If it Bleeds, It Reads: Real Estate Headlines Are Often Deceptive
Old newspaper folks used to say, "if it bleeds, it reads," meaning that to get readers, headlines must include death, violence, or conflict. Well, it appears as if today's YouTubers and reporters have taken that advice to heart.
Headlines for the housing market are bleeding today. Both mainstream and social media call for the collapse of the housing market, but I have yet to find one piece of housing market content that digs to the heart of the matter, the "why" for a housing market collapse.
Many spout obvious issues but never tie together the cause-and-effect relationships that will bring the forecast results.
For example, interest rates are soaring, so we're seeing a lot of reports claiming that home prices will fall due to soaring rates. While this could be true, rising rates alone do not cause prices to rise or fall. With this in mind, I want to uncover the essential truth about today's housing market since it is the one thing that none of these alarmists are addressing.
The Truth About Home Prices
Today, we'll focus on the US housing market, but I must remind our readers that real estate is local. This means that while many US trends will affect us locally, it is the supply and demand for homes at the local level that will determine the direction of home price changes.
Much of the US housing market remains grossly undersupplied with homes. Last week, I used data from the Zillow website to show that 891 out of 894 local housing markets are reporting year-over-year increases in home prices, yet most new stories lately have been centered on the fact that home prices are falling.
I went further to show how home prices rose from August to September in more than 86% of those same market areas, yet the mainstream and social media continue to report otherwise. It's as if they have an agenda beyond reporting what is going on.
If it bleeds, it reads, and one finds this truth by looking at the views on YouTube. Some of the hottest headlines include:
- Home Prices Falling Big Time
- Housing Crash Spreading
- Why 2023 Will Be Worse Than 2008
- Home Prices To Fall 45%
- Home Prices DROPPING FAST on Zillow
But here is what none of these videos and reports are including.
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The Supply And Demand Dynamic For Housing
Nobody seems to feel it necessary to address the supply and demand for homes.
At the local level, there are metropolitan areas where populations are shrinking. If people are moving away, one might expect the supply of homes for sale to rise to a level where prices could fall. Other locales have growing populations, and they need more homes. Overall in the US, the months of supply of homes for sale remains near an all-time low.
Let's start with a few points about the theory of supply and demand:
The law of demand says that at higher prices, buyers will demand less of an economic good.
The law of supply says that at higher prices, sellers will supply more of an economic good.
These two laws interact to determine the actual market prices and volume of goods that are traded on a market.
Several independent factors can affect the shape of market supply and demand, influencing both the prices and quantities that we observe in markets.
The housing market is no different than any other market, and it adheres to these points completely. But it is the fourth point that I think is confusing most people, in that multiple factors influence the housing market's supply and demand dynamic. Numerous factors lead many to believe that home prices will fall, yet nobody accurately “completes the loop” to show how certain factors will first impact the supply or demand for homes. Let's look at a few examples.
Home Affordability Has Hit A 30-Year Low
First and foremost on most people's list is that homes are less affordable today than they have been since 1991 (see my recent report on wage inflation-adjusted monthly mortgage payments). Most reason that since "nobody" can afford these homes, home prices must come down to a more affordable level. I certainly understand that logic.
The graph above plots the median home price in blue, the monthly mortgage payment on that median home in green, and then the wage inflation-adjusted mortgage payment is plotted in red. Today's adjusted payment is as affordable as homes in 1990. It's funny, I got into the business in 1991, and nobody was writing about home affordability back then. We are moving to a future where cheap mortgage interest rates won't drive the housing market.
Regardless, there have been thousands of videos and articles published that declare home prices must (and will) come down due to the decline in affordability. But what if there is other data to contradict this simplistic logic?
For example, we know we are in a high inflationary economy, with the price of all goods and services pushing higher. Do we expect houses to defy inflation? I'm not saying it cannot happen, but I am saying that it WILL NOT HAPPEN until the supply of homes is far greater than the demand for those homes. It is that simple.
So we can look at wage inflation (making homes more affordable) and building materials inflation (making homes less affordable) and push to find the smoking gun that will impact the supply and demand for homes.
The Supply-Side Litmus Test
Long-time readers of the Tallahassee real estate blog know that I refer to rental rates as the litmus test for the supply and demand relationship in the for-sale side of the market. If rental rates rise, we know that the rental market is either balanced or undersupplied.
Today's rental market is as low in inventory as the for-sale market, and rents are up 24% in the past two years. This means that as people get priced out of the for-sale market, they are finding no relief in the for-rent market. This is not necessarily a big deal for people who own homes and are happy where they are. But for people who must make a move (marriage, divorce, change in family size, relocation, etc.), their choices are not good.
The rental rates graph is the litmus test that tells us the lack of supply in the for-sale market is not going away. We have too few homes for rent and sale, and our growing population needs shelter. If you want to know who to blame (or how we got into this mess), you can check out the video below.
What Happens To Home Prices When Interest Rates Rise?
Many reports have noted that mortgage interest rates have doubled (plus) over the past year, and many expect them to continue higher for the foreseeable future. But do rising mortgage interest rates bring down home prices?
This graph plots the US median home price in blue and the average monthly mortgage interest rate in red. The red boxes identify 11 times in the past fifty years when mortgage interest rates rose, and home prices rose too. There is no correlation between rising rates and declining prices. Instead, one might argue the opposite.
In reality, the simple reason is that home prices generally rise.
What Must Happen For Home Prices To Fall?
The only way that we are going to see long-term home price declines during this inflationary period is a dramatic change in supply, demand, or both. YES, rising mortgage interest rates have cooled buyer demand, but you must understand what segment of the buyer pool has been cooled.
Discretionary buyers, those that have no real pressure to make a move, represent the majority of those who have opted out of the market. So why is this important to the supply and demand for homes?
It's the move-up, move-down, and move-over discretionary buyer who also has a home to sell. This means when a discretionary buyer leaves the market, so too does a discretionary seller. This does NOTHING to fix the supply imbalance, it just reduces the number of homes sold in a year.
Discretionary buyers (and sellers) will move when they are comfortable with market conditions, but non-discretionary buyers have a choice to make. They can buy a home. They can rent a home. Or they can live in the streets (US homeless rate has risen 6 years running, this is not a coincidence). None of those choices is attractive today.
Housing: A Binary View
To fix the housing market, it comes down to increasing supply, reducing demand, or a combination of the two. Remember, both prices and rents are rising, so you will not reduce demand by pushing a consumer from one side of the market to the other. When we talk about housing, we're talking about shelter, whether the consumer is buying or renting.
This graph plots the number of homes for sale in blue, the months of supply in red, and the dashed-gray line measures the non-seasonal relative supply of homes.
The first point I will make is that the 1.3 million homes for sale today is 68% fewer than the 4 million homes that were available when the housing market tanked 15 years ago. The one-year average months of supply of homes has risen off an all-time low three months ago, but the US is far from approaching equilibrium. There are not enough homes built to house our growing population.
There are not enough homes, even for the lowered demand that has resulted from skyrocketing mortgage interest rates.
If one looked to the supply side of the housing market to balance with demand, more shelter is needed. Apartments, condominiums, and single-family homes are all needed. I have seen estimates that the US is deficient somewhere between 2.5M and 5M homes right now, and each year that we under-build for demand only exacerbates the problem.
Of course, things could change on the supply side. For example, what happens when a force majeure hits our population? As a dark, extreme example, think of how the supply and demand dynamic would have been impacted had 10% of our population (33M people) been killed by COVID since the pandemic began more than two years ago. Had such a tragedy occurred, it would have, on average, resulted in the addition of 12M homes to the supply side of the housing market.
Our market would have gone from grossly undersupplied to grossly oversupplied in a very short period. Today, we would have 14M homes for sale in the US (where we have averaged about 6M sold each year). Considering the market in 2007 had "only" 4M homes, you can see how devastating the pandemic could have been to the supply side of the market.
I have seen reports stating a large number of new homes are ready to flood the market. This is not true. The pipeline is taking 50% longer than the historical norm due to supply chain disruptions. Thus there are more (but not enough) homes in the pipeline. You can view an in-depth video below on the new construction pipeline.
I have also seen ignorant reports stating that the supply side of the market could change greatly if more current homeowners decide to move. Here's why this is ignorant. Real estate math: One seller enters the market. Unless that person dies or moves to another country, one buyer (or tenant) enters the market.
One new seller plus one new buyer equals a net zero for inventory! No more houses are added. No more consumers are added. You cannot detach the inventory of homes for sale from the inventory of rental homes, as each represents a part of our inventory for shelter.
The demand side of the housing market has two key variables to consider. Mortgage interest rates and jobs.
I think it is safe to assume that mortgage interest rates will remain well above 6% for the foreseeable future. It would not surprise me to see them surge above 8% before year's end as (I suspect) the Fed will be pushing the funds rate higher two more times this year.
I also believe that the US is in, or is heading into a recessionary period. This too will slow demand as (perhaps) one to two million workers lose their jobs.
The former will impact discretionary buyers, while the latter will impact both discretionary and non-discretionary buyers. As a reminder, discretionary buyers are typically discretionary sellers too, so I am more concerned about the economy than I am regarding mortgage interest rates. So long as the US holds on to jobs, I believe home prices will be fairly well protected.
Real Estate Is Local
When you hear that real estate is local, it means that the supply and demand dynamic for homes centers around the population of people who might want to live in those homes. The local economy and the changes in an area's population (growing or receding) will have the greatest impact on the demand for homes.
This means that home values are relative to those of homes around them. That's why you might pay $2M for a tiny apartment in New York City and yet only spend $500K for a 3,000-square-foot home in Tallahassee. These two cities have two very different markets, two completely different sets of buyers and sellers, thus one has no direct impact on the other.
Relative location is also why you can buy a townhouse on Hilaman Golf Course in downtown Tallahassee for $200K less than one in Golden Eagle Plantation, located in Northeast Tallahassee. Real Estate values are hyper-local. Nevertheless, it is important to study the supply and demand for homes in the US. The data is more readily available to most people, and housing is often manipulated at the Federal level in order to tweak the economy. Federal tweaks impact local values too.
Don't Be Sucked In By The Next Hype Headline
I hope today's housing report has given you an understanding of how the supply and demand for homes in your area will determine home price changes. How is your local economy? Is your population growing? Declining? These are the issues you must understand to forecast home prices in your local market area.
For the US as a whole, we don't have enough homes. Home affordability is tanking, and it appears that wage inflation might be the only savior for people who need to move. Rents are rising. Home prices are rising. In fact, due to inflation, just about everything is rising.
Don't let the next headline shock you. Instead, ask yourself, "If what the headline suggests is true, how will it impact the supply and demand for homes?"
The supply side of the housing market remains far too low for even today's lowered rate of demand. Consequently, we should expect most local market areas to continue to struggle against rising home prices and rising rents.
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