What Is a Market Correction & How Can It Affect Real Estate?

Listings inventory is on the rise. Home prices are going down. Homes are selling less and less. Is a full-blown market correction in the works?

Five financial experts from the Federal Reserve Bank of Dallas published a report that caused a bit of panic at the end of Q1 2022. Real-time data showed them signs of an impending correction.

Their evidence pointed to “abnormal U.S. housing market behavior” in a way they had not seen since the early 2000s housing boom. The Dallas Fed cited several factors as their causes for concern, including price-to-rent and price-to-income ratios. 

Their conclusion: house prices seemed more and more out of whack with economic fundamentals. 

Then on May 24, 2022, the U.S. Department of Housing and Urban Development along with the U.S. Census Bureau reported a 16.6% decline in new home prices in April versus March, a two-year low. Notably, home prices fell for the fourth consecutive month—even though home sales typically pick up in April. 

In the same month, Moody’s Analytics said a housing market correction was in full swing. But has US real estate reached correction market levels?  

Some real estate pundits agree while others disagree. Here’s how you can figure out what’s really happening—starting with what a market correction really is. 

What Is a Market Correction in Real Estate?

Corrections in the housing market are characterized by a sustained drop in home prices over several months, as opposed to seasonal price drops. The home price index falls 10% or less from its peak within a year. 

Market correction history reveals that it tends to end a real estate boom and herald a market adjustment when house prices decline in many regions. Home price growth may flatten year-over-year, it takes longer to sell a home, and listings inventory rises. 

Even so, a correction in the market is not the same as a real estate crash.   

What Is the Difference Between Market Correction and Market Crash?

In a correction market, buying and selling prices return to more normalized levels. The price drop is not dramatic and sudden, as in a crash. It is gradual, often playing out over six months. 

In addition, a market correction is marked by a significant drop in home sales, causing homes to remain on the market longer. Prices become more stable as supply and demand balance out. Bidding wars reduce, so homes sell at or below their original listing price. 

Yet, a big indicator of the next market correction is often when home prices fall by up to 10% from their peak within one year. In contrast, a real estate market crash occurs when prices drop over 20% from their peak in the same year.    

So, how can you tell when a market correction or crash is impending, in full swing, or subsiding?

Real Estate Market Correction 2022: 9 Signs of a Market Correction

Corrections in the market are quite common. But any unseasonal and persistent changes in the following signs may signal trouble. Many factors include some warning signs that led up to the last crash.

1. The Number of Home Sales Is Falling

This is a big sign. Sales may decline due to high home prices, high mortgage rates, and economic uncertainty. There may be fewer buyers prepared, willing, or able to purchase a home. A pattern like this may also suggest that many prospective buyers who can afford to buy already did.

In March, sales amounted to 709,000 new single-family homes. But only 591,000 (444,000 on a seasonally adjusted annual rate [SAAR] basis) homes sold in April, much lower than the expected 809,000. 

For the fourth month in a row, new home purchases failed to meet expectations.

Also, existing home sales, or home resales, were down 5.9% year-over-year (2.4% seasonally adjusted), making it the lowest level since June 2020 during the COVID-19 imposed slowdown.

Further, pending home sales, which are signed contracts to buy existing homes, fell nearly 4% in April compared to March, and 9% year-over-year, according to the National Association of Realtors.

One possible reason for the decline in home sales is the higher rates. In 2021, monthly home loan payments were only up about $100. But in May 2022, as prices rose another 21% and mortgage rates jumped to 5.5%, monthly payments pushed up to $1,991.

That is an increase of around $800 per month over its 2019 level. As a result, higher rates, which have increased by 75% in the past several months, have made it more difficult to buy homes for investors and homebuyers.

Related: 7 Best Ways to Find Motivated Sellers

2. Listing Inventory in Active MLS Listings Are Increasing Steadily

A rise in inventory may indicate that homebuyers and investors have slowed down or stopped buying for various reasons—high home prices, higher living costs, higher interest rates, or a slowing economy.

Is This Sign in Effect Now?

According to Realtor.com, as of May 2022, inventory in the 50 largest U.S. metro areas rose 14.9% from a year earlier. Out of the 50 largest US metropolitan areas, 42 had an increase in inventory. 

It is common that buying activity decreases during a market correction, resulting in an increase in home supply. Yet, this is not always the case.  

For example, sellers listed new inventory more rapidly in May 2022 than at any other time since June 2019. This may have been due to sellers’ fears of missing out on a good deal during the housing boom that has lasted for 121 consecutive months.

This rush may indicate that sellers are worried that the market is headed for a correction. So, they want to take advantage of the hot market before it cools.

Yet, the US Census Bureau reported a nine-month supply of homes in April. A six-month supply signifies a balance between buyers and sellers, so the news may suggest a market adjustment favoring buyers.

Moreover, the National Association of Realtors reported more than 1.03 million homes for sale in April 2022, an increase of 100,000 from April and about 180,000 more than in all three previous months.

Meanwhile, other sources report that inventory is down to 2.2 months from 2.3 months the previous year.

Related: An Investor’s Guide on How to Access MLS Listings Without an Agent

3. Homes for Sale Are Taking Longer to Sell

There are similar reasons for homes spending more time on the market as discussed earlier (high prices, high interest rates, or a slower economy). Even though newly listed homes might increase inventory sometimes, they shouldn’t increase days on the market significantly, especially when there is a high demand for homes. 

Is This Sign in Effect Now?

In May, homes were on the market for 31 days. According to Realtor.com’s data, they sold six days faster than last year. It may indicate that while the market may cool, demand remains strong compared to previous years. 

Also, depending on the market, homes selling this fast may indicate that US markets today may take a while to feel a real estate correction—if at all.      

4. Listing Prices Are Beginning to Stabilize—Or Fall

As more buyers become hesitant for a variety of reasons, listings increase, resulting in a saturated market. Listing prices tumble. 

Is This Sign in Effect Now?

According to Redfin, approximately one in five sellers lowered their home prices in April. That was the most significant drop since October 2019.

Realtor.com found that 10.5% of homes for sale in May had reduced prices, compared to 6.2% a year ago. But even this was still 6.2 percentage points below the average for 2017-2019, before the pandemic. 

The proportion of price cuts in the nation’s 50 largest metro areas in May increased from 40 to 49. 

Clearly, prices are stabilizing. 

5. Growth in Home Prices Is Slowing Down to 0% Year-Over-Year

As home sales decline, inventory increases, and homes take longer to sell, sellers reduce home prices further to attract buyers. This slows or flattens price growth. 

Is This Sign in Effect Now?

By the end of May 2022, prices remained high, with double-digit price growth expected to continue. According to Realtor.com, median national home prices reached a record $447,000 in May, up 17.6% from April. 

In comparison, price growth averaged 18.8% in 2021, according to the US National Home Pricing Index by S&P CoreLogic Case-Shiller. So, similar to the days on the market sign, this indicator isn’t raising alarms in the American market.

6. The Number of Mortgage Applications Is Dropping

Because people are buying less during a market correction, fewer people apply for home loans. 

Is This Sign in Effect Now?

The Mortgage Bankers Association reports that mortgage applications have continued to decrease since January 26, with a slight uptick in the first two weeks of May 2022. 

This waning interest may be explained by rising mortgage rates, which have increased over the last seven months and reached 5.46% on average for a 30-year fixed-rate mortgage as of Jun. 3, 2022, according to Bankrate.

7. Building Permit Applications Are Declining

Building companies don’t want to be stuck with inventory when a correction occurs. When they are not confident that their inventory will sell, they reduce construction activity.

Is This Sign in Effect Now?

While building permit applications continued to fall in the first five months of 2022, US homebuilding remained relatively high. In April 2022, multifamily permits fell the least at just 1.0%, single-family permits fell 4.6%, and apartment permits (five-unit properties and more) declined by just 0.6%.  

The number of house completions fell 5.1% to 1.295 million units, with single-family units declining by 4.9%. Multifamily unit completions fell 6.6%.

8. There Are Growing Concerns About the Economy, the Stock Market, and Overvaluations of Homes

The market news today is less rosy than before. Despite a 3.6% unemployment rate, the cost of living continues to climb, with the Consumer Price Index (CPI) rising to 8.3%.

Is This Sign in Effect Now?

The stock market has also experienced some turmoil, with May 2022 recording the biggest drop in a year. For example, the S&P 500 was down 20% since the start of 2022 as of May 23. Some believe the next market correction, or even a bear market, is in the offing following an extended bull market.

Moody’s Analytics estimates that 96% of the US market is overvalued relative to local incomes. Mark Zandi, the chief economist at Moody’s, said such markets are likely to be vulnerable to a market adjustment.

9. The Number of Foreclosures and Mortgage Defaults Is Increasing

The last market crash had a massive impact on the broader economy, resulting in job losses, lost incomes, and ultimately, foreclosures and mortgage defaults.

Is This Sign in Effect Now?

There haven’t been alarming foreclosures and mortgage defaults in 2022. 

Still, some analysts worry that a huge time bomb lies beneath the swell of delayed foreclosures and delayed payments relating to COVID-19 programs.

In addition, those who secured historically low mortgage rates are reluctant to enter a hot market. They worry they would spend a lot of money to find another good home. They are also concerned that they might bear the risk of a much higher interest rate, thus increasing default risk.

So, Is the Market Due for a Correction?

The above signs suggest that the US housing market may not experience a full-blown correction or market crash in 2022. 

Some investors believe a full-blown price correction won’t occur until 2023 or 2024—if it ever does. It will take the tax reforms longer than a year or two to negatively impact the housing market, they say.

Is the Market Going to Crash?

Despite widespread price drops, rising listings, and declining sales, there are no strong indicators that the next real estate market correction or crash will occur in 2022. Instead:

• Increased mortgage rates may help reduce home and rent prices to a reasonable level, thus cooling the housing market. This might not seem like good news for investors, but it could result in more people considering purchasing a home again, helping revive the market.
• Regulations are in place to prevent unethical appraisals, home loans, and other fraudulent practices that led to the US housing market crash in 2008. This could help minimize shock to the broader economy once the housing market cools, allowing the housing sector to rebound.
• Slowing home sales stem from rising mortgage rates—not from fewer or unwilling homebuyers and investors. So, the feds could lower interest rates to encourage more purchases if the cooling threatens to turn into a crash. 
• At the same time, a shortage of new and existing homes is likely to sustain high prices for some time.
• The Fed is trying to lower inflation so people can afford home loan payments.
• The number of new home constructions has increased since February, which may help balance demand and supply and thus prevent overvaluations or record-high home prices.
• Despite a decline in pending home sales in the last few months, homes are still selling faster than in the previous three years.
• Low local unemployment means tenants can pay their rent and may even consider buying a home.

These are just a few indicators that the US housing market might not crash soon. Still, some economists believe a correction will be felt over the next year or longer. How will this affect real estate investors like you?

What to Do as a Real Estate Investor in a Correction Market

It is impossible to know with certainty whether or not a market correction will occur, when it will reverse, how long it will last, and whether it will lead to a housing market crash. 

Still, a market correction is a good time to act to shield yourself from losses in case of an actual crash in the housing market.

If it comes to it, here are just some ways you can protect yourself as a real estate investor in a correction market: 

• Monitor your rental cash flow and let it guide your investing decisions. Use a rental property calculator. Are you satisfied with the property’s cash flow, cash on cash return, and occupancy rate? What if its value drops temporarily, but the rent remains the same? Will you still be satisfied with the property?
• By adding rental properties to your portfolio, you can improve your cash flow in case of a market correction.
• Focus on the local unemployment rate and the economy if you are interested in rental income opportunities. You want to find signs that tenants can afford to rent and are not likely to leave in droves and create vacancies. 
• Ensure your market’s rent isn’t already overpriced. Otherwise, it could fall in a correction, affecting your cash flow.
• Buy a property that you can improve later or sell as-is to make it more affordable.
• As much as you can, take advantage of market corrections by buying properties and then selling when you think you will get a good ROI.
• It may be worthwhile to purchase Guaranteed Rent Insurance to replace lost rental income if the tenant cannot pay.

What to Do as a Real Estate Investor in Case of a Market Crash

Take these proactive steps to protect your real estate investment portfolio during a housing crisis:

• Protect what is profitable in your portfolio by selling what isn’t worthwhile when cash flow is negative or default risk is high.
• If you are going to sell a property, consult a tax expert to ensure that you won’t have to pay a hefty tax on it (capital gains taxes on profits).
• If you’ve been saving money or still have good cash flow, stock up on real estate investment properties while prices are down.
• During the slow period, focus more on purchasing older properties that you can renovate and rent out or sell at an affordable price while earning a profit. During and after a financial collapse, most people won’t buy the best property in the neighborhood.
• Increase your cash flow by renting out properties, which can safeguard against having to sell a property that has accumulated considerable equity.
• Consider selling a property that isn’t generating cash flow as-is. Reinvest the savings in more affordable properties when the market eventually rebounds.
• Look into affordable housing options, like multifamily real estate investing. When people cannot afford to buy single-family homes, they usually end up renting instead.

Related: Multifamily Deal Analyzer—A Must-Have Tool

What’s Next: Make Money in a Market Correction With Mashvisor

The signs are positive for now. But no one can predict with absolute certainty when or if the US housing market will correct itself. In any case, there are several ways to protect yourself, such as those mentioned above.

Even better, you can use a reputable investment property finder to pinpoint the best investment property for your specific needs. In a market where prices could soften at any point, you want to have the right information at your fingertips before putting money into a property. That insight includes:

• Investment strategy (including traditional or short-term rentals)
• Budget
• Cash on cash return goal
• Cap rate target
• Listing price
• Location
• Rental income
• Occupancy rate   

With Mashvisor, you get access to predictive analytics, real-time market information from multiple MLS listings, local real estate expertise, and a tool that lets you compare up to ten properties at once. 

Whether you’re looking for rental income opportunities, fixer-uppers, or single-family homes for sale, you can use this information to pick the right investment properties in any market conditions.

Click here to start your 7-day Mashvisor trial. It’s free. Plus, you’ll get a 15% lifetime discount.