No End in Sight for Housing Prices

Inflation last month reached the highest level it’s been in years while the Fed and most economists continue to suggest that it’s transitory. That means they think that inflation is high now because of the current unique circumstances, but that it will go back to normal as soon as things get, um, well, back to normal. I’m not sure the same can be said for housing prices.

You see, prices on many goods and services declined last year due to the decrease in demand for those goods and services as economic shutdowns prevented even willing consumers to spend any money. Now, the comparisons to last year look high, but the argument is that most of the upside inflation data has to do with those new baseline comparisons.

Here’s an example: if the price of a good goes from $2 to $1, then jumps back up to $2.02, then the most recent increase would be more than 100% even though prices compared to the original $2 are only higher by $0.02 (1%). This is the baseline affect the Fed and other economists are referring to.

But not all goods and services are exhibiting the same pricing dynamics. Oil prices are back up because demand has surged while supply is still lagging. In the US alone, the number of oil rigs in production are well below the level that were operational in early 2020 and it could take some time to get production back up – although OPEC just announced production increases that could help mitigate further oil price increases. If it works, then this would be a good example of a transitory inflationary effect.

Similarly, housing prices are surging as demand for single family homes spiked during the pandemic. The migration from crowded urban centers to more spacious and Covid-friendly suburbs drove up demand for homes at a time when building of single family homes had been at multi-decade lows. The result again was an increase in demand without a supply source to satisfy that demand. The result: price increases often topping 20% annually.

This is pricing out many would-be buyers – at least until builders are able to ramp up their activity – which is also being hampered by rising input costs and lack of labor. Again, this could also be transitory. But is transitory 6 months? One year? Two years? It takes time to build homes.

The problem is that I don’t think housing prices are anywhere near their peak, and rental rates, measured by owner’s equivalent rent (OER), a CPI component, is now starting to spike also. The FHFA House Price Index (HPI) only recently reached the ratio to OER that preceded the last housing crash – but the Case/Shiller index is still well below those levels. Now that rents are increasing, the ratio for both of those indexes will likely stay well below the levels they reached in 2006. Which means, as rental rates rise, home prices have further to run.