A couple of quick thoughts on recent home price appreciation.
In graph 1, I estimate a national median gross rent/price yield from Zillow rent and price data. I compare it to the 30 year TIPS [REAL] interest rate (plus 8%). Certainly a case can be made that some of the recent price movement has been related to declining real long term yields. However, without more historical data, this doesn't tell us much. Two measures both moved in a certain direction over a period of time, and so it's easy to match them up on the y-axis.
Here is a longer series with similar measures. Here, I estimate the national average gross rent/price level with total rent/total residential real estate value for owned homes. I also used the CPI rent inflation measure with the Case-Shiller national home price index, with a scaling constant as a second version of the estimate. Both estimates of rent/price yields follow similar trends.
Here, I use a 30 year TIPS bond issued in 1998 and then in more recent years the general estimate for 30 year TIPS yields. Here I only added a 3% spread to the TIPS yields. Part of the difference is that the mean yield is lower than the median yield. (Price/rent is not the same across the market. It is systematically higher where rents and prices are higher.) Part of the difference is that we imposed a one-time shock on housing during the financial crisis, adding a 2-3% spread on housing yields compared to other assets, so the spread in the first graph from 2014 onward is much higher than it had been before.
|Federal Reserve Economic Data | FRED | St. Louis Fed|
When I first started looking at these things years ago, I excused the pre-2006 price increases with this relationship. I still more or less stand by that. It isn't controversial to say that home prices are related to interest rates. In fact, I think it helps clarify the analysis to show that it is specifically real long-term rates that seem to correlate with housing yields. But, even in 2005, that doesn't tell the whole story. Rent/price yields are not uniform across cities. They decrease systematically where rents are high. Some of that might be attributed to expectations of future rent increases. Some of it might be attributed to lower cost of ownership where rent is a product of location rather than structures and services. In any event, before 2000, gross housing yields had been between 6-7% for some time, and after 2000 they continued to be in that range in most cities. In some cities like LA or NYC, they declined to more like 3-4%. The aggregate yield around 5% was an average of a country increasingly becoming bifurcated into at least two different stories.
So, it may be that the correlation between 30 year TIPS and housing yields from 1998 to 2008 overstates the relationship. In most places, the gross housing yield didn't decline as much as the 30 year real rate. Yet, even if one assumes that a 2% spread remains in place between long term real rates and housing yields, the recent drop in real interest rates is enough to support recent home price increases, even if the relationship is slight.
Actually, I think the causality may go both ways a bit. In other work, I have mentioned that housing used to be cyclical in terms of quantity and now, because we have obstructed construction so much, it is cyclical in terms of price. It is hard not to notice a similar regime shift in interest rates. Before 2000, real interest rates were relatively stable, and changes in interest rates were largely related to inflation expectations. Since 2000, real long term interest rates have become strangely volatile.
In the mid-20th century, housing yields remained stable because when rents increased, a lot of new homes were built until rents declined again. All those new units required capital. Mortgages, construction loans, home equity. An increase in demand for investment (in generally safe assets and securities) drove GDP growth higher and put upward pressure on interest rates.
There is a lot of concern about a lack of safe assets, which is driving down interest rates. Homes in California used to be safe assets. They aren't anymore. They are risky investments in a cartel. Mortgages used to be safe assets for investment, but many aren't legal any more, so the trillions of dollars worth of new homes they would have funded, which also would have been safe assets in Texas, Nebraska, and Tennessee, also don't exist.
So, there is an interesting set of interacting variables here. If inflation rises, I don't think that will have much effect on real home prices or construction activity. If real rates rise, which will be associated with real economic growth (and probably with a mitigation of short-run inflation), then it should have a moderating influence on home prices. But, unless mortgages can flow, multi-unit projects can be easily approved, and construction can run hot, then rents will continue to rise and long-term real interest rates will continue to be limited. In that case, it seems like a "hot" market is likely to remain, with housing growth (but at historically low construction rates) and high prices (low housing yields), while the "have nots" who are under the "tyranny sincerely exercised for the good of its victims" will face rising rents.
I suspect that a construction boom would both lower rents and raise real long-term interest rates. But, the boom must come first. In the meantime, housing is in a peculiar space, where we should expect there to be some sensitivity to rising rates if the economy continues to recover, yet also housing yields continue to retain at least a 2% spread to long-term 30 year rates, compared to pre-crisis norms, so that nobody should expect home prices to revert to earlier relative levels (especially as rents continue to rise).
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