In this episode of The REconomy Podcast™ from First American, Chief Economist Mark Fleming and Deputy Chief Economist Odeta Kushi break out their crystal ball and discuss the outlook for the 2025 housing market, including their expectations for mortgage rates, affordability, sales and house prices in the year ahead.
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“While we do expect affordability to improve, the improvement is not likely to be substantial, given our assumptions of mortgage rates above 6%. So, demand will be tempered by ongoing affordability challenges. On the supply side, existing-home inventory continues to be the primary source of overall housing inventory, and that is likely to be constrained by the rate lock-in effect, as we just discussed. Since prices are the intersection of supply and demand, we expect house price growth to stay not too hot, not too cold, but just about right in the low single digits, though this may vary significantly by market.” – Mark Fleming, chief economist at First American
Odeta Kushi - Hello and welcome to episode 104 of The REconomy Podcast, where we discuss economic issues that impact real estate, housing and affordability. I'm Odeta Kushi, deputy chief economist at First American and here with me is Mark Fleming, chief economist at First American. Hey Mark, I am calling this episode the crystal ball episode and I'm sure you can guess why.
Mark Fleming - Hi Odeta. Well, we must be approaching the end of the year so I'm betting this is our 2025 housing market outlook episode.
Odeta Kushi - You guessed correctly. We'll discuss what our outlook is for existing-home sales, new-home sales, and house prices. But, in order to do so, we do need to set the stage with our outlook for monetary policy and the general macroeconomic landscape in 2025.
Mark Fleming - That's just so easy. We'll just forecast, like, everything. I can't imagine what could go wrong.
Odeta Kushi - Yeah, I'm sure we'll have 100% forecast accuracy and we'll do it all in a 10-to-15 minute episode. Ready and go.
Mark Fleming - Okay, challenge accepted. And listeners interested in commercial forecasts, don't despair because in the next episode, that is episode 105, Xander will be joining us to discuss the commercial real estate outlook for 2025. So back to real estate. Odeta, where do we begin?
Odeta Kushi - Well, the outlook for the housing market is heavily dependent on the health of the broader labor market and economy. In order to make arguably the largest purchase of your life, it's important that you are gainfully employed and feel optimistic about the economy.
Mark Fleming - Arguably the largest. I mean, I think for the majority of us, we can safely drop that qualifier. Here's the good news, or maybe the bad news in this ‘stranger things’ upside down economic world. The economy is stronger than many expected just a few months ago. While job gains have slowed and the imbalance between labor supply and demand has narrowed. In the last six months, we've gained an average of 150,000 jobs a month. Note that I am excluding the October job numbers here because there were impacts from strikes and hurricanes. A little bit volatile, as economists would call it. And, of course, as economic historical context proponents that we are, the long-run pre-pandemic historical average monthly job gain is about 125,000. I always feel like, so quickly do we forget what's normal. So, even now, better than pre-pandemic average, but still a little lower than the 2015 pre-pandemic average of about 190,000 job gains.
Odeta Kushi - So, it's not the 400,000 job gains we were seeing in 2022, but not too shabby from a historical perspective. But, why did you say it's good news and bad news that we have this resilient labor market?
Mark Fleming - Yes, because a strong labor market might make the Fed less likely to cut rates. But I'm sure we'll get to that a little bit later.
Odeta Kushi - I don't think we can avoid a discussion of the Fed in this episode, but back to the labor market. Importantly, the layoff rate remains within the level seen during the expansion period in the decade before the pandemic. But the quits rate is 1.9%, which is the lowest since 2015. Now, we know that quits are a sign of worker confidence or lack thereof. You don't quit your job if you don't think that you can get another job easily or a higher paying job.
Mark Fleming - Yes.
Odeta Kushi - So, if workers are staying put, that means they don't feel very optimistic about their job prospects. Additionally, the hires rate remains below pre-pandemic levels, so employers are reducing hiring activity and employees appear to be staying put. So, while layoffs and discharges are low, which is good news, unemployment may begin to drift higher, if hiring remains low.
Mark Fleming - True, but so far, it's hard to really find a labor market measure that is far from normal. And that's allowed the Fed to fight inflation actually quite aggressively for the last two years. But Powell did recently say there's been enough cooling in the labor market. You've seen enough of it already. Also, we have made sufficient progress towards the Fed's 2% target inflation rate. So, why risk the labor market taking a turn for the worse and result in a job loss recession? It's time to start easing monetary policy and cut rates.
Odeta Kushi - And that's exactly what they did in September. But, speaking of recession risk, certainly a recession would have some implications on the housing market. But we're not necessarily forecasting a recession right now, though I do believe the risks have increased.
Mark Fleming - At this season of joy and merriment, Odeta, ever the economic Grinch? I think so. Yes. Yes.
Odeta Kushi - Yeah, bah humbug. Although I think I'm mixing holiday references here, but you get the point. That does describe me well. My general Grinchiness is based in data, however. 70% of U.S. economic growth is driven by consumer spending. With the labor market softening and delinquency rates for credit cards and auto loans exceeding pre-pandemic levels, consumers may rein in their spending in the coming year. Pandemic excess savings have also been depleted.
And there's already evidence of consumers pulling back on discretionary items and expenses. So, the magnitude of this pullback in consumer spending will fuel the outlook for the economy.
Mark Fleming - The Grinchiness. I'm going to be the voice of holiday joy here. Real income growth is still positive, so consumers can continue to finance their spending on all those holiday necessities that way. But more economically seriously, I agree that there are downside risks. But, as long as the unemployment rate remains low and wages continue to grow, especially above the rate of inflation, we can get to that soft landing.
Odeta Kushi - Ever the voice of holiday cheer. And you know, that does remain our baseline case for 2025. We avoid a recession, but with the labor market continuing to slow. But, what about inflation, the other mandate for the Fed? Are there any upside risks there?
Mark Fleming - Well, now almost two years into that inflation fight and core personal consumption expenditures, the target measure that the Fed is going for in September was 2.7%. So pretty close to that 2% target, but 0.7 is still a little ways to go. And that proverbial final mile to 2% may be the toughest.
Odeta Kushi - So what's keeping inflation above that target?
Mark Fleming - Okay, so we have to simplify things a little bit. I like to think of inflation in three parts, core goods inflation, super core services inflation, and of course, shelter inflation.
Odeta Kushi - Ooh, what's the super-duper core inflation?
Mark Fleming - Yeah, super duper. Well, in order to explain super duper, let's talk about shelter. Shelter inflation makes up about one third of the overall CPI and more than 40% of the core CPI. So, we split it out all by its lonely self due to its importance and weight. Although, it's also because we are real estate economists, of course. And then, with shelter inflation all on its own, then what's left over in services is that super-duper, as you say, core services. So Odeta. How are we doing in these three parts of inflation?
Odeta Kushi - That's a technical term, by the way. You can feel free to use super-duper inflation and everyone will understand. It sure does, but maybe not at an economic conference. So, in the goods sector, we know that demand for physical goods soared in the early days of the COVID pandemic as consumers were confined to their homes and obviously couldn't spend on things, such as travel or dining out.
Mark Fleming - Super duper. Works well at the Christmas cocktail parties.
Odeta Kushi - We also know that supply chains, global supply chains were blocked during the pandemic, meaning goods weren't hitting the shelves as quickly as consumers wanted them. So, these supply and demand dynamics drove up goods prices as goods consumption was pulled forward by the pandemic. But, when the world opened up again, goods demand dropped and prices declined. Real bona fide deflation for goods, like home furniture for a living room, kitchen or dining room, et cetera.
Mark Fleming - Okay, so part one, goods, deflating, check. Part two, super core services. This segment of the economy is very labor intensive. It's industries such as healthcare, education, recreation services, and financial services. Inflation in this segment of the economy is still well above the historical average, but still making progress. Where we need to make the most progress though is with part three, shelter inflation. But here's the tricky thing about that. Shelter inflation is primarily driven by changes in the rental market, and due to the way it's measured in the CPI, lags observed prices, rent declines on new leases are slow to show up in the inflation index. But we know they're coming. In other words, shelter inflation is still high, but only because it's reflecting rental prices from 12 to 18 months ago, not today.
Odeta Kushi - So, because that shelter inflation plays such a big part in overall inflation, we expect it to drag overall inflation lower as those lags catch up. So, barring no shocks, we expect inflation to continue to decelerate.
Mark Fleming - That's right. But investors are now roughly split about a December rate cut by the Fed because of that stronger-than-expected economy and that more resilient labor market, as well as some uncertainty about the future of economic conditions under the new administration.
Odeta Kushi - Okay. So does that mean the Fed will continue to cut rates in 2025?
Mark Fleming - I think as long as inflation continues to decline and we sort of deal with that last final mile, then yes, but the Fed may not ease monetary policy by as much as they implied in their September projections. In other words, slower easing than previously expected. But, we'll definitely know more about what the committee members are thinking when they release their December projections.
Odeta Kushi - And little plug here, more about those projections in our previous episode, episode 103.
Mark Fleming - Great plug. And so, I think we're saying soft landing, monetary easing, but maybe less than before. But what does this all mean for housing?
Odeta Kushi - Well, it means that, while we may expect lower mortgage rates, they won't be significantly lower than they are today unless the Fed throws us a curveball, such as cutting rates even more than expected. But, while that sounds good, that probably means that recession risk has risen significantly.
Mark Fleming - Yeah, I'd rather not take the recession, honestly. But Odeta, you're dodging, you're weaving. Care to give us a number, Odeta?
Odeta Kushi - Right. I'm sorry, my crystal ball just got little hazy, so...
Mark Fleming - How convenient.
Odeta Kushi - I know, I know. I will give, I'll give a range. How about that? We expect mortgage rates in 2025 to be between 6 and 6.5%.
Mark Fleming -That works. That's a really committed range, by the way.
Odeta Kushi - Hey, that's pretty darn good. That would still be lower than what the 2024 average is shaping up to be, which is above 6.7%.
Mark Fleming - And I seem to recall that many mortgage rate forecasts for 2025 had a 5 on the left-hand side of the decimal not too long ago.
Odeta Kushi - That's right. And I think that's really what matters here, when we talk about forecasts, is sort of the change, like how have our expectations changed? And, unfortunately, our expectations are that of higher-for-longer rates.
Mark Fleming - Agreed. And when have we heard this before? It's like the never-ending story. Covert ‘80s reference mission accomplished here.
Odeta Kushi - Ha ha! I don't know how covert that was, but you did manage to keep your streak going. And I've got to say, I love that movie.
Mark Fleming - Wait, an ‘80s reference that Odeta gets? Bonus points!
Odeta Kushi - Yes, yeah, that was the movie we all watched when we were like homesick from school, but I digress. Back to the housing forecast portion. What are you seeing based on what we just discussed for existing-home sales?
Mark Fleming - Well, even slightly lower rates and a still stronger labor market means there will be a little bit of loosening of the rate lock-in effect and a modest affordability boost for potential buyers. So, these are both good things for the sales market.
Odeta Kushi - So, a little bit more demand and a little more existing-home supply, but are you expecting existing-home sales to get back to the five-year, pre-pandemic average pace of about 5.4 million seasonally adjusted annualized?
Mark Fleming - Well, there, we may be not so lucky because the October pace of sales was 3.96 million. So, the bar is quite low to do better than in 2024 because we're at such a low level now. But we do expect progress towards a pace of existing-home sales in the low 4 million range by the end of next year. The reason for the low estimate is that still more than 80% of existing homeowners will be locked-in with rates well below 6%. So, they will continue to not have that financial incentive to sell.
And, while we do expect existing-home inventory to rise, it will still remain historically low because of this lock-in effect.
Odeta Kushi - But demand for new homes remains a bright spot, I think, which is a pretty sharp contrast with the weakness that you're explaining in existing-home sales. Builders have the ability to offer incentives, and they also have a higher inventory of new homes for sale. And I think that that supports the relative strength of the new-home market compared to the existing-home market. But, with existing-home inventory rising steadily, builders will have a little bit more competition in next year's market.
We also expect single-family home construction to steadily rise in 2025, bolstered by modest declines in financing costs for builders and buyers, and by the ongoing scarcity of existing homes due to that rate lock-in effect. So, we've covered new, existing, what about house prices?
Mark Fleming - Yes, the nexus between supply and demand. While we do expect affordability to improve, the improvement is not likely to be substantial, given our assumptions of mortgage rates above 6%. So, demand will be tempered by ongoing affordability challenges. On the supply side, existing-home inventory continues to be the primary source of overall housing inventory, and that is likely to be constrained by the rate lock-in effect, as we just discussed. Since prices are the intersection of supply and demand, we expect house price growth to stay not too hot, not too cold, but just about right in the low single digits. Though this may vary significantly by market, afterall, real estate is local. We all know that adage. And, while everyone gets the Goldilocks reference here, but to the low single-digit level of an annualized price appreciation, that's actually right in line with the long-run norm. So, it really is just about right.
Odeta Kushi - That's right. So, to wrap things up, because I've been wanting to go and rewatch Never-ending Story ever since you mentioned it, we believe that a soft landing is still possible and that the Fed will continue to cut rates next year, but maybe a little less than they initially implied in their September dot-plot projections. Lower rates should stimulate demand and supply, prompting a modest uptick in existing-home sales, though we still anticipate the new-home market to outperform due to higher inventory and builders' ability to offer incentives, such as rate buy-downs. Prices should remain relatively stable and close to historical norms, as Mark mentioned.
Mark Fleming - I'm waiting, I'm waiting for the part where you provide all the disclaimers and caveats and on the one hand on the other hand?
Odeta Kushi - Nope, you're not getting it. I've changed. This is it. This is the forecast.
Mark Fleming - No, bah humbug?
Odeta Kushi - No, but if I were to say something, it would be that a lot can change between now and 2025. Policies, geopolitical conditions, and lots of other factors that can all dictate macroeconomic trends, which then shape the housing market.
Mark Fleming - Ugh! There it is. But you know what? REconomy will be there through thick and thin to help us navigate all those twists and turns along the way.
Odeta Kushi - We sure will. We will likely revise our forecasts if we need to. So, thank you all for joining us on this episode of The REconomy Podcast. If you have an economics-related question you'd like us to feature in the future, you can email us at economics@firstam.com. And, as always, if you can't wait for the next episode, you can follow us on X. It's @OdetaKushi for me and @MFlemingEcon for Mark. Until next time.
Thank you for listening, and we hope you enjoyed this episode of The REconomy Podcast from First American. We're pleased to offer you even more economic content at firstam.com/economics. This episode is copyright 2024 by First American Financial Corporation. All rights reserved.
This transcript has been edited for clarity.