Shambling away from affordability again, July 2023

The bounce back in prices this year has dragged up both the valuation index, and the monthly payment index (the latter to a new high for the cycle, thanks to stubbornly high mortgage rates).

In the prior valuation update, I discussed some potential long-term outcomes. My views haven’t really changed on that issue so I refer you to that article if you’re interested.

Here I’ll share some thoughts on how prices have held up so well, despite the dramatic rise in mortgage rates. (With the disclaimer that I’m not a housing economist, or any kind of economist… these are just the musings of an amateur).

To begin with, you can toss all San Diego-specific rationales out the window. National home prices have held up a bit better than San Diego prices, both from their low point earlier this year and their high point in 2022:

I think there are two main factors at work here.

First, the job market is on fire. Here are some stats. (Yes it’s Twitter, but the author is a legit macro dude. No, I will not call it “X”).

Second is the oft-discussed “rate lock”: people with pre-2022 mortgages don’t want to sell and give up their low rates. And thanks to the healthy job market, few of them have to. (To be clear, I’ve definitely been surprised by the strength of this effect!)

So the rise in mortgage rates did crater demand. But the rate lock/strong job market combo cratered supply just as much. Here are some charts showing that both supply and demand are near historical lows:

These two shocks have offset each other such that, despite the underlying craziness, prices are just kind of creeping up as if things were normal.

What could disrupt this equilbrium? I think the biggest vulnerability would be a serious weakening in the job market. (I’m not predicting that will happen, just that it would upset the equilbrium if it did). This would result in fewer buyers, as well as more sellers — the desire to hang onto a sweet mortgage rate doesn’t amount to much someone is forced to sell due to job loss or relocation.

It’s harder to assess the potential impacts of interest rate changes, because of the offsetting effects involved. A reduction in rates increases affordability/demand, but also increases supply as homes become un-rate-locked. And vice-versa for rising rates.

What about if rates just stay where they are? Again, there are some potential offsetting effects.

• On the positive side, higher rates imply higher inflation in rents and incomes, which would be supportive of nominal (though not necessarily real) home prices.
• On the negative side:
  • The farther we get from the low-rate salad days, the more homeowners will have post-2022 mortgage that aren’t subject to rate lock, potentially freeing up supply.
  • Also, it seems to me that a lot of buyers are ignoring the steep monthly price tag and buying now with the intent to refi “when” rates go back down. The longer rates stay high, I suspect, the smaller this contingent will get, as more people will start to wonder whether that “when” is actually an “if.”

So those are my thoughts on the near term. Very short version: watch the labor market.

For the longer term, the very brief version is that the following all seem like plausible outcomes (listed in descending order of likelihood IMO): a decline in the monthly payment index, a decline in the valuation index, and a decline in nominal prices. I went into more detail on those possibilities in the prior installment.