Considering it’s size and importance, the housing market seems very poorly understood. It sure seems like we have a supply problem, but on the flip-side we are currently at a record number of housing units per capita. We apparently had new household formation during Covid but didn’t we also lose a million people? There is already talk of homebuilders pulling back on production despite extraordinary margins, how is that possible?
I don’t think we know how many people own unoccupied 2nd/3rd/4th homes and that seems relevant. Strikes me that part of the problem is when homes have rising real values (after taxes & maintenance) there is no perceived cost to hoarding.
Or maybe if you print enough money it simply looks like there are supply shortages everywhere.
In terms of what to do, better zoning is obvious but clearly can’t happen. All the “next best” ideas are basic some version of “subsidize housing and hope it produces a supply response.” That logic seems terrible - imagine subsidizing SUVs in the hope it gets us to drill more oil!?
With money itself a commodity used as a store of value with a negative real interest rate the analysis becomes different. When the real interest rate (nominal interest - inflation -- including energy and food) is negative by over -7%, as it is now), if you can borrow in nominal dollars at any interest rate less than the inflation rate , it makes sense to borrow to the max and invest in any "real" asset from land to housing or even scrap aluminum. You will make a profit of 3% or more on other peoples money that you borrow. This assumes the FEDs will keep the inflation rate high.
This would really be a bet that the FEDS will repeat the '70s and be political pawns, while allowing the real interest rate to remain negative as inflation eat the store of value in money and gives it to big debtors like the government itself. As inflationary instability of the '70s forced people to protect themselves against this theft of value with COLA (cost of living adjustments) the inflation rates became a solid double digit amount with contracts tied to inflation indexes, the government effectively stole enough "value" to pay down a lot of debt from Vietnam and the Great Society spending blowouts.
In other smaller countries when the local government debases the currency to steal value from the citizens, the citizens can shift to using dollars. What will happen when the "reserve" currency for the world is debased?
If the FEDS don't raise the nominal interest rate faster than the inflation rate there is every reason to expect the system is unstable and inflation will go the way of the late '70s making the correction impossible and transferring wealth to owners of "real" assets of all kinds and big debt holders like Trump where everything is leveraged.
With housing being a store of value available to most citizens at high leverage, negative real interest rates will increase demand creating housing shortages as it is in the self-interest of the citizen to buy more highly leveraged property than they need or desire, especially with government backed and subsidies loans typical of housing.
Running the real interest rate to inflation + 2 to 3% (a nominal 11+%) would create housing demand decreases and downsizing would create effective supply increase. Of course the huge spending debt and fiscal irresponsibility of the government will become apparent.
Arnold, thanks for reading and for commenting! Back before my books were even published, I enjoyed trading notes on these topics with you. I hope we get back in the habit of doing that again.
This is basically also how I would think about the relationship between rent and price. You have outlined well some of the reasons why we might see a positive relationship between rising rents and rising price/rent ratios. I wrote that statement intentionally. (“For each 1% increase in rents, you always see more than a 1% increase in prices.”) I did not mean it to be a conceptual or theoretical assertion. The reason I stated it so bluntly is that after years of slicing and dicing this data, I cannot think of a single example where systematically rising rents on some dimension were not associated with rising price/rent ratios.
You can see this across metro areas at any given point in time in Figure 4 and Figure 5 of my post on rising rents and prices. You can see it within metro areas in Figure 12 and Figure 13. In Figure 13, you can see that the price/rent ratio has become pretty flat in a lot of metro areas, probably due to some of the expectations you write about in your post. But, I haven’t seen a price/rent ratio pattern become systematically negative in a metro, where price/rent ratios are lower in ZIP codes with higher rents or incomes.
It is also true over time. Over the past 50 years, the portion of GDP going to rental expenditures has increased by 30%, and real estate values/GDP have doubled. Increasingly, I have come to see that 30% rise in rents as the primary cause of the doubling in prices. You can see how that is likely the case in Figures 4 and 5, because it has happened proportionately across MSAs. In other words, where rents have risen 60%, prices have likely tripled, etc.
This is one of the big blind spots in the academic literature about the housing boom and bust. As far as I can tell, nobody accounts for this relationship at all. The issue is so far off the radar that in most articles, rent is simply ignored. One important place where the error is made explicitly is on page 158 of the Financial Crisis Inquiry Commission (FCIC) report. They wrote,” the cost of owning rather than renting was much higher than had been the case historically: … In some cities, the change was particularly dramatic. From 1997 to 2006, the ratio of house prices to rents rose in Los Angeles, Miami, and New York City by 147%, 121%, and 98%, respectively.” Ironically, what the FCIC had inadvertently done there is explicitly identify 3 metros that had seen the highest rent inflation over that period. That was why they were the best examples of rising price/rent ratios. The FCIC went on to spend another 400 pages reaching around the elephant in the room that they had now agreed not to notice, trying to explain how prices could have changed so much.
The long term cost of housing should track the long term inflation rate. Any deviation would be explained by changes in consumer preferences. However, any price increases in housing above the inflation trend must be capped by affordability. At the end of the day, people have flexibility in their housing - people can trade down in housing quality, rent basement apartments and stay with a friend or family member.
The volatility of house prices since 2001 correlate with extremes in US policy. Post 9/11 interest rates were slashed and the Bush administration, with the eager support of lenders, pushed a pro-housing agenda. There was a financial bubble, driving by home loans, and when this bubble cracked there was a housing depression. Between 2011 and 2020 the housing industry regained its confidence. Than in 2020 interest rates were dropped to zero and money poured again into housing. We had another bubble - more a buying frenzy - and now that bubble is popped. Homes priced to sell with mortgage rates below 3% now must sell with mortgage rates above 5%. At the margin this requires prices to drop.
I am concerned with government / social agendas that appear to be anti-housing. I concur that zoning can be unnecessarily restrictive. What I see as a larger issue is government blocking development. They do this by adding building restrictions and by enabling litigation on environmental and social concerns. This interference blocks small developers from the market and adds to the overall costs of housing.
Erdmann has great data - but I don't believe all his analysis. He notse how housing is both a consumer (use value) product AND and investment. Even for the rich who own multiple houses.
Housing is part of the Investor Price Index asset-hyper inflation that we've been having since the 2008 crash. As the asset price of housing goes up, it pulls the use-price rent with it. I don't even try to prove this, but Erdmann doesn't convince me it's rent price first, then asset price.
He also is good in using ZIP code data - altho for big cities, individual school zone area is likely more significant as well as more difficult to find. The big increases in house prices are those city & suburban houses in good school districts. LA city schools district is too big, the smaller high school community borders are more important.
His 4 Demand categories are interesting, but might not be comprehensive enough to cover Detroit.
Demand outstripping capacity. Sales high, homes under construction increasing.
Demand normalizing. Sales declining, homes under construction high but decreasing.
Demand overcorrecting. Sales declining, homes under construction declining.
Demand excessively overcorrection. Sales bottoming, homes under construction declining, prices declining.
But the national trends aggregate different school district markets, so it remains more Location than Erdman credits.
I'm in Miami where the vast majority of buildings are slab on grade/CBS, in other words, lots of concrete. Concrete is next to impossible to source in a timely fashion this year, it's also very expensive. Also, virtually every home built in this region features impact doors and windows, which currently have a lead time of 6 to 8 months. It's hard to seal a building's envelope and start your fit and finish without windows, which means even if you're hustling on all other disciplines, you're going to hit a long standstill if you are not on your window order extremely early. Labor is another issue altogether.
My point here is that the sudden increase in average build time is indeed almost entirely supply-chain related. All you need are one or two of these quirky supply issues in large markets (e.g. South Florida) to put a dent in national averages. I would not be surprised if the 2022 numbers are worse.
"Homes have taken 6-7 months to construct for decades, until 2021. It currently stands at 9.7 months.
As he points out, this is symptomatic of supply bottlenecks."
Or labor bottlenecks. I have a neighbor who is a builder who complains about not being able to recruit and retain full crews at a wage viable for the business. Working with partial crews to cope would tend to slow things down.
Considering it’s size and importance, the housing market seems very poorly understood. It sure seems like we have a supply problem, but on the flip-side we are currently at a record number of housing units per capita. We apparently had new household formation during Covid but didn’t we also lose a million people? There is already talk of homebuilders pulling back on production despite extraordinary margins, how is that possible?
I don’t think we know how many people own unoccupied 2nd/3rd/4th homes and that seems relevant. Strikes me that part of the problem is when homes have rising real values (after taxes & maintenance) there is no perceived cost to hoarding.
Or maybe if you print enough money it simply looks like there are supply shortages everywhere.
In terms of what to do, better zoning is obvious but clearly can’t happen. All the “next best” ideas are basic some version of “subsidize housing and hope it produces a supply response.” That logic seems terrible - imagine subsidizing SUVs in the hope it gets us to drill more oil!?
With money itself a commodity used as a store of value with a negative real interest rate the analysis becomes different. When the real interest rate (nominal interest - inflation -- including energy and food) is negative by over -7%, as it is now), if you can borrow in nominal dollars at any interest rate less than the inflation rate , it makes sense to borrow to the max and invest in any "real" asset from land to housing or even scrap aluminum. You will make a profit of 3% or more on other peoples money that you borrow. This assumes the FEDs will keep the inflation rate high.
This would really be a bet that the FEDS will repeat the '70s and be political pawns, while allowing the real interest rate to remain negative as inflation eat the store of value in money and gives it to big debtors like the government itself. As inflationary instability of the '70s forced people to protect themselves against this theft of value with COLA (cost of living adjustments) the inflation rates became a solid double digit amount with contracts tied to inflation indexes, the government effectively stole enough "value" to pay down a lot of debt from Vietnam and the Great Society spending blowouts.
In other smaller countries when the local government debases the currency to steal value from the citizens, the citizens can shift to using dollars. What will happen when the "reserve" currency for the world is debased?
If the FEDS don't raise the nominal interest rate faster than the inflation rate there is every reason to expect the system is unstable and inflation will go the way of the late '70s making the correction impossible and transferring wealth to owners of "real" assets of all kinds and big debt holders like Trump where everything is leveraged.
With housing being a store of value available to most citizens at high leverage, negative real interest rates will increase demand creating housing shortages as it is in the self-interest of the citizen to buy more highly leveraged property than they need or desire, especially with government backed and subsidies loans typical of housing.
Running the real interest rate to inflation + 2 to 3% (a nominal 11+%) would create housing demand decreases and downsizing would create effective supply increase. Of course the huge spending debt and fiscal irresponsibility of the government will become apparent.
Arnold, thanks for reading and for commenting! Back before my books were even published, I enjoyed trading notes on these topics with you. I hope we get back in the habit of doing that again.
This is basically also how I would think about the relationship between rent and price. You have outlined well some of the reasons why we might see a positive relationship between rising rents and rising price/rent ratios. I wrote that statement intentionally. (“For each 1% increase in rents, you always see more than a 1% increase in prices.”) I did not mean it to be a conceptual or theoretical assertion. The reason I stated it so bluntly is that after years of slicing and dicing this data, I cannot think of a single example where systematically rising rents on some dimension were not associated with rising price/rent ratios.
You can see this across metro areas at any given point in time in Figure 4 and Figure 5 of my post on rising rents and prices. You can see it within metro areas in Figure 12 and Figure 13. In Figure 13, you can see that the price/rent ratio has become pretty flat in a lot of metro areas, probably due to some of the expectations you write about in your post. But, I haven’t seen a price/rent ratio pattern become systematically negative in a metro, where price/rent ratios are lower in ZIP codes with higher rents or incomes.
It is also true over time. Over the past 50 years, the portion of GDP going to rental expenditures has increased by 30%, and real estate values/GDP have doubled. Increasingly, I have come to see that 30% rise in rents as the primary cause of the doubling in prices. You can see how that is likely the case in Figures 4 and 5, because it has happened proportionately across MSAs. In other words, where rents have risen 60%, prices have likely tripled, etc.
This is one of the big blind spots in the academic literature about the housing boom and bust. As far as I can tell, nobody accounts for this relationship at all. The issue is so far off the radar that in most articles, rent is simply ignored. One important place where the error is made explicitly is on page 158 of the Financial Crisis Inquiry Commission (FCIC) report. They wrote,” the cost of owning rather than renting was much higher than had been the case historically: … In some cities, the change was particularly dramatic. From 1997 to 2006, the ratio of house prices to rents rose in Los Angeles, Miami, and New York City by 147%, 121%, and 98%, respectively.” Ironically, what the FCIC had inadvertently done there is explicitly identify 3 metros that had seen the highest rent inflation over that period. That was why they were the best examples of rising price/rent ratios. The FCIC went on to spend another 400 pages reaching around the elephant in the room that they had now agreed not to notice, trying to explain how prices could have changed so much.
Current mortgage rates are 5.7%. 30 year t-bonds are 3.25%. So they aren't really equivalent.
Mortgage interest is tax deductible. I pay taxes on t-bond interest.
Home appreciation is tax free. Asset accumulation and dividends are subject to taxes.
If rates increase I'm locked in at a lower rate. If they decrease I can re-finance.
The home remains one of the best tax adjusted inflation hedges out there.
The long term cost of housing should track the long term inflation rate. Any deviation would be explained by changes in consumer preferences. However, any price increases in housing above the inflation trend must be capped by affordability. At the end of the day, people have flexibility in their housing - people can trade down in housing quality, rent basement apartments and stay with a friend or family member.
The volatility of house prices since 2001 correlate with extremes in US policy. Post 9/11 interest rates were slashed and the Bush administration, with the eager support of lenders, pushed a pro-housing agenda. There was a financial bubble, driving by home loans, and when this bubble cracked there was a housing depression. Between 2011 and 2020 the housing industry regained its confidence. Than in 2020 interest rates were dropped to zero and money poured again into housing. We had another bubble - more a buying frenzy - and now that bubble is popped. Homes priced to sell with mortgage rates below 3% now must sell with mortgage rates above 5%. At the margin this requires prices to drop.
I am concerned with government / social agendas that appear to be anti-housing. I concur that zoning can be unnecessarily restrictive. What I see as a larger issue is government blocking development. They do this by adding building restrictions and by enabling litigation on environmental and social concerns. This interference blocks small developers from the market and adds to the overall costs of housing.
Erdmann has great data - but I don't believe all his analysis. He notse how housing is both a consumer (use value) product AND and investment. Even for the rich who own multiple houses.
Housing is part of the Investor Price Index asset-hyper inflation that we've been having since the 2008 crash. As the asset price of housing goes up, it pulls the use-price rent with it. I don't even try to prove this, but Erdmann doesn't convince me it's rent price first, then asset price.
He also is good in using ZIP code data - altho for big cities, individual school zone area is likely more significant as well as more difficult to find. The big increases in house prices are those city & suburban houses in good school districts. LA city schools district is too big, the smaller high school community borders are more important.
His 4 Demand categories are interesting, but might not be comprehensive enough to cover Detroit.
Demand outstripping capacity. Sales high, homes under construction increasing.
Demand normalizing. Sales declining, homes under construction high but decreasing.
Demand overcorrecting. Sales declining, homes under construction declining.
Demand excessively overcorrection. Sales bottoming, homes under construction declining, prices declining.
But the national trends aggregate different school district markets, so it remains more Location than Erdman credits.
I'm in Miami where the vast majority of buildings are slab on grade/CBS, in other words, lots of concrete. Concrete is next to impossible to source in a timely fashion this year, it's also very expensive. Also, virtually every home built in this region features impact doors and windows, which currently have a lead time of 6 to 8 months. It's hard to seal a building's envelope and start your fit and finish without windows, which means even if you're hustling on all other disciplines, you're going to hit a long standstill if you are not on your window order extremely early. Labor is another issue altogether.
My point here is that the sudden increase in average build time is indeed almost entirely supply-chain related. All you need are one or two of these quirky supply issues in large markets (e.g. South Florida) to put a dent in national averages. I would not be surprised if the 2022 numbers are worse.
"Homes have taken 6-7 months to construct for decades, until 2021. It currently stands at 9.7 months.
As he points out, this is symptomatic of supply bottlenecks."
Or labor bottlenecks. I have a neighbor who is a builder who complains about not being able to recruit and retain full crews at a wage viable for the business. Working with partial crews to cope would tend to slow things down.