Most Americans have more than a casual interest in the price of their home given that home equity represents 45% of the median homeowner’s net worth. Thanks to Nobel Prize winner Robert Shiller, we have home price data from 1890 onward although I will focus on the period 1950-2024 to keep the analysis manageable.
Over that period, home prices increased at an average annual rate of 4.7%. Interestingly, there were only two periods of declining prices. In 1990 and 1991, prices fell a modest .9%. More dramatically, prices fell 25.8% between 2007 and 2011. Both followed periods of outsized price increases.
While more stable than stocks and even bonds, home prices do fluctuate from year to year raising the question of whether we can identify factors that explain annual differences.
The second chart adds a line depicting annual changes in the Consumer Price Index. Housing prices tracked the CPI very closely until the early 1980’s suggesting that the overall level of inflation was a key determinant. However, that relationship broke down around 1983, and volatility increased along with significant price surges in the mid 1980’s, 1998-2006, 2012-2017, and 2020-2023. What was driving prices during these periods?
The 30 year fixed mortgage rate fell from 16.9% in 1981 to 12.8% during mid- 1983. While 12.8% is very high by any standard, that decline in rates did enhance affordability modestly. When combined with first home purchases by baby boomers, improved affordability stimulated a surge in demand leading to a cumulative increase in home prices of 42% from 1984 through 1988. Mortgage rates declined steadily from there hovering between 5% and 8% in the early 2000’s. This period of moderate rates was also characterized by lax lending standards, housing speculation, immigration, and initial home purchases by Generation Xers. The result was tremendous demand for housing and a cumulative price increase of 111% between 1998 and 2006. Next, the 2012-17 surge was driven by still lower mortgage rates which fluctuated between 3.5% and 4%. Moreover, there was a combination of pent-up demand and low supply due to the trauma inflicted on both buyers and builders by the Great Financial Crisis. Prices rose 44% during this six year period. Many of the same factors were present in the most recent surge in which prices rose 53% between 2020 and 2024. Mortgage rates fluctuated between 2.5% and 5% for much of this period, and construction of new homes remained constrained. Supply was also restricted by the fact that many existing homeowners were unwilling to move given low interest rates on their current mortgage. Finally, the Covid pandemic induced some people to leave cities for more rural settings, and work from home created demand for larger homes with more amenities. In summary, many factors were involved in these price surges, but they had low or declining mortgage rates in common.
Where are we today? Based on current prices and interest rates, 75% of U.S. households do not have sufficient income to purchase the median single family home. Another indicator of the difficulty facing potential buyers is the National Association of Realtors Affordability Index which has declined by more than 50% over the past decade. And, various estimates suggest we have a shortage of as many as 6.5 million housing units nationally. This shortage is a function of many factors including restrictive zoning regulations, unwillingness of developers to take risk, inflation in the cost of building materials, labor shortages, demographics, and regulation. Hopefully, mortgage rates will decline which would help somewhat with the affordability problem. Unfortunately, the housing shortage is a long-term issue that will require thoughtful solutions and cooperation between the housing industry and government at all levels.