US home prices have steadily increased over the past 10 years, with prices accelerating toward the end of the period.
The Federal Reserve has also recently announced that the housing market shows abnormal trends using statistical models. Does this mean the US is in a housing bubble?
According to the US Census Bureau, the average price of a new house in the US reached $511,000 in February 2022, increasing from $407,500 a year prior.
Growing home prices have raised concerns regarding how sustainable this trend could be and its potential implications on monetary policy.
In particular, a recent analysis by researchers from the Federal Reserve Bank of Dallas has shown that home prices have exhibited explosive, but abnormal behavior, moving away from market fundamentals. So what factors have caused home prices to grow so quickly?
Low housing inventory
Following the Great Recession in 2007-09, the supply of houses in the US grew between 2013 and 2020.
However, the outbreak of COVID-19 (coronavirus) led to the housing supply falling in April 2020. Fewer consumers were looking for new homes, and fewer homeowners were willing to sell a house due to economic and health uncertainties.
While lower demand typically leads to lower prices, the combination of low supply and low mortgage rates resulted in home prices remaining high compared with pre-pandemic levels.
Eventually, demand for houses began to rise in late spring and early summer of 2020, but supply did not recover at the same rate as demand due to supply chain issues and municipal zoning laws.
According to Zillow’s March Home Price Expectations survey, 75.0% of industry experts believe the housing inventory will return to pre-pandemic levels by 2024.
Low mortgage rates
In general, mortgage rates are assumed to have an inverse relationship with home prices: when mortgage rates are high, demand for houses declines, leading to lower prices.
Mortgage rates experienced drastically decline in 2020 and 2021, with the average 30-year mortgage rate being 3.11% in 2020, below 3.94% in 2019. The mortgage rate continued to decline, reaching an average of 2.96% in 2021, according to data by Freddie Mac.
One of the factors affecting mortgage rates is Fed’s monetary policy. While the Fed does not determine mortgage rates directly, its monetary policy may influence mortgage rates.
Following the beginning of the coronavirus pandemic, the Fed used every tool at its disposal to fight the economic shock, including purchasing treasury bonds and mortgage-backed securities, supporting the flow of credit while also leading to lower mortgage rates.
However, Fed’s tightening fiscal policy and historically high inflation have recently pushed mortgage rates up.
According to Freddie Mac, the average 30-year mortgage rate reached an 11-year high of 5.00% on April 14, 2022. As mortgage rates go up, growth in home prices will likely decelerate.
Commodity prices, supply chain and consumer sentiments
While housing inventory and mortgage rates are the two main factors that affect home prices, other variables, including the cost of construction materials, supply chain efficiency and consumer sentiments, also influence prices. In recent years, these factors have contributed to growing home prices.
For example, the producer price index for iron and steel, which are key components in residential construction, grew 71.3% in 2021 alone, according to data by the Bureau of Labor Statistics.
Meanwhile, sourcing issues and consumers’ fears of “missing out” will continue to affect home prices.
Will the housing market crash?
Overall, there are no expectations that the housing market will experience a correction comparable to the one that happened between 2007 and 2009.
The analysis by the Federal Reserve Bank of Dallas indicates that household balance sheets appear in better shape, while excessive borrowing does not appear to drive the housing market boom.
Some key takeaways: While the US housing market won’t likely crash, home prices will likely continue to grow, although at a slower rate. According to the forecast by BMO Capital Markets, home prices are expected to grow 14.2% in 2022 and 4.3% in 2023.
