Everybody knows that mortgage rates are by far the dominant force in determining home prices. The steep Fed-induced drop that sent the 30-year from nearly 5% in the fall of 2018 to under 3% from late 2020 to the close of 2021 ignited never-before-seen gains of nearly 33% in just two years. Likewise, Central Bank’s tightening campaign that’s almost tripled rates to 7.3% as of November 15 halted the boom and started a brief slide that lasted from June to December of last year. Since then, prices have rebounded modestly but are still just a point or two higher than at the peak. After years of beating inflation by a huge margin, the value of capes, colonials and condos overall have waxed a lot more slowly than the CPI measuring the prices of all goods and services that Americans buy.
While changes in mortgage rates—and we’ve seen gigantic ones in both directions in the past few years—guide housing values nationwide, they don’t explain the huge divergence in the performance of different metros in both the boom and flattening periods. Home loans are a national market. Folks buying a new or existing dwelling pay roughly the same monthly nut for each $1000 they borrow from coast to coast, since virtually everyone but the wealthy get their mortgages from one of the three programs that dominate single family home lending, Fannie Mae, Freddie Mac, and the FHA. So all homeowners get approximately the same lift or hit from a drop or rise in the costs of that U.S. institution, the benchmark 30-year home loan.
Since changes in mortgage rates help or hurt all metros pretty much equally, what are the forces that explain that in the same periods, at the same home loan costs, some metros log far more appreciation than the national averages, while others do much worse than the norm? To answer that question, Ed Pinto and Tobias Peter, co-director of the American Enterprise Institute’s Housing Center, conducted an in-depth study of America’s 100 largest metros over nine time periods from 1980 to mid-2022.
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The idea? To find out what forces made prices increase 242% in Boise since January 2012 versus the rise of just 73% in Baltimore,” Pinto told Fortune. “In finding those fundamental levers, we’re able to explain why the market’s remained relatively resilient despite the giant spike in rates. The macro factors that traditionally support prices are still strong in many markets, and the big winners are still benefiting from a phenomenon that gained speed in the pandemic and persists today, the big migration to sunbelt and other relatively low-cost cities.”
Over time, the two biggest factors are income growth and new construction
Pinto and Peter examined the influence of 18 metrics in the 100 metros over those 42 years to pinpoint the ones exerting the biggest sway on their prices. How a metro fares in four of them, he discovered, accounts for how its price trajectory compares with the national averages and the course of the individual cities. The first of the Big Four is income growth. It’s the principal driver of demand. “The category’s defined as the metro’s annual change in total wages as reported by the Census Bureau,” he says. “It consists of the raises the existing residents are getting plus the incomes of net new people moving to the city. If those newcomers are making more than the average wages, that really turbocharges the market.” The second factor: the degree of new construction. That’s the supply side. “It works in the opposite direction from income increases,” Pinto notes. “The more new houses that are being built, the greater the restraint on prices. Big overall wage gains in a market with little new construction guns prices. In places where incomes are growing, high levels of building tends to tamp down prices.”
The third is leverage. “In periods where Fannie, Freddie and the other government-sponsored mortgage agencies loosened the rules, they artificially inflated demand by allowing buyers to pay a much larger shares of their income in carrying costs,” says Pinto. “So on the same salaries, they could afford a higher-priced house than under the tighter regime. People suddenly have more dollars to spend on housing, causing prices to jump.” The big leverage allowed in the late 1980s and the early ‘aughts, epitomized by the spread of notorious “liar loans,” lit the fires that followed. In both periods, the rise in leverage was far bigger in the 1980s in the west and northeast, and in the prelude to crash, it was the sand states of Florida, Nevada, Arizona and California. The Dodd-Frank law and other reforms have greatly tightened the “debt to income” requirements, says Pinto, so that leverage hasn’t been a significant factor in the price equation in the past fifteen years. But, he adds, “Fannie, Freddie and FHA can always turn the leverage faucet on or off, so it may rear again.”
The fourth determinant is migration. It’s measured as the net number of people, including kids, measured by IRS data, who move to a new metro as a percentage of the existing residents. “It’s obviously related to income growth since new workers are adding to total wages in a city,” says Pinto. “In the work from home economy, people can move to less expensive housing markets from states like California, and bring their paychecks with them. But the migration phenomenon has a different dimension that’s gotten much more important since the onset of the pandemic.” He explains that since the outbreak, retirees have been moving from northern cities to the sunbelt in droves. “During the pandemic, they wanted to relocate from the dense urban areas to get away from the congestion,” observes Pinto. “Keep in mind that the biggest homebuying cohort in America now are the Baby Boomers. They’re moving south and tapping their big savings to buy homes.”
Since their incomes flow not from wages but pensions and investments, those extra dollars add to the reported wage increases. But for Pinto, the influx of new residents is a good proxy for the extra bags of money that the retirees are bringing to a metro, and that trend’s a new, and sizable source of the the extraordinary gains across America’s southern tier.
Appreciation was strong in 2011 to 2020 due to potent wage growth and low building
To understand why housing holds steady despite the surge in rates, it’s instructive to study the two most recent periods in the Pinto-Peter analysis, the post Great Financial Crisis rebound from 2011 to 2020, and the pandemic-interlude explosion spanning the start of 2020 to Q2 to 2022. In the earlier timeframe, the biggest appreciation happened mainly in the southeastern and southwestern cities. In that period, the three cities posting the biggest price gains were Boise, Las Vegas and Reno, all at around 12%, double the national average, for ten years! Austin gained over 8% a year, as did Sunshine State stars Orlando and North Port, and the Golden State stalwarts Riverside and Stockton. All of these cities featured income growth well above the national average of 4.4%, with Stockton at the low end of big price movers adding 5.5% in total wages, and Provo leading at 9.2%. “Cities in Nevada, Arizona and Texas benefited greatly from a big outflow from the expensive California cities, a trend that substantially increased their total wages,” says Pinto.
A problem that would later get much worse was already swelling prices much faster than incomes in the many hot markets: A chronic shortage of new housing. For example, the two metros that added most to their stocks were Austin and Provo, yet prices in each still rose 8.1%. The reason: their respective income increases of 7.2% and 9.2% overwhelmed the rise in supply. A rare case where ample building powerfully restrained prices was Raleigh, where despite 6.7% wage growth, prices waxed a relatively moderate 5.4%.
By contrast, dozens of metros from Des Moines to Louisville to Greensboro, and from Omaha to Philadelphia to Buffalo, achieved lower than average wage growth, and although building was also subdued, their price increases all trailed the national norm. Pinto’s takeaway: What the shooting stars had in common was fast-rising pools of wages that swamped the onset of newly-build homes, while the laggards suffered from sub-par wage performance. It’s important to note that the bargain mortgages that benefited all markets made this a great period for housing—witness the national average price gain of 5.8%, a number that easily beat inflation.
In the 2020 to mid-2021 span, the annual price marc far outstripped those of the previous decade. And once again, the conquerers were the cities boasting the biggest wage growth. Boise, Austin and Provo all reprised as big winners, each garnering over 10% wage increases that raised their prices around 25% on an annual basis. But the most amazing shift is what might be called the “Florida factor.” Nine of the fifteen cities posting the biggest price increases are Floridian. Naples, North Port, Cape Coral, and Lakeland all notched increases of 24% to 28%, driven by total wages that advanced 9% or more.
What the ‘fundamentals’ tell us about where housing’s future
The Pinto-Peter analysis helps explain housing’s remarkable resilience. Three of the fundamental factors are still working in its favor. The tight labor market is keeping incomes strong, and relatively few Americans are out of work. The migration trend is still a tailwind for markets from Ocala to Myrtle Beach—but it’s important to point out that the income those hot cities win is also wages another metro loses, so on an all-in basis, the inflows and outflows net to zero extra demand for the nation as a whole. But the big one is supply: Although home sales are down around one-third since 2019, inventories have dropped by the same proportion, leaving today’s “months of supply,” meaning the average time it takes to sell all homes on the market, at 3.9 months, about the same number as in the flush months before the pandemic struck. “A balanced market is over 7 months, so today’s number means that we’re still in a strong buyers’ market for the U.S. as a whole,” says Pinto.
Leading the market today, are such midwestern cities as Milwaukee, Chicago, Cleveland and Kansas City. In the year ended in September, Milwaukee’s prices leapt 10.4%, more than double the national change of 4.8%. As Pinto explains, these were laggards in boom period, leaving them more affordable than the places that had the big surge.
The gigantic price increases from 2020 to mid-2022 have rendered some of the hottest markets unaffordable, and led to big declines. It’s an especially big problem for metros that were already pricey by national standards before the huge upswing started. That’s the case for Austin, Boise and Phoenix, which are all down substantially since the peak. It’s also the true in a few of the Florida markets, including Cape Coral and Jacksonville. “In Cape Coral, prices rose three times as fast as total wages during the pandemic,” says Pinto. “It went in a few years from very affordable to much less affordable.”
Remarkably, many cities that fared well in crisis and before are still hovering at or above their peak prices. They include Tampa, Miami, and Orlando, as well as Charlotte, Charleston and Myrtle Beach. Those are examples of today’s dynamic, a push from strong incomes and super-low supply that’s countering the record jump in rates. Of course, that delicate balance also suggests that if we get a recession leading to big wage and job losses, the fundamentals would reverse, causing a downward reset. That’s also a potential scenario that evolves from Pinto’s analysis of the basics. And a scary one indeed.