Oregon Office of Economic Analysis

This morning the S&P / Case-Shiller Home Price Indices for January 2013 were released and showed continued home price appreciation across the major cities in the US, including Portland. On a year-over-year basis, the 10 City Composite index is up 7.3% from January 2012, while Portland is up 8.3%. Prices in Portland are effectively back to the same levels as seen in Spring 2005, based on the index. They are up that same 8.3% from the bottom, coincidentally reached last January, but are still down around 23% from their peak in 2007. This continued home price appreciation is just another confirmation that the housing market recovery is here, and is boosting household balance sheets as asset values rise.

As both a major cause and consequence of the Great Recession, our office and our advisors have spent a considerable amount of time thinking about and discussing the housing market and its outlook. One common theme that emerged was that it was highly unlikely we would have another asset bubble in housing again. There was a resetting of consumer expectations in the value of homes, we took this large downward plunge as the bubble burst and moving forward as the economy improved, so too would the housing market. As jobs returned and population grew, this would lead to increased demand, which would lead to more new construction, more homes for sale and modest home price appreciation just a bit over the rate of inflation. While our outlook for the medium and longer run housing market remains this way, in these early stages of the housing market recovery we haven’t seen this nice, clean cut, ebb and flow of the supply and demand. In fact, there is increasing evidence that the rising demand is taking home builders by surprise, which may mean the market will be more supply constrained in the near future. We’ve known for awhile now that we’re actually under-building new homes, even after accounting for the run-up in new construction during the bubble (see this post from nearly 2 years ago.)

Why is this and why are we seeing such strong home price appreciation in recent months? I don’t have all the answers but a lot of it really comes down to basic Econ 101, supply and demand. First, one major factor that does affect the demand for housing is the ability to finance the mortgage. Mortgage rates continue to hover in the mid 3 percent range, and possibly more important today, lending standards are loosening somewhat. You still are required to fill out paperwork documenting your income and the like – I haven’t heard of any recent NINJA loans – but the banks and brokers are underwriting mortgages for a somewhat wider audience than in recent years. This is a welcomed development and does support housing demand in the market.

The graph below shows annual data for Metro Portland based on the year-end RMLS reports. The actual data here are not perfect measures of supply and demand but they are the data I was able to pull off the reports and certainly act as good proxies for the real underlying series. I will not rehash the changes over the past decade, however it is hard to remember, at least for me, that 2005 was the top of the buying market in terms of volume. 2007 was the top of the market for prices and this continued price appreciation from 2005-2007, even in the face of declining demand which was supported through the loans with the loosest underwriting standards and disproportionately ended up in foreclosure down the road, spoke to the bubble mentality. In fact, as Case and Shiller wrote back in 2004:

During a housing price bubble, homebuyers think that a home that they would normally consider too expensive for them is now an acceptable purchase because they will be compensated by significant further price increases.

I want to focus on that last change, from 2011 to 2012, as this is the most interesting and most important aspect in the housing market today. We are seeing an increase in housing demand (red line increasing). Household formation has picked up, investors are looking for deals and to buy in bulk for rental properties, and buyers want to get in at the bottom of the market. Additionally, we are also seeing declining inventory of homes as new construction, while growing briskly, is down considerably from anything approaching a normal level. The market has worked through the majority of existing supply and homeowners who would like to sell, also do not want to sell at the bottom of the market. Active residential listings in RMLS in early 2013 are down nearly 50% from two years ago. When you have increasing demand and decreasing supply, the natural market movement is for price increases.

This is the basic story of the housing market today. The good news (for sellers, underwater homeowners, the economy more generally) is the bottom of the housing market is clearly in the past. We’re seeing stronger than anticipated home price appreciation today given this somewhat clunky ebb and flow in supply and demand. However over the medium and longer term we expect the market to move back into an equilibrium of steady increases in both supply and demand, resulting in price appreciation more in-line with the rate of inflation. Until we reach that place, we can likely expect more of the same, so long as the economic expansion continues, leading to stronger housing demand. Additionally, as home values rise and more and more homeowners come above water on their mortgages, this will likely help increase supply. These developments are both very interesting and important to the economy overall, so keeping track of the market is high on the priority list as we begin to develop the next forecast.