This week brings the latest round of S&P CoreLogic Case-Shiller Indices, which measure the average selling price of single-family homes across the country. In summary: Sales prices have not slowed or flattened this summer. Instead, prices continue to rise nonlinearly in pretty spectacular ways. The national year-on-year average rose 16.6% in May and rose from 14.8% year-over-year in April.
S&P Dow Jones Indices Managing Director and Global Head of Index Investment Strategy Craig J. Lazzara said: “A month ago I described April performance as ‘really exceptional’ and this month I have no superlatives … the An increase of 16.6% is the highest value in more than 30 years of S&P CoreLogic Case-Shiller data. “
In April, there were five subways at their highest ever value. In May, five other cities – Charlotte, Cleveland, Dallas, Denver, and Seattle – had all-time highs.
But to be honest, there is no longer any region in the country: the year-on-year price gains in all 20 metros were in the upper quartile of historical performance. In 17 of 20 metros, the price gains were in the top decile of all time.
The West Coast had the top three bubbly numbers, with San Diego, Seattle, and Phoenix all rising more than 23% in average retail prices last year.
What is Case-Shiller?
As a brief introduction, the US National Home Price NSA Index measures the 20 largest metropolitan areas in the US and is calculated using a three-month moving average. More specifically, the Case-Shiller measures the 20 largest statistical metropolitan areas, or MSAs. Urban areas and the surrounding suburbs are combined in an MSA.
The moving average is key to our discussion here: everything we see in newly released numbers is already looking quite a bit backwards – not just for the two-month lag itself (e.g. July) – but also taking into account the moving average of the last one Months.
It’s important to keep this context in mind when looking at a metric that is not increasing linearly. Here is a chart of the Case Shiller for the past 14 months:
And here’s the point of view, if we broaden our view to the 12 years after the Great Recession of 2007-2009:
The central theses
The steady increase that was maintained through 2020 has been great and sustainable. Interest rates have been historically low and personal incomes rose along with employment growth. The supply of homes for sale remained a bit underdeveloped as millennials reached their prime buying homes. They became the largest demographic of real estate buyers in the late 2010s.
But this tail curling last year is unsustainable – that is an objective mathematical certainty. Average home sales prices are rising faster than any of the key figures can keep up. Wages do not rise linearly. Interest rates have been hovering at floor levels for a couple of years and can’t really go down (especially given that inflation has been going as fast as it has been for over a decade).
In short, the affordability metrics are moving in the wrong direction: south. We were able to read the tea leaves in May when we noticed the sticker shock that hit the faces of potential homebuyers.
Estimates vary between lenders and different investment sectors, but a fair consensus is that the average home buying power has increased by around 8% over the past year, thanks to rising incomes and slightly lower mortgage rates. But that pales in comparison to an increase in average sales prices of more than 16%.
Here’s where to point your finger
There are a few important factors that are driving prices up hopeful unique and will dissolve soon. The pandemic was the largest of these. COVID-19 initially sent city dwellers looking for a way out of the city and into the suburbs. Your employees as employers largely fueled this turnaround when the zoom economy was in full swing.
It’s hard to gauge how much of the homework trend will endure when COVID-19 finally recedes as a national health concern. But certainly enough companies are still using the remote working train as I write this to motivate a large segment of the population to seek housing in the suburbs and rural areas.
This is one half of the reasons the Midwest has the fastest sales pace in the U.S. The other half of the reason: The Midwest has the lowest average sales price of any region in the country – and people are begging for anything affordable somewhere.
The ripple effect of higher prices
We are already seeing one of the simple but big effects of rising home prices too quickly: people no longer want to pay them.
Lots of people have shrugged and kept renting, half content to wait and see if prices will go down. This is a powerful psychological factor as most of us remember that not so long ago house prices fell … a lot.
The ingredients that caused the big 2007-2009 crash are now absent, so there is a very unlikely possibility that a similar outcome could develop today. Today’s mortgages are not issued without an income verification. The standards put in place by the government and the country’s largest lenders make a fairly robust firewall against worst outcomes.
But sales can and could slow down, despite so many potential buyers. We are already seeing this in the new US Department of Commerce real estate sales information. In the June report, the US hit a 14-month low in sales for the third straight month of declines. The 676,000 reported sales were a huge mistake versus the expected number of 800,000. May’s originally reported number has also been revised down by 45,000 households – another sign of deterioration between the handshake phase and the signature phase.
The data is broken down into four regions – and only the Midwest saw net sales increase in June. The east, south and west (where prices are highest) all saw declines.
Some constraints are easing
Anyone who hopes for an increase in new residential construction may see a glimmer of hope: wood prices have fallen by more than 50% in the last few months. In addition to delivery bottlenecks for molded parts, copper derivatives and labor, the timber prices were a major burden for the building owners. Input costs rose even faster than home sales prices, causing a sharp drop in building permits, which hit a nine-month low in June.
The lower input costs should quickly establish themselves in the hardware stores and help ensure that the necessary influx of new objects remains in motion. But despite the improvement in the supply of housing over the months, it is still not enough to meet the needs of millennial shoppers or the flow of remote workers looking for bigger homes outside of the cities.
For this reason, the average sales prices keep reaching new records despite the solid increase in the available inventory.
It’s always good to keep an open mind when it comes to something unforeseen. There’s no modern precedent for COVID-19 – especially not in a digital economy – so we don’t know how ubiquitous the “escape to the suburbs” trend will be. Nor is there any precedent for all of the incentives and interventions that we have had in recent years and the possible subsequent effects on inflation and mortgage rates.
However, don’t be looking for an incremental property to add to your portfolio – not at these levels. Homes cannot and will not behave like stocks, crypto, or any other asset class. All of these other things can be bought by someone for as little as a few hundred or thousand dollars. This is not the case with single-family homes.
As soon as the price gains are twice as high as the purchasing power gains, the party is as good as over. Expect a plateau as the overall pace of sales slows sharply until inventory levels can keep up with rampant demand. And that will take some time – at least 12 to 18 months given the extreme delays in construction.