Framing Home Price Inflation
The ever-increasing cost of homes obviously causes a lot of people a lot of angst. Chief among those groups, naturally, are the people who are planning to buy a home but do not yet have one; and, since higher home prices are very highly correlated with higher rents, renters too are alarmed that the rent is too damn high! (if that reference eludes you, educate yourself at this link: https://www.youtube.com/watch?v=OUx_32ABtw4 )
Right behind the people who have to actually buy homes and rent apartments, though, are the economists who seem to be perennially alarmed that home prices are “in a bubble” again. Certainly, if you look at nominal home prices (represented here by the S&P Case Shiller U.S. National Home Price Index, normalized like all of the charts in this article so that December 31, 1989 = 100 and the latest figure is for the end of September 2024) then you can see the cause for concern. Home prices are up 75% since the peak of the home price bubble of the late 2000s! If a house at $241,000 was in a bubble in 2006 (and subsequently declined in price to 175k), then surely it’s in a bubble if it’s now at $425k?
You can see in this chart the rapid acceleration in 2021-2022, and that should be a clue about one of the things that is going on with home prices. The overall price level is a lot higher than it was in 2006; the dollar simply doesn’t go as far as it did back then. Indeed I’ve chronicled how, thanks to the supercharged increase in the money supply, consumer prices are up 23% since just before COVID. Obviously, then, we have to adjust the dollar price of a home for the change in the measuring stick (the dollar) itself. Here are real home prices.
This still looks like a bubble, if real home prices are 13% higher than the bubble peak. After all, homes are unproductive real assets. Over a long period of time, home prices have risen less than 0.5% per year after inflation. In this way a home is like a lump of gold. Ten years from now, the lump of gold is still a lump of gold and so you would expect the real return to be roughly zero (you have the same amount of stuff at the end that you started with). In the case of home prices, there is deterioration of the housing stock over time but also new construction and homes have historically gotten larger and more comfortable, so some small drift higher in real prices makes sense. But home prices since 1989 are up 70% in real terms, when they should be up roughly 25 * 0.5% = 12.5%. And since the 2006 peak, we’d expect 9% (18 years x 0.5%) would represent a similar peak. We’ve risen more than that!
So, definitely a bubble, right? That deflation everyone keeps promising us is imminent, along with the collapse of banks and all the other stuff? Not so fast; there is one other important thing to consider and that is household formation. Or, rather, household formation compared to housing-unit formation.
We start by imagining what could plausibly push real home prices above or below a long-run flattish trend, that would represent a legitimate effect and not a bubble. What immediately comes to mind for me is the fact that for at least the last few years we have seen a massive increase in the US in the number of heads over which we need to put roofs. Something in the ballpark of 10 million new residents need roofs, and we surely have not constructed that many new roofs. For a long time, I’ve been highlighting this as one really good reason to not expect rental or home price deflation: the demand relative to the supply is out of whack. However, it turns out that we don’t actually need to rely on the ‘unofficial’ increase in the population to conclude that the “bubble” isn’t so bubbly.
The chart below, covering 2004 to the present, shows the real home price (the second chart above) on the y-axis. On the x-axis, I have a ratio of the number of households in the United States (source: US Census Bureau) divided by the total number of housing units in the country (source: US Census Bureau). As the ratio moves higher, it means there are more households for every housing unit or alternatively, fewer vacant units. I only have the housing unit data back to 2004, as that’s what was on Bloomberg.
There is a pretty clear relationship here between real home prices, and the occupation ratio. I have highlighted two areas. One, in red, is the January 2006 through June 2007 period – sort of the teeth of the housing bubble. Those points are well above the line, suggesting that prices were high relative to the occupation ratio. In fact, January 2007 is the point that is the highest above the regression line. On the other hand, we have the most-recent point in green. This is right on the regression line. Yes, real home prices have gone up a lot. But that’s mostly because the construction rate of new housing units has not kept up with household formation.
As an aside, the three points at (0.91, 130) or so are from mid-2020, when there was a surge of household formation but home prices (and rents) were being constrained by the lockdowns. In retrospect, it was a great time to buy a house!
Note that the charts above do not include undocumented residents in the US, except inasmuch as the Census Bureau is including them. Since the total increase in households since January 2021 is only about 6mm…and for the prior 4 years, the increase was 5mm…I am fairly confident that the recent surge in illegal immigration is not reflected on this chart. Ergo, you could make the case that home prices are too low in real terms. If every 5 illegals form one household, the ratio would rise from 0.912 to 0.926, and we would be off the chart to the right-hand side.
Now, this does not mean that real home prices will not decline. In fact, I am very confident that at some point they will, as building catches up with household formation. That does not mean that home prices will fall in nominal terms, however; I suspect that what is more likely to happen is that over a number of years, home prices will drift sideways to slightly higher while overall consumer prices continue to rise. But, if 10 million illegal immigrants are deported, the building of new units will catch up a lot more quickly and nominal prices and rents could decline in that case.
If that happened, rents really would be ‘too damn high’. And that is one very big reason that mass deportation is not inflationary. It also is not very likely; I have the over/under at 1mm deportations.
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I suspect another factor in the feeling about house/rent prices is the mix of new homes being built does not meet the needs of lower/mid-income households. Not sure about the whole country, but here in Charleston SC there are lots of luxury apartments being built, and lots of high end homes being built, but not that many entry level apartments/single family homes being built.
People are accepting less in exchange for more of their money, and communities are allowing multiple families to occupy the same house, a practice which was previously outlawed. When multiple families occupy the same house they are better able to afford paying a higher price for a house, however that does not increase the tax base which is per homestead rather than per person. We end up with cars parked on lawns, trash pickup being overburdened, waste water treatment being overburdened. Everyone gets less except for the real estate agent.
Nice piece of work. It provides a useful amount of information about the housing market and its potential impact of inflation. I would like to highlight two paragraphs ” In fact, I am very confident that at some point they will, as building catches up with household formation” and “But, if 10 million illegal immigrants are deported, the building of new units will catch up a lot more quickly and nominal prices and rents could decline in that case.”
Immigrants normally leave in high number in one house unit that increase the ratio leading to higher prices. On the other side, deportation of illegal immigrants will decrease the manpower to build new house units increasing the cost and reducing the offer of new one. How do we know that the net result of illegal immigrant deportation would be a price reduction if the Sept 2024 graph show that price increases with a higher ratio ? Did I miss something in your analysis?
Thanks Bruno – I have yet to see any evidence that a significant portion of the 10mm ‘new’ illegal immigrants are employed. It is an oft-repeated argument that losing 10mm workers would raise prices. It would, if those 10mm consumers were also employed. But if, say, 8mm of the 10mm are employed, my question is…where did those 8 million jobs come from? That’s a HUGE number of new jobs. And they didn’t displace domestic workers in huge numbers, or the unemployment rate would have risen. So those 8mm jobs are all off the books?
If even 1 million of those folks went into construction, we should have seen a MASSIVE increase in building. We haven’t.
I think the construction world has some number of undocumented workers…but not RECENT undocumented workers which are the ones being targeted for removal. And while I think the proportion of labor that is undocumented (and even recent migrants) may be high in things like yard maintenance, house cleaning, agriculture (though there aren’t as many picker jobs as there used to be!) and other low-skilled jobs, I don’t think the recent crossers are getting jobs in skilled craftsmanship in numbers big enough to notice.
Again, because this is all undocumented it’s all speculative. But I have to wonder why the surge of labor hasn’t shown up in any other data. My belief is that illegal immigrants have an enormously high unemployment rate, so that they are absolutely consumers (and often government-funded consumers of housing, etc) but not nearly as impactful on the production side.
Of course, 5 years from now they would be much more assimilated. But the argument is that these folks are already assimilated and will be ripped out of productive pursuits. I think that’s a myth.
I agree with your statements. I will provide additional statements of my own: If they had jobs lined up, then they would not have needed to immigrate illegally. Some of them did have jobs lined up, but because they crossed illegally, keeping those jobs required being paid less. The illegal individuals are often taken advantage of by family or friends of family by working at the “family” business in many cases a restaurant, auto shop, nail or massage parlor, restaurants are the big offender. Yes it affects the economy and is pertains to discussions on this blog especially in these days where the census methods are flawed.
I have always wondered about how to account for how the purchase of a home allows you to avoid the alternative cost of renting a home. Perhaps you can help me.
When you write:
… ” Over a long period of time, home prices have risen less than 0.5% per year after inflation. In this way a home is like a lump of gold. Ten years from now, the lump of gold is still a lump of gold and so you would expect the real return to be roughly zero (you have the same amount of stuff at the end that you started with). ” …
… It seems to me that I can’t live in a lump of gold. But I can live in a house.
For a really concrete example, suppose that I am faced with the choice of buying a NYC apartment for $750k, or renting that same apartment for $3,500 per month.
If I buy the apartment, I will be hit with about $1,500 a month in common charges. So, buying the apartment for $750k saves me approximately $2,000 a month after tax.
(2000 x 12) / 750k is a yield of about 3.2% after tax. How do I figure in this 3.2% after tax yield when trying to judge the relative value of $750k being too high or too low a price for an apartment?
To put it another way, a lump of gold is just a lump of gold. A house yields me 3.2% after tax. So isnt a house a lump of gold that pays you an extra 3.2% after tax? (And that 3.2% would have to be not in dollars, but in extra lumps of gold!)
Well, there are lots of calculators etc on the web that can help make an informed decision between rent/buy. But the way I would answer your specific question is to make sure that you’re not ignoring the 750k in the case that you rent an apartment. In that case, you’d have 750k in cash you hadn’t spent, and if you invested it in something that pays you $2000 per month then you’d be indifferent. So, whether you’re indifferent is based on what your alternate uses for the $750k are. I actually wrote something on this a while back, because this is sort of like a breakeven (to do it right, we also need to consider the tax advantage of the mortgage, the appreciation of the apartment when you own rather than rent, etc). https://inflationguy.blog/2021/09/02/are-home-prices-too-high/
Frankly, it’s REALLY the same question the landlord asks. They bought the apartment for $750k and are renting to you for $3500 per month…
May you quantify the impact of the fire on house prices or rents? Thank you
That’s a bit of a stretch for a free blog. 🙂 But also very difficult to say until we know how many units have been destroyed, what sort of laws the city council will pass (currently they are debating a rent freeze and an eviction moratorium; if they did that then like happened when we did the same thing with COVID nationwide we’ll get inexplicably low rent growth until the moratorium is over, and then inflation as rents quickly catch up to where they would have been – except in this case it would be higher, since freezing rents would also freeze developer interest in building new units and exacerbate the housing shortage). You’d also need to know a lot about the population preference curves. In short, that’s a really big question. The initial jump in rents before landlords were threatened with jail time for price gouging suggests that rents should go up 20-40%, but that’s in a narrow part of LA too. The LA case-shiller home price futures have barely moved, up less than 1% since the fires began, which seems crazy.