Could a real estate crisis threaten the stock market and the entire economy?

The blisteringly hot housing market is showing the first signs of cooling down. Prices have risen to levels that are unaffordable for many potential buyers and mortgage rates have skyrocketed following the US Federal Reserve’s rate hikes and a rise in bond yields.

The blisteringly hot housing market is showing the first signs of cooling down. Prices have risen to levels that are unaffordable for many potential buyers and mortgage rates have skyrocketed following the US Federal Reserve’s rate hikes and a rise in bond yields.

But will the slowdown in housing construction hurt the broader economy and cause the stock market to fall further? That is unclear.

Homebuilder Lennar, whose shares have fallen nearly 45% this year, delivered a dose of good news on Tuesday. The company reported profits and revenue that beat forecasts and said new home orders were up 4% year over year.

Lennar’s shares rose on the news on Tuesday. Rival builder KB Home, which is set to report earnings after Wednesday’s closing bell, was also inching higher.

However, Stuart Miller, Lennar’s CEO, struck a very cautious note when describing the living environment. This is a “complicated moment in the market,” he said in a earnings release.

“The weight of a rapid doubling in interest rates over six months, coupled with accelerating price increases, caused buyers in many markets to pause and reconsider,” Miller said, adding that Lennar “began to see that impact after the end of the quarter.”

Rising interest rates dampen home demand, but don’t kill it

Miller said, “The Fed’s stated determination to contain inflation through rate hikes and quantitative tightening has begun to have the desired effect, slowing sales in some markets and halting price hikes across the country.” He added adding that “the relationship between price and interest rates is being rebalanced.”

This slump is undeniably affecting the entire housing industry. Online real estate broker Redfin and several other housing companies have started laying off their employees.

Some experts are hoping that a further slowdown in housing construction will not devastate the economy in the same way that the housing bubble burst and subprime mortgage collapse did in 2008.

“Banks are in much better shape now and aren’t lending to people with bad or bad credit,” said Michael Sheldon, chief investment officer at RDM Financial Group in Hightower. “If there is a recession, the impact on housing could be small. There aren’t as many imbalances as there used to be.”

Property prices have also continued to rise in many markets despite the broader market and economic turmoil.

The National Association of Realtors said in a report Tuesday that the median home price surpassed $400,000 for the first time in May, hitting a record $407,600. That’s almost 15% more than a year ago.

But existing home sales fell for the fourth straight month, according to NAR, down 3.4% from April.

Housing construction slowdown…but not a crash

“Further sales declines are expected in the coming months as housing affordability is challenged by the sharp rise in mortgage rates this year,” said NAR chief economist Lawrence Yun.

“Nevertheless, reasonably priced real estate is selling fast and inventories have yet to rise significantly…to moderate the rise in house prices and give home buyers more options,” Yun added.

But that doesn’t have to mean that prices will suddenly fall — home demand is still holding up quite well. The problem is affordability.

“We think the housing market is beginning to mimic the late ’70s to early ’80s when price growth stalled but didn’t collapse,” said Brett Ewing, chief markets strategist at First Franklin Financial Services, in a report.

But many prospective buyers – especially younger people who want to make the leap from renting to home ownership – cannot afford to own a home.

Still, many current owners who are selling a property in order to exchange it and buy another home can make deals. So while the housing market is starting to show cracks, the fundamentals remain relatively strong. It may take a much larger hike in mortgage rates to deter potential buyers for good.

“The average home was on the market for just 16 days in May, setting a new record low for this measure,” Jefferies economists Aneta Markowska and Thomas Simons said in a report Tuesday after the release of existing home sales data.

“This suggests that supply is still tight and new stock being launched is still moving very quickly,” they added.

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