Housing-Market Warning Signs Economists Are Watching

By a number of metrics, the US housing market is frozen.

Inventory is piling up and sales volume has plunged, and the slowdown in what is a key pillar of the economy has some forecasters worried.

Existing home sales dropped 0.7% year-over-year in May. That came after a particularly sluggish April, with homes making their way off the market at the slowest pace in 16 years, according to the National Association of Realtors. The situation is worse for new home sales, which dropped almost 14% in May.

The drop in activity is raising alarms, and while most economists don’t expect the US to tip into a full-blown recession in the near or medium term, a stagnating housing market has ramifications for the wider economy.

“Housing is the quintessential leading indicator. And it’s not just about volumes,” David Rosenberg, a top economist and the CEO of Rosenberg Research, told Business Insider.

“If the housing market falls a long way, we will obviously get much lower transactions. That’s less activity for realtors and real estate agents. You tend to then also see quite big pullbacks in new construction and construction employment as well,” Oliver Allen, a senior US economist at Pantheon Macroeconomics, told BI.

Here are the warning signs that three economists said they’re watching for.

1. A 5% drop in home prices

Home prices falling significantly could open up the door to a host of negative consequences for the US economy, according to Pantheon’s Allen. That’s because lower home prices tend to dent how consumers feel about their finances.

It’s another example of the “wealth effect.” Losses on paper stemming from the value of homes or stock portfolios declining can cause consumer sentiment to sour and lead to reduced spending.

While much of the market is still seeing prices grow, home prices have declined in some markets, while increases broadly are slowing. The S&P CoreLogic Case-Shiller US National Home Price Index rose 2.7% year-over-year in April, down from the prior month’s 3.4% year-over-year gain.

Allen estimates that home prices would need to drop by around 5% before there would be a “noticeable drag” on consumer spending and make a recession a “serious concern.”

Andrew Hollenhorst, the chief US economist at Citi, said he would be worried about a recession if home prices fell for six straight months or longer. If prices were to fall for that long, it would more seriously impact people’s spending decisions, he said

Meanwhile, the trend of declining home sales translates into less spending on other things like appliances and furniture that people tend to splurge on when they buy a house.

“Every new home needs a washing machine, it needs a dishwasher. You’re going to park some cars in the driveway,” Hollenhorst told BI. “Those things will be slower also.”

Rosenberg said he believes home prices have room to fall. He pointed to the growing backlog of unsold new homes, with new unsold housing inventory now at its highest level in around 15 years, according to US Census Bureau data. The stock of existing homes for sale, meanwhile, is at an all-time record by dollar amount, Redfin said recently.

“I believe that looking at the supply-demand backdrop right now, that deflation in the housing market is in its early stages,” Rosenberg said.

2. A drop in housing investment

A decline in housing investment is the most direct way the housing slowdown could impact the economy, according to Pantheon’s Allen.

This category includes everything from housing construction to improvements and renovations to existing homes.

Residential real estate investment activity started to fall dramatically in 2022 and has stagnated in recent years. The US saw $794.4 billion in private real residential fixed investment in the first quarter of this year, down 15.6% from its peak in the first quarter of 2021, according to the Bureau of Economic Analysis.

Pantheon Macro said it expected residential investment to slow enough to subtract around 0.2 percentage points from annualized GDP growth in the second and third quarters this year.

Residential private fixed investment accounted for around 4% of GDP in the second quarter of 2024, according to an analysis from the Richmond Fed. In a briefing, central bank economists said it was one of the most volatile components of US GDP.

3. Impacts on the labor market

Economists told Business Insider that a final component of the housing story they’re watching is any impact on the labor market.

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A frozen housing market means less construction and less construction employment.

The US has around 8 million construction workers who help build $2 trillion worth of residential and commercial structures in the US each year, according to the Associated General Contractors of America.

The rate of employment growth in the sector has decreased over the past year, in line with the sales slowdown. According to the US Bureau of Labor Statistics, construction employment grew 1.5% year over year in May, nearly half the rate of growth at the same time last year.

The overall unemployment rate in the US stood at 4.2% in May, near a historic low. But Citi’s Hollenhorst says he sees signs that the labor market is growing fragile, pointing to rising layoffs and a low hiring rate among employers.

Hollenhurst says that weakness in the job market is one of the top indicators he’s watching to gauge the risk of a recession in the coming year. He said he’d become concerned about a recession if joblessness and continuing unemployment claims were to pick up.

“If you don’t have a job or you’re worried about not having a job, that’s really going to cause you to pull back on spending,” he said. “That’s what really drives a downturn.”

Pantheon’s Allen and Citi’s Hollenhorst don’t think a recession is likely. They said the economy looks more on track for a slowdown and weaker GDP growth than it’s seen in recent years, pointing to the strong levels of spending and productivity the economy has seen in recent years.

But it remains a risk on the radar, Hollenhorst said.

“These things do happen together, if you have less demand for housing, less demand for services,” Hollenhorst said. “There’s always the potential that things could end up in a more negative scenario.”