Housing struggles to stave off headwinds
The November Economics Insider deep dives into the impact of high mortgage rates and home prices on the housing market. While some near-term respite is likely, long-term hurdles will remain.
As the Federal Reserve tries to engineer a “soft landing”1 for the US economy, what keeps intriguing some economists is high housing-related inflation.2 Rising home prices and rents, however, come at a time when home sales have been steadily declining,3 housing starts and building permits have dipped,4 and real residential investment is down 14.6% since its most recent peak in the first quarter of 2021.5 That’s quite a bit of a contrast from the brief surge in fortunes right after the pandemic.
There are multiple factors keeping housing under pressure, currently. High mortgage rates—driven partly by tight monetary policy over the last two years—have deterred buyers and sellers. That’s kept home sales low and prices elevated. As affordability dips, more people have turned to renting, driving up rents.6 Some of these near-term pressures are expected to ease as the Fed continues on its path of interest-rate cuts. Yet, those changes may not be enough to take housing back to its heydays of the early 2000s.
A surge in housing right after the start of the pandemic …
In 2019, the year before the pandemic, home prices (as measured by the S&P CoreLogic Case-Shiller home price index) grew by a steady 3.5%7—the story of most of the last decade. Year-over-year rises in home prices peaked at 10.8% in October 2013—that too after nearly two years of declining prices. After that, price growth steadily eased till 2019. The scenario changed after the pandemic hit American shores (figure 1). From May 2020 onward, home prices started edging up, with year-over-year growth rising to 20.8% in March 2022—a pace unseen since 1976 (when records began for the index). Data on median sales prices of existing homes by the National Association of Realtors also shows a similar trend of rising prices after mid-2020.8
Why did home prices rise so much between 2020 and 2021? There are likely two reasons. First, the pandemic forced a sharp turn to remote work, which boosted demand for homes.9 Also, excess savings of households during this period—boosted by stimulus payments—went toward debt repayment and financial savings.10 These factors likely (indirectly) drove housing demand up.
Between May 2020 and January 2021, existing home sales rose by a staggering 61.4%, and for another year, sales remained elevated relative to pre-pandemic times (figure 2).11 Second, mortgage rates fell sharply in this period (due to an easing of monetary policy), thereby aiding demand. Builders responded as well, with housing starts almost doubling in the two years to April 2022.12
… and then came the fall
The housing sector’s fortunes started turning sour from 2022 onward. First, mortgage rates went up sharply as the Fed tightened monetary policy in response to high inflation—at a pace and scale unseen since the early 1980s.13 Between January 2022 and October 2023, mortgage rates more than doubled (figure 3). As mortgage rates rose, homeowners shied away from refinancing.
An overwhelming majority of US mortgages are fixed-rate ones.14 For a large share of homeowners with such mortgages, the rates they had locked in were suddenly much lower than existing rates. Hence, they were reluctant to sell, leading to a steady decline in sales of existing homes between mid-2022 and end-2023.15 Researchers at the Federal Housing Finance Agency estimate that this mortgage-rate “lock-in” lowered home sales by as much as 1.3 million between the second quarter of 2022 and the last quarter of 2023.16
Inventories for existing homes, therefore, fell over this period. The number of vacant housing units for sale fell by 22.7% between the end of 2020 and the second quarter of 2023, albeit with some volatility, while the homeowner vacancy rate fell to 0.7% from 1% during this time.17 Declining supply ensured that home prices kept rising. Rising mortgage rates and home prices dented housing affordability (figure 4). By August 2023, the housing affordability index, from the National Association of Realtors, fell to 91.1—a figure last recorded in the mid-1980s.
In such a scenario, builders also shied away from new construction. Housing starts are down 25.9% since their recent peak of April 2022. Building permits, an indicator of future starts, have followed a similar trend (figure 5).
Some headwinds will likely ease in the near term …
There is likely some relief coming for the housing sector, however. First, home price growth has slowed compared with the highs seen in 2022. For example, the S&P CoreLogic Case-Shiller home price index has gone up by just 7.1% since August 2022—much lower than the 35.5% rise in the prior two-year period. Second, mortgage rates have eased a bit over the past year with rates likely to fall further as the Fed eases monetary policy.18 However, the 30-year fixed rate may not completely move in tandem with the federal funds rate. That’s because the 30-year fixed rate is also influenced by long-term Treasury yields, which in turn may be affected by changing inflation expectations and fiscal spending.19
Third, housing supply has been going up and is likely to increase further as mortgage rates likely ease over the next year. The pool of existing homes for sale has gone up by 40.4% since December 2023, although part of this rise is likely a seasonal trend.20 Data on housing inventory from the US Census Bureau also shows that the number of vacant homes for sale (available round the year) has gone up by 18% since the fourth quarter of 2023.21 As borrowing costs go lower and demand picks up, new housing construction is also likely to rebound. Sentiment among single-family homebuilders is already edging up, with the National Association of Home Builders/Wells Fargo housing market index going up in September and October.22
… but other challenges are here to stay
Homeownership rates have been going down over the past two years. While ownership rates started picking up in 2015—after households had recovered from the global financial crisis of 2007 to 2009—that uptick had peaked by the second quarter of 2020 (figure 6).23 In fact, the sharp mid-2020 jump in homeownership appears to be a temporary spike. At 65.6%, currently, the rate is higher than the trough seen in the second quarter of 2016, but it is still much below levels seen in the late 1990s and early 2000s.
Homeownership for young people—where the age of the householder is 35 years and lower—had gone up between 2015 and 2022; since then, however, the rate has been edging down and is now lower than pre-pandemic times.24 And the share of people in the age group of 18 to 34 years living with their parent(s) continues to remain high—a trend which started right after the global financial crisis.25
A key reason for declining homeownership is that income hasn’t kept pace with rising home prices, thereby denting affordability. The ratio of median existing home prices to median household income was 4.8 on average per year in the last four years, much higher than the average annual figure for 2010 to 2019 (3.8) and 2000 to 2009 (4.0).26 This is also evident from price trends in “starter homes”—or compactly designed units for first-time homebuyers. According to Zillow, a “starter home” is typically priced in the bottom third of home values in a region.27 Yet, research by Zillow shows that, in 237 cities, starter homes are priced at US$1 million or more, putting them out of reach for many first-time homebuyers.28 Back in 2019, there were only 84 such cities, indicating prices have gone up sharply over time.
Changing demographics will also weigh on housing demand growth in the long term. Population growth has been steadily declining in the United States, and the pace is expected to slow further in the years to come (figure 7).29 Growth in household formation too has eased over the years. Since 2020, the number of households has gone up by about 0.6% per year on average, lower than the 0.9% average annual rise in the previous decade, and the 1.2% rise between 2000 and 2009.30
Some deft policymaking may help
There are two areas where concerted policy action may help drive homeownership, and subsequently, the wider housing sector. First, to make housing more affordable, additional construction needs to be directed toward “starter homes,” especially in cities or regions where population growth has been the highest in recent years.
This is likely to ease price growth for starter homes. Second, tackling high student debt levels may aid young households in their homeownership decisions. Student loans have gone up sharply over the past two decades and currently account for 8.9% of total household debt—much higher than their 3.1% share 20 years back.31 Any rise in delinquencies in student debt will impact younger households more. Easing student debt burdens may help shore up finances for younger households, thereby driving more homeownership.