What Happens in a Recession to House Prices?

With the economy shrinking for a second quarter in a row, the U.S. is in recession, according to a common definition, although President Joe Biden denies it.

For aspiring home buyers, that means that home prices, which have skyrocketed in the past 12 months, are now likely to finally start falling, according to experts. But price drops might not be as significant as a recession would suggest.

The way the housing market reacts will depend on what kind of recession it will be, Managing Director at Fitch Ratings Kevin Kendra told Newsweek.

"Clearly we had a recession following the financial crisis [2008-2009] that was driven largely by the housing overvaluation," said Kendra.

U.S. home prices fell by over a fifth on average from the first quarter of 2007 to the second quarter of 2011.

"So what happened to home prices in the recession following the financial crisis will be different than what happened with home prices following other recessions that might have been triggered by other mechanisms, by a general slowdown in the economy, for example."

So the question we should ask ourselves, Kendra said, is what type of recession are we going to be in and what's triggering that? And how will that potentially impact on home prices?

"When we think about it from that perspective, I would say that we're probably more likely to be going into something that is a 1990s-type of recession where there was a broad downturn in all sectors, it wasn't concentrated in one particular area," Kendra told Newsweek.

"I think there's a general slowdown in the economy that is broad across many sectors and broad across almost all regions. I think that type should have a dampening [on home prices], but it shouldn't have a severe drop in home prices. So I think that it would be a manageable lowering of home prices."

This slowdown of the housing market has already started.

For the past two years, the housing market has seen an incredible surge in demand boosted by low interest and mortgage rates during the pandemic, while supply remained limited.

This combination fueled home prices, which have since become unaffordable for many, especially first-time buyers. This year, mortgage rates reached their highest level since 2008—the time of the U.S. Great Recession and the housing crash—pricing out buyers.

Now, the pandemic-era housing boom is finally showing signs of slowing down.

Sales of new homes have plunged for the fifth time this year in June, at the same time as consumer confidence crashed to its lowest level since February 2021. Sales of existing homes also plunged by a dramatic 5.4 percent in June compared to May, falling for the fifth consecutive month this year.

But home prices have yet to start falling.

"Home prices are still going up or still holding strong, even though we've been in a rapidly rising rate environment. So much of the home price story is about supply and demand imbalance, and that still hasn't gone away," Kendra said.