Current Factors Influencing Home Prices
Home prices have seen extraordinary growth due to the pandemic. Increased demand, rising building costs, and long-term supply constraints have all played a part. Let's break down these factors influencing home prices.
Market Disruptions
Pandemic-related disruptions such as increased demand and rising building costs are major contributors. The Case-Shiller U.S. National Home Price Index shows an increase of 18.6% over the last 12 months—a record growth rate. Additionally, asking rental prices initially fell but have since recovered, now exceeding pre-pandemic trends, according to the Zillow Observed Rental Index (ZORI).
Demand Factors
Work-from-home arrangements and increased mobility heightened demand. People fled city centers for suburbs, causing churn in the housing market. Home mortgage rates plummeted to all-time lows, making borrowing more affordable. However, the catch-22 here is the inventory of homes declined by over 50% since February 2020, as per Redfin data.
Supply Constraints
Local zoning restrictions and limited affordable housing have been long-term constraints. Add in pandemic-driven supply issues, and you've got skyrocketing costs for key commodities like lumber and steel. Lumber prices hit a 114% increase year-on-year by May 2021, though there was a slight reprieve with a 20% decline between June and July.
Inflation Dynamics
Despite these spikes in home prices, they have contributed less to overall inflation. This anomaly is mainly due to how shelter costs enter the Consumer Price Index (CPI). Shelter makes up nearly a third of the CPI basket but hasn't mirrored the rise in home prices. Instead, owner's equivalent rent (OER) captures the implicit value that homeowners get from living in their homes. Essentially, it's more about the service a home provides, not its investment value.
Rental Market Trends
During the early pandemic days, rental prices saw an unusual decline. Many people moved out of cities, either returning to their family homes or opting for more suburban and rural areas due to remote work possibilities. This migration led to a sudden drop in demand for rental properties in urban centers.
The recovery of rental prices was noticeable. By the end of 2021, ZORI data indicated that rental prices had not only recovered but had also surpassed pre-pandemic levels. This recovery was fueled by:
- The return of some of the urban migration trends as people sought to enjoy urban amenities again.
- A notable decrease in rental inventory, as many landlords converted properties to other uses or sold them due to the initial low rental demand. This reduced supply helped prop up rental prices as demand started to return.
These rising rental prices interact significantly with CPI inflation data. The Consumer Price Index, which measures the cost of a basket of goods and services, includes rent as a substantial component. Given the significant weight of rent within the CPI, fluctuations in rental prices can markedly influence the overall inflation figures.
The CPI's shelter component includes both rent for current tenants and the owner's equivalent rent (OER). The latter estimates the rent homeowners would have to pay if they were renting their homes, reflecting the service value of housing rather than its asset value. As rental prices, as tracked by ZORI, increase, this indirectly affects the OER and hence the overall shelter component of CPI.
Projections suggest that as rental prices stabilize or continue to rise in response to demand and supply dynamics, the CPI will reflect this through increased shelter costs. This impact could contribute several basis points to overall inflation, given the significant weight of shelter in the CPI basket.
The Relationship Between Housing Prices and CPI Inflation
The relationship between housing prices and CPI inflation involves several layers of economic indicators and methodologies. To understand this relationship, it is essential to grasp the CPI's 'rental equivalent' methodology, which plays a crucial role in how housing market dynamics influence inflation data.
The Consumer Price Index (CPI) aims to measure the cost of living by tracking the prices of a basket of goods and services that households typically purchase. Within this basket, shelter costs constitute a significant portion—almost a third of the total index. However, unlike other consumer goods, housing presents unique challenges due to its dual nature as both a consumption good (shelter) and an investment asset.
To address this complexity, the Bureau of Labor Statistics (BLS) employs the 'rental equivalent' approach. Instead of using the actual purchase price of homes, the CPI includes the concept of owners' equivalent rent (OER). OER estimates what homeowners would pay if they were renting their homes, focusing on the consumption value of housing services rather than its asset value. This method differs from pre-1983 practices, where CPI calculations included mortgage rates, property taxes, and maintenance costs, closely mirroring actual home prices.
The shift to the rental equivalent approach in the early 1980s significantly altered the correlation between housing prices and CPI: Shelter. Post-1983, because the CPI started to measure only the consumption value of housing through OER, the direct linkage weakened.
This change means that even when home prices surge—as seen during the pandemic with an 18.6% increase in the Case-Shiller Index—the corresponding rise in CPI: Shelter is less pronounced and delayed. Historical data indicates that a 1 percentage point increase in housing prices now leads to only about an 11 basis point increase in CPI: Shelter, emerging roughly 16 months later.1
The impact of rising home prices on overall CPI inflation is cushioned because OER is a hypothetical construct. It is based on survey data from homeowners estimating the rental value of their properties rather than hard transaction data. Consequently, the sharp rise in home prices since the pandemic has not caused an equivalent spike in the CPI. Inflationary pressures have been more muted, appearing gradually as rental markets adjust and OER captures these dynamics over time.
However, these higher housing costs are likely to manifest more clearly in CPI data down the line. As rents rise—whether due to recovering urban demand or reduced inventory—the CPI's shelter component will reflect this, potentially adding several basis points to overall inflation. This delayed impact serves as a buffer, ensuring that CPI inflation remains somewhat stable and predictable, despite volatile housing markets.
Understanding this relationship and the methodology behind it helps demystify why, despite significant home price increases, the CPI only shows incremental inflation. It's a fine balance between accurately gauging cost-of-living changes while tempering the swings inherent in asset markets. As we continue to monitor these trends, it becomes evident that while home prices are a key economic indicator, their translation into everyday inflation metrics involves a complex, methodical process finely tuned to capture the true essence of consumer experience.
Future Predictions for the Housing Market
Analyzing expert predictions for 2024 and beyond reveals a multifaceted outlook driven by various economic, demographic, and political factors.
Home Prices and Sales Trends
The National Association of Realtors (NAR) and Fannie Mae provide optimistic yet cautious forecasts for home prices and sales. Despite the steep climb witnessed during and just after the pandemic, home prices are expected to increase more gradually in the coming years. The NAR expects the median existing home sales price to rise to $390,000 by the end of 2024, marking a 1.8% uptick from 2023.
This incremental growth aligns with historical patterns where real estate markets stabilize following periods of rapid appreciation. For instance, home prices from 2025 to 2028 are projected to expand at a more moderate pace, about 1% above the inflation rate annually.2 While prices will continue to climb, the market won't see the runaway growth of the past few years.
Sales of existing homes, having rebounded from 2023 lows, are predicted to follow suit. Prospects for new home sales are even brighter, supported by an expected fall in mortgage rates and a sustained demand backlog. New single-family home sales could see a cumulative increase, with 680,000 units projected for 2024 and 750,000 units by 2028.
Rents and Rental Market Trends
Rents, like home prices, are also forecasted to rise, but at a slower rate. The stabilization seen post-pandemic is expected to continue as new multifamily units come online, increasing supply and tempering rent hikes. Single-family home rents, in particular, might see faster growth compared to multifamily units owing to the burgeoning Build-to-Rent movement, predicted to command more interest.
By 2028, median single-family home rents are expected to hit $2,380, up from $2,146 in 2023. Multifamily rents, impacted by abundant new supply, will see slower growth, with predictions of $1,970 from $1,840 within the same period.
Mortgage Rates and Financial Dynamics
Mortgage rates are vital for gauging future market dynamics. The current high rates have been a barrier for potential buyers, but experts foresee a gradual decline. While a return to pre-pandemic lows is unlikely, rates are expected to stabilize around 5% by 2028, creating more favorable conditions for homebuyers. However, should rates drop too rapidly, this could spark another surge in demand, driving prices up again and counteracting the effect of increased inventory.
Economic, Demographic, and Political Factors
Several overarching factors could influence these trends:
- Economic Factors: The broader economic outlook heavily impacts real estate trends. Economists project slower GDP growth compared to the robust post-pandemic recovery phase. Persistent inflation, although expected to moderate, will keep a lid on rapid economic expansion.
- Demographic Shifts: An aging population and Millennials entering peak home-buying years will continue to drive demand. However, intergenerational living arrangements and pooling of resources to purchase homes might become more common as affordability challenges persist.
- Political and Policy Influences: Government policies on housing, tax incentives for builders, and regulations on lending rates remain critical. Legislative measures to boost affordable housing supply can shape market dynamics significantly. Geopolitical events such as global conflicts or significant shifts in foreign policy could impact investor confidence and economic stability.
Pre-pandemic, housing markets exhibited more stability with steady yet modest growth rates. The frenzy triggered by pandemic-induced demand shocks is gradually subsiding. Experts anticipate that the market will return to a more normalized state—characterized by moderate price increases, steadied sales figures, and stabilized rent levels.
For first-time buyers, navigating this landscape will still be challenging due to high prices and relatively stable interest rates. However, a more balanced approach to growth brings a semblance of predictability and better planning opportunities for prospective homeowners and investors alike.
While the future housing market is fraught with variables, expert predictions point towards a gradual stabilization with continued growth. The interplay of economic resilience, demographic trends, and policy measures will determine how closely the market's trajectory aligns with these projections. Staying informed and adaptable will be crucial for anyone engaged in real estate, whether as a buyer, seller, or investor.
Regional Variations in Housing Trends
Regional variations in housing trends provide a complex and nuanced picture of the U.S. real estate market. While broad national trends offer a general outlook, regional specifics reveal much about the underlying dynamics driving housing prices and sales.
The fastest-growing home prices are often found in regions experiencing significant migration inflows. For instance:
- Austin, Texas: Home values surged by as much as 43% since March 2020 before seeing a slight correction due to the overheated market.
- Boise, Idaho: It has become one of the nation's most competitive real estate markets, with an influx of remote workers and retirees.
Conversely, cities like San Francisco, New York, and Chicago have experienced slower growth or even declines in home prices. San Francisco, in particular, saw a slight drop due to its already high prices and an exodus of residents during the pandemic seeking more space and lower costs. This shift underscores the interplay between work-from-home policies and housing demand.
Migration patterns are a key driver of these regional differences. People have been moving from high-cost, densely populated urban areas to more affordable, spacious regions. This migration has been accelerated by the pandemic, which showcased the feasibility of remote work. States like Texas and Florida have benefited greatly from this trend. The relatively lower cost of living and favorable tax policies in Texas have made cities like Dallas and Houston attractive to new residents.
Local economic conditions also play a crucial role. Areas with strong job markets and growing industries tend to see higher home price growth. The tech boom, for example, has markedly influenced housing markets in cities like Seattle and Denver. Conversely, regions dependent on industries that have struggled during the pandemic, such as tourism-reliant cities, have faced challenges. Las Vegas, for instance, saw its housing market cool off after the initial surge due to the impact on tourism and hospitality sectors.
Unique regional challenges further illustrate this complexity. Coastal cities face issues related to high population density, limited land for new construction, and stringent zoning laws, driving up housing prices. Inland areas might struggle with different problems such as lower economic growth and less attraction for new residents.
The interplay of these factors creates a diverse real estate landscape across the country. Regions experiencing growth reflect broader trends such as migration and economic resilience, whereas areas facing declines highlight the challenges of urbanization and economic transition.
Understanding these regional variations is essential for prospective buyers and investors to effectively handle the housing market. By analyzing how migration patterns, economic conditions, and regional peculiarities influence housing trends, stakeholders can make more informed decisions that align with both national narratives and local realities.
House prices will continue reflecting these intricate dynamics, emphasizing the importance of localized market knowledge in an ever-changing real estate landscape.
In summary, various factors continue to shape home prices and rental trends post-pandemic. Understanding these dynamics helps handle the housing market more effectively, offering insights into future projections and regional variations.
- Glick M, Lansing KJ. Housing demand and remote work. FRBSF Economic Letter. 2022;(11):1-5.
- National Association of Realtors. Housing market forecast: what's ahead in 2021. National Association of Realtors. Accessed January 17, 2021.
