Posted by: Josh Lehner | May 27, 2021

How Frothy is the Housing Market?

Housing has been going gangbusters over the past year. However supply constraints and rising costs have slowed the market in the last month or two. Where we go from here is an interesting outcome and while we could/should be at an inflection point, it is tough to get a good read on exactly what is happening. This post tries to make sense of the current lay of the land.

First, there are clear, strong drivers for homeownership today due to the nature of the cycle where the job losses are heavily concentrated among low-wage workers, record low interest rates during the pandemic, and the demographic tailwind of the Millennials aging into their 30s and 40s.

Second, the sticker price for homes sold is up 15-20% in the Portland region since the start of the pandemic. However due to the drop in interest rates, this hasn’t had a material impact on affordability — measured as monthly housing expense as a share of income — until just recently. Record low interest rates at the end of 2020 allowed household budgets to stretch further in terms of home prices while keeping the monthly payment steady. Interest rates fell by one percentage point from late 2019 to late 2020, going from 3.7% to 2.7%. A one percent decline in rates offsets roughly a 13 percent increase in purchase price, while maintaining the same monthly mortgage payment. This means if a household was looking to buy a $400,000 home pre-pandemic, they could afford a $450,000 home during the pandemic. A $500,000 budget became a $565,000 budget, and so on.

You can see the offsetting impact of lower interest rates on higher home prices in our office’s affordability tracker. For all of 2020, affordability essentially moved sideways. Affordability did not worsen. However so far in 2021 that is now starting to change. Interest rates have ticked up from those record lows at the end of 2020 and are settling in around 3% or so recently. This increase of 30 or 40 basis points is not immaterial! And with ongoing price appreciation and higher interest rates, the monthly payment as a share of income is now up a 2-3 percentage points just in the past couple of months. This is at the upper range of normal from an historical perspective, but not yet way out of line.

A complicating factor here is we do not actually know what underlying income growth is for the typical family today. Real-time national estimates for median household income dropped a little bit during the recession and have grown slowly in the past 6-9 months. I am using that income pattern underneath the numbers shown in the chart above for the affordability calculations. However it’s hard to know how accurate those are and we really need to wait for the lagged Census data to confirm or deny. We do know that wage gains have continued apace for those who kept their jobs throughout the pandemic. If underlying family incomes continued to grow in the past year like they were pre-pandemic (~5% annually) then the current state of housing affordability does look a bit different. Instead of being at the upper end of the normal range, current affordability at today’s prices and interest rates is right in line with the historical average. Mathematically that means we could see another 8% price appreciation from here and then be at the upper end of the historical range.

Note I am excluding the impact of the recovery rebates on family incomes. They certainly can help with a larger down payment or other costs, but the bank won’t give you a larger loan due to a one-time rebate. Also note the income used here is median family income and not median household income. The reason is most homeowners are families (72%) with married-couple families accounting for the bulk of that (60% of all homeowners).

Now, given the sticker price of housing is so much higher today, there is increased chatter that the housing market may be in another bubble. While identifying bubbles in real time is challenging, there is no question that the current market is substantially different than the one from the mid-2000s.

In particular, even if buyers are overextending themselves a bit in part due to the belief home prices only go up, the macroeconomic implications today are much less dire. The credit quality of new mortgage loans has never been stronger. Any fallout from the housing market will not have the same spillover into the broader economy or financial system. Additionally today’s market is supply constrained where much of the mid-2000s was tied to speculative pricing and not underlying imbalances in supply and demand.

Even so, one key metric to watch on the bubble front is the differences in housing costs for owning and renting. At a fundamental level, housing is all about having a roof over your head. Households make the best choice for themselves given the various options and costs. But ultimately these costs for owning and renting should move together over time, which is what you see in the historical data even if they do differ at various points in time.

Today, the traditional price to rent ratios are through the roof. This can be a bit disconcerting. But those measures all use the sticker price of home sales and not the underlying monthly housing cost which is sensitive to interest rate changes. If we switch to using the monthly expense and compare with rents, we see a much more stable relationship. That said, given the run up in ownership costs and the somewhat slower rent increases, the price to rent ratio is getting near the upper end of the historical range, albeit a long way from where it was during the actual bubble.

Note that I am using Owners’ Equivalent Rent from the CPI data as the rent inflation measure. If you don’t like OER, and some do not, I have also used the Zillow rent index as a different measure and it shows nearly the exact same pattern in the past 7+ years.

What is the outlook from here?

Inventory remains very low. The adjustments are much more likely to come on the demand side than on the supply side. When ownership costs rise like this and affordability worsens, demand traditionally slows and price appreciation does too. We saw this back in 2018-19 when interest rates rose. A similar pattern is likely underway today. Weekly applications for mortgages have slowed and anecdotal information from builders indicates the cost increases and supply chain delays are starting to weigh on demand some. These are all happening within the past handful of weeks, and aren’t yet part of the broader housing market narrative.

Now, on the supply side, new single family construction activity is the strongest its been since the mid-2000s. It should stay at these higher levels, even with the supply chain constraints. National reports indicate builders are starting to throttle back on new sales due to the uncertain building material prices, and the fact they need to catch up on actually building all the homes they sold recently. As such the headline new construction numbers may soften in the months ahead, even as the underlying fundamentals remain strong. Additionally, the share of current homeowners saying now is a good time to sell is also back to high rates. It is possible existing home inventory will pick up, helping with the overall supply of homes for sale. Of course the problem for homeowners today is if they sell, they need to find somewhere else to live.

Now, these big market adjustments take time. They are not instantaneous in part because every one of us has a slightly different situation in terms of need, income, etc. It is possible, especially given the strong underlying drivers of housing demand, that the adjustment process takes longer than usual, or longer than you might think. Should this occur, and affordability worsens further, and the price to rent ratio diverges more, then, and really only then can the discussion turn to whether another bubble is forming. However today that is far from clear. No doubt the sticker price of homes has risen considerably during the pandemic. However these gains to date are pretty easily explained by higher incomes, strong demographics, and low interest rates.

Finally, one of the main reasons we care so much about affordability is how it relates to population growth and in-migration. Oregon’s ability to grow at a faster pace than most other states is largely about our ability to attract young, working-age migrants who allow local businesses to hire and expand are faster rates. Affordability has been at the top of the list of concerns our office has had in the past decade. Usually it’s not so much that worsening affordability pushes people to pack up and leave so much as it is more of an initial repellent where people looking to move choose to move somewhere else to begin with due to affordability and availability challenges.

For more on the overall housing market, see our office’s latest economic and revenue forecast (starts on PDF pg 21).


  1. Great article. I love seeing housing prices tied to interest rates. One thing you might have mentioned is Oregon’s restriction on rent increases during the pandemic. I don’t know if that has had much of an effect on actually slowing rent increases, but it was an institutional change in the market during the time period of your analysis.

    • Thanks Erik. Hmm. I’m not sure how binding the rent increase legislation has been. What the (imperfect) data shows is rent declines in Portland’s urban core (in part because of all the new units coming online, not because people packed up and left per se) but strong gains in the suburbs. So if there are properties constrained by the legislation, that’s my guess as to where it would be — single family rentals in the suburbs. Will be interesting to track in the years ahead for sure.

  2. There is a strong correlation between low housing inventory and house price growth. Inventory is very low nationally and in many metro areas. This, in isolation, implies continued rapid house-price growth in the near future.

    Another factor to consider when looking at housing affordability in the near future: At some point during the next 24 months, the Fed is likely to pull back on its incredibly easy monetary policies which have been in place for several years (and expanding each month, due to fed balance sheet continued growth). When monetary policy tightening happens, it is likely that mortgage interest rate will rise substantially, which in turn will make buying a home much more expensive. An end to the super-long and super-easy monetary policy party is likely to have many knock-on effects.

    Also, note that the federal tax law changes in late 2017 eliminated the mortgage-interest tax deduction and property-tax deduction for most homeowners, and to an even greater share in Oregon (due to the state’s more heavy reliance on property taxes and personal income taxes). This tax change lowered home affordability relative to income for 2018 and forward, in comparison to prior years. It’s a factor that’s not explicitly accounted for in your first chart “housing affordability”. One prominent effect of this SALT deduction tax change essentially increased housing costs in Portland. Taking this factor into consideration elevates the current housing prices closer to bubblicious territory.

    • Thanks David. I suppose the good news is that inventory looks like it may have found a bottom lately? Hard to know, but there is a little bit of an increase. It’s interesting that the inflows onto the market (new listings) look a lot like recent years, the lack of inventory is much more about stronger level of sales, not fewer new listings. I agree that when interest rates increase, prices will have to slow (unless income growth is very strong). That’s certainly embedded in our office’s home price forecast but not mentioned in this piece. I’m less sure about the MID and SALT impact on the overall market. Certainly itemized tax returns are down a lot nationally, but given the increased standard deduction the net tax impact for most people isn’t much. Now it matters much more at the top end of the housing market, and top end of the income distribution.

  3. Please stay strong for two more months, I have a SFR rental I’m selling.

    I don’t like when it gets quiet like now, that’s the equiv of ringing a bell at top.

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