Economists say “fundamental” economic factors, such as interest rates and household income, determine house prices. For some unknown reason, economists don’t consider people’s expectations for future house prices to be a fundamental factor determining current house prices–but they should. 

Economists have done a ton of research on this general idea. Unfortunately, they call it a ton of different things–which is very confusing. The general idea has been called: price expectations, price extrapolation, biased expectations, adaptive expectations, diagnostic expectations, irrational exuberance, learning from prices, momentum trading, and other names.

Despite all the different names, the idea seems obvious: If you expect house prices to be higher in the future, you are, naturally, less willing to sell now, more willing to buy now, and more willing to pay above the current market price for a house. That expectation causes house prices to go up even more rapidly, which causes people to become even more confident prices will continue to go up, so prices continue to go up, and so on in a feedback loop. To some degree, higher prices lead to higher prices.

If you expect house prices to be lower in the future, you’re more willing to sell, less willing to buy now, and less willing to pay current market prices for a house which creates a negative feedback loop of lower prices leading to lower prices. 

It’s not just house buyers and sellers who are affected. When prices go up lenders also tend to extrapolate the increasing prices and their increasing profits out into the future, and in turn, they may become more willing to lend money leading to more money chasing houses, higher house prices, and so on in another feedback loop. 

This is the opposite of standard economic thinking. Higher prices are supposed to reduce demand. It’s true higher prices will reduce demand in the long run–but if higher prices make people think prices will go even higher in the near future, higher prices can cause demand to increase in the short and medium run. The reverse happens with falling prices.

Perhaps that’s why economists don’t call price expectations fundamental: It’s just too hard to explain that, with houses, the secondary effect of price changes (their impact on future price expectations) can sometimes temporarily overpower their textbook effect.

The point is, whether prices are moving up, down, or sideways, many people will expect the current price trend to continue into the future and those expectations can be a big part of the current demand for houses.

The fundamentals

Mortgage rates are one of the most fundamental of all housing market demand drivers. When you’re borrowing for 30 years with a small down payment, mortgage interest rate changes have a huge impact on your monthly payments. Starting in late 2018, mortgage rates fell for two years, driving down monthly payments and driving up house prices. Changes in the other fundamentals caused by the pandemic further stoked the demand for houses.

Interest rates stopped falling in January 2021. Stimulus checks ended in early 2021. The work-from-home movement was old news by then too. Nevertheless, house prices continued to skyrocket until May 2022.

Many investors who had made a ton of money on house price appreciation doubled down, borrowed as much money as they could, and bought more houses. Many potential live-in homeowners wanted to buy before prices increased even more, fearing they might be priced out of home ownership forever.

House prices continued to rise in 2021 and 2022–in large part because people expected them to continue to rise even though many of the underlying fundamentals were no longer bullish.

Many people were just extrapolating out the past price increases. We probably had a lot of herd instinct kick in as well, “Everyone’s offering tens of thousands of dollars over list price, you have to too!”.

The future

Then in 2022, mortgage rates skyrocketed. The music stopped and the punch bowl was taken away. House prices leveled off. Expectations for future price increases started to shrink. Today, the future-price-expectations part of demand is a lot smaller than it was last spring and it will continue to fade as long as prices aren’t increasing.

The takeaway is that demand will continue to fall for many months–regardless of mortgage rates–because people are slowly lowering their expectations for future house price increases. Housing demand is falling along with the expectations for house price increases in the future.

Another round of Fed rate increases would cut demand immediately in addition to the fading demand from falling expectations for future prices.

Median house prices have already started to fall in several cities, such as Phoenix and Boise. If prices fall enough for long enough, and enough people start to expect prices to continue to fall in the future, that would change the game entirely. It would create a new feedback loop but this time a negative feedback loop: lower prices leading to lower prices.

It seems extremely likely that many house buyers’ tune will change from last year’s, “Let’s buy ASAP” to “Let’s wait and see.” 

In addition, some potential house sellers will slowly become more interested in selling when their second home or rental property is no longer appreciating more in a year than they make at their full-time job.

The future price expectations part of demand will very likely fade for a year or two–maybe two or three. Things would get rough if on top of that we also got a recession cutting housing demand.

John Wake is an independent real estate analyst.

The opinions expressed in Fortune.com commentary pieces are solely the views of their authors and do not reflect the opinions and beliefs of Fortune.

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