Wednesday, June 15, 2016

Many assume home prices will keep rising upwards

Rising home prices set off fears that real estate will become even more expensive, making it impossible ever to buy a home in a given city.

It’s easy to understand how such worries spread, but the historical record suggests that these fears are generally exaggerated. Cities with steep price increases today will probably have much smaller upticks in the future. And for the most part, differences in price increases among cities are well explained by short-term variations in employment growth.

Consider some recent trends. In the year ended in March, cities like Denver, Seattle and Portland, Ore., had employment growth of more than 3 percent, according to the Bureau of Labor Statistics, along with double-digit home price increases, according to the S.&P./Case-Shiller indexes. At the same time, employment growth has been relatively tepid in cities like Boston, Cleveland and New York, and so have home price increases.

This is not rocket science. When businesses in a city have an unusually successful year and hire a lot more people, new employees arrive, but initially there aren’t enough homes for them. Home prices rise immediately so that demand effectively equals the existing supply, inevitably causing ripple effects. Someone with a new, high-paying job will outbid someone else, who will have to lower her sights and accept a less attractive house. People much further down the ladder will end up living with their parents or with roommates.

On a national scale, this suggests that weak employment growth of the kind shown in May’s jobs report, with only a 38,000 increase in nonfarm payrolls, could eventually hurt home prices across the country. That’s possible. But even without a national price slowdown or decline, there is reason to believe that double-digit increases won’t continue for long in individual cities. Short-term variations abound, but for the most part, the differences in long-term home price increases in individual cities are about plus or minus one percentage point annually. (Exceptions include San Francisco and Portland, whose home prices have grown almost two percentage points above average annually since 1987.)

Cities with big home price increases recently have issued more building permits per capita. This supply response has the potential to reverse at least some of the prices: When housing supply increases, it tends to bring high real estate prices down, though that takes time.

There is another wrinkle, however. Demand lately has tilted toward homes in central cities, where land is scarce, rather than in more spacious distant suburbs. This creates imbalances. New homes in the suburbs have often remained unsold for long intervals. Construction of apartment buildings has increased in cities since the financial crisis, but new arrivals with good jobs often haven’t wanted to live in apartments. This may explain 2016 data showing that permits for new buildings with five or more units have flagged. Despite these problems, the supply response to higher home prices should moderate or reverse some of the biggest increases.

Yet many people assume that home prices will rise ever upward. These expectations are more modest than in the years leading up to the 2008 financial crisis, but they are substantial. The January 2016 Pulsenomics U.S. Housing Confidence Survey showed that expectations for home price increases over the next 10 years averaged 3.7 percent a year nationally, which implies a 44 percent total increase by 2026. Expectations were a little higher for homeowners than renters and higher yet for recent buyers — which appears to reflect a wishful-thinking bias. They were highest for recent buyers in high-price-increase cities, peaking at almost 6.5 percent a year.

Historically, however, investing in homes just hasn’t rewarded most homeowners that much. As I have calculated, home prices corrected for Consumer Price Index inflation nationally were nearly flat for the century ending in 1990. And when nominal home prices are deflated by per capita disposable personal income, it turns out that real prices of existing homes fell 12 percent while real prices of newly built homes fell 30 percent from 1975 to 2015.

As their disposable income has grown relative to home prices, individuals have bought more housing. That’s partly why average household size declined to 2.5 people in 2015 from 2.9 in 1975. The percent of households consisting of a single person rose to 28 percent in 2015 from 20 percent in 1975. There are other explanations for this, but one is certainly that housing has been getting cheaper, relative to income, so we are consuming much more of it.

New homes are larger: Median floor space has risen to 2,169 square feet in 2010 from 1,525 in 1973, census data shows. This large increase generally holds within major metropolitan areas and outside them. While living space is constrained in the heart of large, high-priced cities like New York, builders elsewhere have usually been able to accommodate people’s demands for cheap large homes roughly where they want them.

Given these facts, why do people still worry that home prices are getting out of reach? The answer can’t be found in the housing data. Instead, these fears may reflect anxieties about other issues — like income inequality, globalization and the threat of job losses because of robots and artificial intelligence. In prosperous cities, rising prices may connote economic exclusion.

After all, American society is increasingly divided according to educational attainment and income. In some circles, rarefied home prices may set off worries about being unable to live in choice locations shared with successful people. Home prices may, unfortunately, be viewed as a measurement of success in life rather than merely of floor space, and fear of being priced out of housing may well be rooted in deeper broodings about maintaining a position in the social hierarchy.