The church is in the condition that it is because we no longer understand, believe in, or require the new birth. (John 3)
When God saves people, He does it to conform them to the image of His Son. (Romans 8:29)
When His true children rebel, he will chasten them, not allowing wickedness to continue. Hebrews 12:6, 1 Cor 11:29-30
But churches want to follow the American model of success: Numbers, money, programs, etc.
So they compromise on requiring members to be born again.
I believe most pastors are unregenerate. They are like Nicodemus, teachers in Israel and don't know these things.
House churches: Spoken of in Scripture, I believe they can be good or bad. A church of the Lord Jesus Christ is a place where the gospel is rightly preached and heard, the ordinances are rightly practiced and church discipline takes place. I would agree with your friend Martin Luther and the Augsburg Confession on that. (Although we would disagree on his practice of baptism - which I would say fosters the idea that people are saved without the new birth, but that is for another discussion)
May the Lord bless him, if this is what God is calling him to do. There are times when you must leave your church, however if this man doesn't understand/have the new birth - his house church will quickly fill up with unregenerate people and repeat the mess we have now in American churches as they seek to build a building, grow and have music and programs that will appeal to unregenerate people.