Home Prices Continue to Set Records Amidst Growing Economic Complexity
Wednesday’s release of the S&P Core Logic Case-Schiller Index confirmed the continuation of seemingly unstoppable record setting home price growth. The national index reporting a 6.0% year over year increase, up from 5.5% in the previous month. This extends the annual price growth trend to 8 consecutive months, without a single market reporting a decline despite the highest borrowing cost in decades.
The 10 city and 20 city indices reported an acceleration in price growth with gains increasing to 7.4% from 6.1% and 6.6% from 6.1% respectively.
Every major market reported an annual price increase for the second consecutive month with San Diego leading the nation with a white hot 11.2% price increase. Los Angeles posted the second largest increase at 8.6% up from 8.0% the preceding month. Notable gains in the Midwest region continue with Detroit, Chicago and Cleveland at the top of the list and Charlotte posting a top 5 gain at 8.1%
Midwestern homeowners continue benefiting from the upward price pressure as the bar to achieve the American dream for many working-class families in the region continues to heighten. It appears this market is catching up with regions more prominently sought during the great covid migration as many of those most previously sought after regions are beyond the affordability for many. The steady home price increase in the midwestern region continues despite the lagging wage growth in relation to national levels.
While San Diego has consistently led the nation in sustained price growth, at what point does the current double-digit pace of this specific market becoming concerning? The most recent data set indicates a second straight month of double-digit annual price increases, a figure nearly 3 times greater than national wage growth and a trend last seen in the years preceding one of the most well-known periods of price corrections in our nation’s history. While I continue to maintain confidence that a large-scale systemic correction is simply not possible, concerns of overheating in this [isolated] market become ostensible when double digit gains persist. Should the trend of less traditional institutional and foreign investment subside, is there sufficient domestic demand to sustain the current price level moving forward?
On a monthly basis the raw data hints to a slightly different narrative for the midwestern region with several markets reporting noticeable near term declines. While interest rates have decreased over a full percentage point during the past quarter, most buyers closing in the month of January were the last of the group to incur the multi-decade high costs locked in during mid-November and early December. The high borrowing costs and holiday effect combined to create the near-term declines in colder markets delivering a relatively unchanged market in all 3 indices when setting aside the customary seasonal adjustments. On an adjusted basis, the National market reflected a .4% increase with the 10-City and 20- City posting .2% and .1% respectively.
The chart above illustrates the recent reduction in borrowing costs which decreased from 1.0 to 1.25% from November to January. This reduction in borrowing costs will increase the demand coming in to the new year and leads to the expectation of further price increase on both an annual and near-term basis on next month’s report.
With many homeowners benefiting from historically low rates made available during the Covid era, a troubling paradox of affordability is on the horizon.
As interest rates decline and the cost of home ownership decreases, the amount of qualified buyers will increase as more renters meet the income eligibility requirements. However, most homeowners are financing their current home with a mortgage rate in the high 2 to mid-3% range. This group of property owners who would typically consider selling will be reluctant to make the transition knowing the cost of financing a new property could be twice the cost of their current home. Simply put, a potential seller will be reluctant to incur a 6-7% borrowing cost when they currently pay 2-4%.
The problem is most likely to occur in the case of an incremental rate decrease to say 6%, where a considerably larger number of potential buyers will be eligible, but few would be sellers will be motivated or capable of making the move.
This increase in buyer demand coupled with a limitation in available supply will most surely drive the prices upward, quickly eliminating the improved affordability. To manage this Delta in the price relationship of opposing parties the Fed must craft a strategy to send mortgage rates sharply lower to the 5-5.5% range where the cost of borrowing on the next home will be more palatable for would be sellers thus eliminating this constraint on supply and fostering a more fluid market.
Navigating this paradox will prove to be a challenging balancing act on behalf of policy makers this coming year.
The stakes are much higher than some may believe as the interests of more than just would be homebuyers rest in the balance. The banking, insurance, transportation, real estate and durable consumer goods sectors are largely driven by a fluid exchange of real estate transactions. While the decrease in real estate transactions over the past two years has helped the fed’s initiative to bring inflationary pressures under control, an opposite and equally concerning effect is starting to appear.
Halfway through Q4 of last year it appeared inflationary pressures were coming in line with the 2% target growth rate in consumer prices, considered sustainable by traditional measures.
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As increasing data in support of this milestone materialized, anticipation of Fed policy rate cuts on the horizon mounted. The expectation of lower borrowing costs in tandem with the AI revolution fueled the sharpest increase in stock prices Wall Street has experienced since the dot com era. The S&P, Dow 30 and Nasdaq remain at increasing record high levels.
Record high levels in equity prices certainly doesn’t sound terrible for anyone concerned with the prospect of retirement or the obtainment of personal wealth, so what then is the problem. From that point in early December until the present moment, the data relied on to measure inflationary pressure on various sectors of the economy has been anything but clear. A slurry of mixed signals has created a foggy picture at best and justification for standing pat on previously expected changes in the target rate by policy makers.
Two of the indicators responsible for the mixed signals are recent increases of the consumer price index (CPI) and Consumer sentiment reading (in addition to others). Consumer sentiment is a measure of the consumer perception of overall financial well-being. Despite the highest levels of consumer debt and lowest personal savings rate in modern financial history, consumer sentiment has increased sharply (figure that out). This may be a result of the rally on Wall Street and the attractive numbers on the most recent 401k statements received by many. Simultaneously the consumer price index has reversed course and for two consecutive months has reported hotter than expected readings. Sustained increases in dwelling costs (rent) are a considerable factor behind the uptick in CPI and ties us back into the point of this article and paradox. The increased dwelling (rent) costs are one of the factors driving consumer spending levels above the desired range. If the cost to purchase a home continue to rise, the cost to rent a home will continue along with it.
So, to recap, if the Fed takes action to lower the borrowing costs slowly remaining cognizant of unsettled inflationary concerns, home prices will most certainly increase which furthers the housing affordability issue further fueling the inflationary pressure. If the Fed does not act and the real estate market sustains the historically low transaction volume, a substantial reduction in economic activity will most certainly result. Sounds like a lose-lose situation for policy makers?!? Those familiar with this topic will identify this as Stagflation. Stagflation is an economic phenomenon where one factor improves while an opposing factor worsens. The result is steadily increasing costs with steadily declining output. This is one of the few topics that if brought to full understanding, all would agree should be avoided.
So, what happens next? How does the Fed navigate this complex set of economic conditions in a manner which solves the affordability paradox and avoids the highly undesirable blackhole of stagflation?
The Federal Reserve is limited in terms of controlling the broad economy while mainly influencing the buyer or demand side of the price equation. The office of the President is often and logically viewed as having an equal effect on the supply side of the economic equation as one of the offices key responsibilities is foreign trade. The president also has considerable power to influence economic output both domestic and abroad.
While reductions in the Fed Funds Target Rate (or Prime Rate) seem less likely now than just 60 days ago, the one move we can expect the Fed to consider is adjusting a lesser-known policy involving mortgage-backed securities. During the covid-era the Federal Reserve purchased a prominent share of mortgage-backed securities which “artificially” drove rates to historically low levels. Over the past year the Fed has taken an opposite position by selling those mortgage-backed securities back into the market, artificially driving rates up. Part of the solution may involve the Fed taking a neutral position and simply maintaining its current MBS holdings. A change of policy to this effect may provide for sharply lower rates while maintaining a short leash on inflationary pressures.
While the solution to this complex economic challenge is unclear, the one thing that remains certain is continuation of upward movement in home prices nationwide.
Read the March 2024 Press Release here: 1471289_cshomeprice-release-0326.pdf (spglobal.com)
Michael Bardy
Real Estate Finance Professional | MacroEconomist