By Dr. Ralph G. DeFranco

The only thing that can be said with certainty is that everything changes.

Even though uncertainty is a given, here are a few predictions on how I see the housing market evolving during 2019 – along with my one wish for the new year.

1. Home prices will increase, with only minor exceptions. A housing shortage coupled with a strong job market should keep the current housing market slowdown from getting out of hand. It follows that since the strong economy is widespread, home price growth is likely to be widespread as well, even in the face of rising interest rates. While the national average home price is likely to increase 2 percent to 5 percent next year, regional home price changes will vary widely based on local supply and demand conditions. Areas likely to do well include retirement areas near water and metros popular with professionals and foreign buyers, such as coastal international hubs. At the other extreme, some limited and short-lived price declines would not be surprising as housing markets rebalance and adapt to higher interest rates. The areas most at risk of price declines are the extremes in both directions: metros with the hottest markets in recent years, some of which may have gotten ahead of themselves, and regions that already have relatively weak housing markets, including both legacy industrial centers and economies dependent on energy extraction, such as Alaska, North Dakota and West Virginia.

2. Millennials drive the hottest markets. The most rapid home price growth is expected to occur in the areas most desirable to Millennials. These include neighborhoods in, or close to, downtowns and vibrant areas near universities. It is worth noting that these areas have done better than average in recent decades. That has been true during both booms and busts, at least in “magnet” cities that are attracting workers from other areas, such as Washington D.C., Seattle and Denver. This trend continued in 2018, with above-average home price growth in the ZIP codes with the most Millennial buyers. This makes sense, given that Millennials now dominate the first-time homebuyer market.

3. Credit risk will increase. Lending guidelines may continue to gradually loosen (and yet still remain vastly better than during 2005–2008 thanks to the stricter regulations that were put in place after the housing market collapse). When you combine more relaxed guidelines with the trend to higher debt to-income ratios and loan-to-value ratios, which is mostly driven by worsening affordability, it’s easy to see why credit risk will continue to increase.

On top of that, credit risk from economic factors may be higher since some forecasters are starting to think we could be in or close to a recession in 2020 due to the way current tax and spending laws are structured. One implication of any loosening at the margins would be increased housing demand (all else remaining equal), particularly for starter homes.

4. Housing affordability will continue to worsen. Both interest rates and home prices are forecasted to increase, hurting affordability. With unemployment at peacetime historic lows and the tax cut adding an oddly timed and only temporary stimulus, the Federal Reserve needs to continue raising interest rates. For one thing, the inflation rate is expected to trend upwards (wage growth increased from 2 to 3 percent over the past year and makes up the majority of product costs). Even though higher interest rates reduce home sales, modest increases in mortgage rates are not as apocalyptic for housing as many believe. Rising rates historically only caused temporary, mild slowdowns in home sales, ranging between 5 to 10 percent.

The potential implications of higher interest rates in 2019 include the following scenarios:

• Total originations fall due to fewer refinancing loans.
• Longer loan life. Loans with low mortgage rates will stick around on investors’ portfolios longer than usual.
• Fewer trade-up home sales, keeping inventory tight. This will negatively impact home ownership rates, affecting Millennials the most.

5. No bursting housing bubble. Why? Because there is no widespread housing bubble. The typical warning signs--excessive debt levels, poor quality loans, exponentially increasing home prices, rising vacancy rates and a high number of internet searches on house flipping--are not present. The one warning sign flashing red at the moment is poor affordability compared to the past in many metros. But the trend of firms to concentrate in denser cities, together with interest rates lower than the historical average, suggests that high home prices are more supportable than 10 years ago. Last, my 2019 housing wish is for more construction of entry-level homes. The demand is certainly there and the high end of the market is fairly saturated (as suggested by much slower home- price growth in recent years).

About the Author: Dr. Ralph G. DeFranco is the global chief economist for Arch Capital Services. This article first appeared in the winter edition of “The Housing and Mortgage Market Review” from Arch Mortgage Insurance Company.