The US Home Price Index saw unprecedented growth from mid-2020 thru 2021. Demand was outstripping supply for numerous reasons: below trend home building for the prior decade, people looking to get out of big cities, remote work adoption, etc.
In the chart below we had an 18 month surge that showed US home prices increasing at an average pace of more than 1.5% per month:
What fueled this rise? Mainly the lack of supply. As we see in the chart below, after the housing pump and crash between 2007-10, we had a drop in the supply of homes for sale as measured by the number of months of available supply (basically, homes on market versus average time to sale and close). On average, there were more buyers than sellers in this period. This situation should persist (more about it later).
Why the continued drop in supply? There are number of reasons, but in our view, there are 2 main reasons. The first reason is the lack of home building from 2007-2020. The long term average for housing units built in the US is about 1.5 million annually going back to the 1960s. Although there are certainly peaks and valleys (home building is very cyclical) even at market bottoms the single month lowest levels were around 700,000 units prior to 2009. But from 2009-2011 we had only about 600,000 units built annually, a very long, significant under build. In fact, we didn't even get back to the 1.5 million average until 2020 (and then only for 2 months). Our overbuilding peak in 2007 was not even as large as that in the early 1970s. So our under building period was significantly greater than our over building period.
The second reason, is ‘affordability’, which measures the degree to which a typical family can afford the monthly mortgage payments on a typical home.* Compensation of salaried employees was increasing faster than the rate of inflation and mortgage rates continued to fall. With the housing boom going bust in 2007, home prices fell which further helped affordability and the excess supply (measured in months) was gone by 2015. Yet, while affordability fell, it still stayed strong before it began increasing again in 2018.
*A value of 100 means that a family with the median income has exactly enough income to qualify for a mortgage on a median-priced home with a 20% down payment. A value above shows an excess of income, below shows a deficiency of income to qualify.
Mortgage rates have been an important factor in affordability and have been on a near 40 year down trend as shown below. Interest are now expected to rise and that means mortgage rates will rise as well. This should have a negative effect on affordability.
We think home prices will continue to rise but at a more muted pace and that some regions will do better than others. The factors driving higher prices are mainly supply driven, we still have a shortage of housing units after a decade of below trend home building. At the same time, the largest demographic wave in US history is in their child rearing and home buying phase.
Another positive factor for home prices is the rise inflation. We expect materials prices to continue to rise for a time. Given the number of job openings (as measured by JOLTs) and the lack of available workers in the US we also expect wage and compensation inflation to continue higher.
While we believe that rising mortgage rates effect on home affordability will begin to dampen this price rise, it will not stop it. Housing affordability is still significantly higher than the long term trend meaning that people can more easily afford homes, but this will face regional factors including population migration. Housing prices should still rise, but except in a fewer and fewer places, the days of the common bidding wars is likely over.
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