages have fixed rates, which means, that even if the interest rates increase, most homeowners won’t experience a sudden surge in the costs of repaying their debts.
3. Households have healthy balance sheets, with low overall debt levels and significant savings accumulated during the COVID-19 pandemic.

 

Future Housing Market Outlook: Not Straight Forward

The US housing market will continue to be in a state of flux, with many uncertainties lurking on the horizon. So far, it’s been a tale of two countries, with the west coast having price reductions and the east of the Mississippi seeing price growth.  

Figure 1: Source wsj.com

  With rising interest rates and a sharp downturn in housing demand, mortgage applications have fallen significantly. So, on one hand, there’s less demand, potentially more interest rate rises from the Fed, and price reductions lending evidence for a housing crash, but on the other hand, there’s low inventory, and ‘plenty of money’ on the sidelines. Just two weeks after Goldman Sachs predicted a housing market decline of 6.1%, the company revised course. The new predictions stand at just a 2.6% decline in home prices at the end of 2023. This uncertainty will undoubtedly influence homeowners’ investment in real estate. The high inflation, coupled with skyrocketing mortgage rates and market tightness, will impact the global housing market. However, the downturn would not lead to cascading defaults, as seen in the post-GFC drawdown. The previous correction in the 2007-2008 downfall led to a 26% decline in market prices, but this time, the peak-to-trough decline is expected to be 6%. While the prediction for the 2023 year-end is 2.3%, every market won’t be that lucky. The heated markets, as mentioned above, are predicted to experience a double-digit decline. Additionally, poorly performing operators will get washed out during this period. As rental data suggests that vacancy rates may rise, underwriting investments will get trickier with higher cost of capital, negative rents, and higher potential vacancy rates as household formation decreases. Across many major metros, millennials are not forming homes at the rate their peers were prior to COVID. In a nutshell, the tug-of-war battle between supply and demand will dictate the metro-level trends. MSAs with stronger affordability, such as Philadelphia and Chicago, will encounter smaller declines in housing prices. On the other hand, the cities in the West that feature poor affordability will see a significant decline in the housing market.  

Final thoughts: How I’m Investing

Personally, I don’t think we’ll have a significant housing recession like 2008. We now value bigger homes as a society due to the rise of remote work and too many people have mortgage rates below 4%.  

Figure 2: Mortgage rates by year from redfin.com

  If you’re considering investing in real estate, it’s important to know there will be ups and downs. Overall, it’s a great way to balance a diversified portfolio, but it can be capital-intensive and difficult with interest rate headwinds. Given I live in the Seattle area, I’ve been investing more aggressively for the first time since 2008; prices have dropped relative to rent since. In 2008, cap rates (net operating income/purchase price) did not drop because we entered a nearly 15-year period of low to zero interest rate policy. As a result, cap rates tended to be lower. Now, there are many opportunities above 6.5% in Seattle, but they’re moving quickly, which is evidence of supply-demand equilibrium for now. Where they will bottom is hard to say, but I’m already seeing some anecdotal evidence in places like Seattle and Miami that prices are rising again. Homes in desirable areas are starting to get more offers and rents are either flat or going up this summer despite click-bait reports of rents dropping (in Seattle at least). The calculation for me has been that interest rates will likely drop in the mid-term – ~4-5 years – and if one can find a spread between cap rates and interest rates, it’s a good time to buy,  assuming you can account for a potential refinance in 3-5 years. Being very conservative on underwriting a deal and thinking through potential rehabs is really the key.