Inflation Fears Explain A Seeming Housing Market Mystery

Housing has become increasingly expensive. According to the National Association of Realtors, mortgage rates on average have risen by more than a full percentage point over the last 12 months. The average price of a home has inched up as well. Taken together and measured against household incomes, the statisticians at the Association estimate that affordability of home ownership for the average American has plummeted nearly 10% over the past year and today sits at its lowest level since 2011. Economics 101 would tell us that demand should slack off. Yet, home sales continue to rise. The Census Bureau reports that sales of privately owned houses fell off a bit in October, the most recent period for which data are available, but remain some 18% above year-ago levels. Sales have held up in defiance of standard price theory because Americans are still very concerned about inflation.

Indeed, the behavior of the housing market, more than any other economic gauge, announces that Americans, though aware of easing rates of inflation recently, are concerned that the economy is far from out of the woods on this matter. They fear a rising cost of living and exhibit that fear by flocking to the best inflation hedge available to them — home ownership — and secure it even if it means stretching their household budget to the limit. Few homeowners can quote the numbers, but the history of the last great inflation guides their decisions. From the mid-1970s to the mid-1980s, the crushing burden of 6.2% inflation a year tracked by the Bureau of Labor Statistics was still bested by an 8.7% rise in residential real estate values recorded by the Census Bureau. The 2.5 percentage point difference more than made up for the burden of paying mortgage rates that rose to double digits during that time.

For others, the logic of ownership is compelling in yet a different way, even if it means paying high mortgage rates and stretching the household budget to do so. Once the house is secure, whether financed with a cash purchase or a fixed rate mortgage even a high-rate one, the family has fixed the price of a major budget item – shelter – a great comfort when people fear that all other prices will rise unpredictably. For those who remain wary of inflation – and that is most people outside the White House – the peace of mind purchased this way is well worth the budget strains. Affordability might prevent a purchase as large or in as desirable location as hoped, but these benefits justify sliding down the pricing distribution. And this kind of buying has held up demand, despite rising costs.

Pricing might have given way despite this support for demand were it not that supply has also declined. It seems that existing owners, especially those who purchased at the very low mortgage rates that prevailed until last year, have no desire to walk away from such advantages. If for some reason, they need to change residences, they cling to the original mortgage and the house to which it is attached and rent the property, encouraged further by the 11% rise in national rents recorded between 2021 and 2022. They then rent in their new location until conditions for a new purchase are more favorable. Then they sell the old house to buy a new one. At the same time, homebuilders, the Census Bureau reports, have cut back on the construction of single-family houses, some 4.4% over the last year, and some, noting the earlier rise in rents, have turned to the construction of rental properties. Together, this shift by builders and the relative slowdown in the supply of owner-occupied dwellings available for sale has held up prices in this area of the market while causing a sudden halt this year in what was a powerful uptrend in rents.

As is so often the case, the matter is more complex than simple supply-demand-price considerations, especially in a product like housing that lasts for a lot longer than a haircut. If and when inflation fears fade and the Federal Reserve begins to lower interest rates, matters will seem equally perplexing as this confluence of motivations works in reverse.

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