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Speaking of the Economy
Speaking of the Economy - John O'Trakoun
Speaking of the Economy
Dec. 29, 2021

The Housing Market During the Pandemic ... and Beyond

Audiences: Business Leaders, Economists, General Public

John O'Trakoun discusses the factors that have increased the cost of single-family and multi-unit housing in recent months, as well as what shapes overall supply and demand for housing over the longer term. O'Trakoun is a senior policy economist at the Richmond Fed and primary contributor to the Bank's Macro Minute blog.



Jessie Romero: Hi, I'm Jessie Romero, director of research publications at the Richmond Fed. Thanks for listening to Speaking of the Economy. You can find more episodes and subscribe via Apple Podcasts. And if you like what you hear, please leave a review and tell your friends and colleagues about us.

A recurring story during the pandemic has been the red-hot housing market. Home prices have gone up nationwide. And it seems like everyone has a story about a neighbor who had multiple offers on their home within minutes of listing it, or a friend who had to endure multiple bidding wars before finding a home.

Today we'll be diving into the housing market with John O'Trakoun, senior policy economist at the Richmond Fed and the author of our Macro Minute blog, which you can read on our website,

Thanks for being here today, John.

John O'Trakoun: Thanks, Jessie. Great to be back.

Romero: Let's start with a little bit of background. Why does the Fed care about the housing market?

O'Trakoun: That's a great question. This goes back to the Fed's dual mandate, which is maintaining stable prices and also getting to maximum employment in the economy.

The housing market matters on the first point — stable prices — because the cost of housing services plays a big role in the overall price level. It makes up almost 20 percent of one of the most important price measures that's followed by the Fed, and that's called the Core Personal Consumption Expenditures or Core PCE Price Index. And, housing services prices make up more than 30 percent of the Consumer Price Index, or the CPI. That's a price measure that's always in the news. It plays an important role in cost-of-living adjustments and it's in some legal contracts as well.

When it comes to the second point — which is maximum employment — the housing market matters because it can play a role in amplifying the business cycle, by that I mean the ups and downs the economy faces as it switches between periods of growth and recession. For example, we have economic models that incorporate housing. They found that when overall demand goes up, housing prices can go up. That allows people who use their homes as collateral to borrow more, allowing them to spend even more, and so that makes the boom even bigger. There's the opposite effect too, and that makes a recession and recession-related job losses more severe. So, for the Fed to target employment, to look at how it goes up and down during recessions and to get to maximum employment, it's really important that the Fed keeps an eye on the housing market as part of overall economic conditions.

Romero: It certainly makes sense then that the Fed would care about the housing market. Does the housing market care about the Fed, by which I mean do the Fed's actions affect the housing market?

O'Trakoun: Yeah, the Fed uses a couple tools to influence the economy and to achieve those dual mandate goals.

By setting the benchmark interest rates for the economy — the federal funds rate — [or] even talking about what the interest rate will be like in the future, monetary policy is able to affect mortgage rates. Mortgages are basically the price of borrowing money to buy houses.

Another tool in the Fed's policy toolbox is quantitative easing or QE. That's about buying certain kinds of assets to lift the economy by making spending today more attractive and spending in the future. One of the assets that the Fed buys and sells is called agency mortgage-backed securities. That's a mouthful, but basically it just means mortgages that have been issued by government-sponsored entities or agencies. Because these entities like Fannie Mae and Freddie Mac are major backers of conventional mortgages, these QE policies have an impact on the overall mortgage market and they can make borrowing more affordable to homebuyers.

Romero: House prices have been a source of constant conversation and headlines during the pandemic. Personally, I've had more than a few conversations with my neighbors about what the homes in our subdivision are selling for. What explains that increase?

O'Trakoun: One factor is a shift in preferences that happened during the pandemic. Many people who are living in core downtown areas decided that they wanted to move to less dense areas because of health reasons, or because their employers gave them increased flexibility in terms of where they can work. In the early days of the pandemic, people who are living in big cities found out they were paying the high rent to live in a tiny space at a time when a lot of these big city amenities like restaurants, museums and sporting events had all shut down. A lot of companies implemented remote work policies, so people were spending more time at home than ever. That made at-home amenities like comfort and space so much more important. It became really attractive to own a house somewhere else when companies began allowing some workers the ability to work from different cities or even move across state borders. That led to an increase in demand for housing, especially for single-family homes in the suburbs. That pushed up prices all across the nation.

A second factor lifting up home prices was the extraordinary amount of monetary policy accommodation by the Fed. By keeping the federal funds rate at the lower bound, the Fed contributed to the record low mortgage rate environment that we saw following COVID. And, like I said, the Fed also purchased these mortgage-backed securities through QE. That also contributed to keeping mortgage rates low and making borrowing money for buying a house relatively cheap.

From a bigger picture, home prices have been in the news a lot because they're a symptom of some of the widespread pressures reverberating through the economy right now. In particular, we've got a lot of demand running into low supply of homes on the market. A mismatch of supply and demand has been really visible throughout the pandemic, from the toilet paper shortages at the beginning of the pandemic to the semiconductor shortages that we see today that are causing the prices of new and used vehicles to skyrocket. In housing, we've seen issues like a shortage of construction workers and supply bottlenecks in raw materials and products like lumber, windows and shingles, all exacerbating new home prices and delaying construction time. Those labor and supply shortages are representative of these big, broader issues in the post-COVID economy.

Romero: So how does the Richmond Fed's district, which includes the Carolinas, Virginia, Maryland, D.C. and most of West Virginia, compare to the rest of the country?

O'Trakoun: Home prices in the Fifth District have seen a lot of the same growth that the rest of the country has seen. According to data from CoreLogic, as of September, home prices in the Fifth District are up almost 17 percent over last year and they're up almost 14 percent from the start of the pandemic in February 2020. These numbers are pretty much in line with what we've seen nationwide, where home prices are up 20 percent year over year and about 15 percent since the start of the pandemic.

The Fifth District has also seen the supply of homes on the market dwindle, much like the rest of the country. That's a topic that's discussed in a recent Regional Matters post by Benjamin Lukas. I'd recommend our listeners go to the Richmond Fed's website to look up that post.

Romero: You mentioned some of the kind of supply chain and worker constraints that have affected the housing market. Are there other factors that might be contributing to the low inventory of homes?

O'Trakoun: Part of the reason for the low inventory is lingering scars from the bursting of the housing bubble in the mid-2000s. That put a damper on the construction of new homes for many years after the Great Recession. From 2006, the first quarter [of that year], to the first quarter of 2009, new starts of single-family houses fell 80 percent. Since then, they've never returned to that 2006 level. Just before the pandemic in the fourth quarter of 2019, single-family housing starts were still 47 percent below their 2006 level.

That's a huge contrast to multi-family housing starts, which did return to the level that they were at prior to the Great Recession. By Q4 of 2019, they were up 23 percent over their 2006 levels.

I think that reflects that, before the pandemic, many people thought that millennials and Gen Z had a strong preference for living in city apartments and condos rather than suburban houses. But the pandemic shock revealed that maybe this new generation, the young people, their tastes might not have been as fixed as we thought. During the pandemic, people just didn't want to live in multi-family housing units and they wanted to go out and buy the single-family homes.

Policies might have also contributed to the low inventory situation. There's a body of research by economists like Edward Glaeser and other authors who looked at the role of housing supply regulations like zoning restrictions in making large-scale development difficult. Especially in areas of the country where housing prices grew rapidly, where houses are more expensive to buy, those types of policies also helped keep housing inventory low.

Romero: You mentioned multi-family housing. While tastes may be shifting away from multi-family towards single-family homes, there are still a lot of people who rent the place that they live. So what effects do housing prices have on rental prices?

O'Trakoun: Over time, housing prices and rents tend to move together because both are ultimately … influenced by fundamentals like income in a certain area and the willingness of people to spend in a certain area on shelter. Some people even use the gap between housing prices and rents as an indicator of whether homes are overvalued. But it can be hard sometimes to know whether a big gap means that housing prices will come back down or rents will have to go up.

What we're sure of is that during the pandemic, we've definitely seen a bit of divergence between the two. In the beginning of the pandemic, we saw some landlords freezing or even lowering rent as demand for those rental units fell. Especially in the dense downtown core areas of cities, home prices were outpacing rents.

With a pandemic still ongoing and remote work arrangements still in place, these trends are still there — housing prices are still growing stronger than rents. By the spring of 2021 rents have started to catch up, but they're still being outpaced by home prices. As of October, according to data from Zillow, the ratio of home values to observed rent has reached a new record high.

Romero: You wrote about rents starting to increase in a post for our Macro Minute blog over the summer, where you noted that a measure of asking rents — meaning what landlords were asking for new leases — was growing quickly. You also noted that this could be a harbinger of future price increases. How has that played out in the months since?

O'Trakoun: Since that blog post came out in July, asking rents have continued to grow on a monthly basis, although the growth has cooled down a bit. The monthly growth rate of asking rents has peaked at 2.1 percent in August. In the latest October reading, prices rose though rents rose 1.2 percent monthly. Still, this is high relative to the five years right before the pandemic. Back then, the median monthly growth rate was 0.3 percent, so rents are still growing four times faster than they were before the pandemic.

Meanwhile, the shelter price indexes that are incorporated into CPI and PCE are starting to accelerate. In the five years before the pandemic, we saw that median monthly growth rate of shelter [at] about 0.3 percent per month. But for September and October, in the latest data, we've seen it grow at 0.4 percent annualized per month. That is a sign of accelerating shelter prices and it could lift overall inflation readings in the months to come.

Romero: Well, that's a great segue to ask you about what the future holds. What indicators are you watching to gauge the housing market going forward?

O'Trakoun: I think the big question now is whether the housing market is starting to cool after this period of strong demand. So, I'm watching both the level of home sales and prices, because sales can dip either because supply is low or demand is weakening. The difference is what happens to prices. If prices are still going up then, likely, demand is still strong.

Another thing to watch is inventories and new building permits. They're important to monitor to see if the supply situation improves or if it's on track to get better.

Finally, I also track homebuying sentiment and consumer sentiment surveys from the University of Michigan and the Conference Board. They're an indicator of what might happen to future demand, as well as how big the role of high housing prices is in terms of affecting consumer psychology and behavior.

Romero: So what are all those indicators telling you?

O'Trakoun: Existing home sales rose to a 6.3 million annualized pace in October, which was the strongest pace of home sales in nine months. New home sales rose to a six-month high annualized rate of 745,000. Existing home sales are above their pre-pandemic level and new home sales are basically at their pre-pandemic levels. By that yardstick, it looks like demand is really strong, even though both are slowing down a bit and they're down versus recent peaks at the end of 2020. Home sales this year are still on track to be the strongest since 2006.

When it comes to prices, housing price growth is slowing but it's still strong. That supports the view that demand is pretty robust in the housing market. The S&P CoreLogic Case-Shiller Home Price Index rose 1.2 percent in September, and that was a bit slower than what we saw in August. Still, it was three times higher than the monthly growth rates that we saw in the five years before the pandemic. There's another price index that's published by the Federal Housing Finance Agency that rose about 0.9 percent in September. That was also higher than what we had there before the pandemic as well.

When it comes to the supply front, inventories are still under pressure but with signs of improvement. The Census Bureau estimates that the total stock of vacant housing fell 2.9 percent versus the second quarter of this year and it's down 5.8 percent versus pre-pandemic levels. There's data from the Census Bureau and the American Enterprise Institute that says that there's only one month supply of existing homes for sale at the current sales rate. That's a record low and we've been stuck at this record low for nine straight months now.

When it comes to new single-family homes, things are on an improving trend. It reached a record low of 3.5 months supply in October of last year, but now it's recovered a bit. Now it's up to 6.3 months supply, which is actually above the pre-pandemic level.

Taking all these factors into account, along with what we're seeing in the improving labor market and with interest rates at historical lows, I think the housing market is in for a few more months of high prices and strong sales. But there's definitely downside risks on the horizon.

In the latest University of Michigan Survey of Consumers, 68 percent of people reported that it was a bad time to buy houses. That was the highest share since August 1982. The share of consumers that said that high prices are a reason for their negative sentiment … reached a record high in data that stretches all the way back to 1978. So, having that negative sentiment translate into a slowdown in sales is definitely a downside risk to the economy that we'll be keeping an eye on over the next year. I recommend viewers and listeners keep following this space and reading the Richmond Fed Macro Minute blog for more analysis as the new data come in.

Romero: Well, thank you so much, John. I know that both current and aspiring homeowners as well as policymakers will certainly be watching with interest in the months to come and we so appreciate your insights.

O'Trakoun: Thanks a lot, Jessie.

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