“Where We Are in Housing Is Pretty Extraordinary”: Discussing Residential Real Estate

11/03/2023

Tom Heintjes: Hello, and welcome to a new episode of the Economy Matters podcast. I’m Tom Heintjes, managing editor of the Atlanta Fed’s Economy Matters magazine and your podcast host. Today I’m sitting down with one of our regular guests, Domonic Purviance, a subject matter expert in the Atlanta Fed’s Supervision and Regulation Division. Domonic is here today to discuss trends in housing and residential real estate, which of course has seen a great deal of activity in recent months. Now, Domonic, I say you’re a regular guest on the podcast, but it’s actually been a while since you’ve sat down with us, and a lot has happened in housing since we last spoke, so I’m looking forward to catching up on this topic. It’s really good to have you back in the studio.

Domonic Purviance: It’s good to be back, Tom.

The Atlanta Fed’s Domonic Purviance. Photo by Stephen Nowland

Heintjes: Domonic, one of the storylines we heard earlier in the year was the shortage of existing home inventory and that shortage’s effect on house prices. Is that still the case?

Purviance: Very much so. Actually, I think where we are in housing and the inventory situation is pretty extraordinary. If you think about it, with interest rates going up since the beginning of last year, we’ve seen a pretty strong contraction in overall home sales. I think the most recent number has sales down about 16 percent, and at the trough I think we had a year-over-year decline in home sales close to over 20 percent. And that decline is actually sharper than the decline that we saw in 2008, at least on a national level, and several markets in our district with higher rates have obviously seen people priced out of the market and seen sales decline. And yet we’ve still seen home prices actually stabilize and start to trend upward over the past few months. The culprit is, of course, the shortage of inventory. We measure inventory levels by looking at the months’ supply of inventory, typically—that’s how many months it would take to absorb the current amount of inventory, given the current rate of absorption. Even with absorption rates down, the months’ supply of inventory is about three months—it sort of has stabilized around three months—and what’s considered balanced is somewhere between four to six. And so as long as there’s this shortage of inventory, we’re going to see some steady upward pressure on home prices.

So last year, I think in around June, home prices peaked at—at least, the number that we have is—between $380,000 and $400,000, and it’s come down about 10 percent. But recently, since the beginning of this year, home prices have started to trend upward. And I think if we were to go back and listen to our podcast we did about a year ago—I think we were probably talking about the potential impact of a rise in rates—and if you would have told me that even with rates going up from the beginning of last year at 3.8 percent and now they’re over 7 percent, if you’d have told me that in that scenario we would have home prices trending upward, I wouldn’t have believed it. But definitely, because of the shortage of inventory, nationally we’re at three months. Some markets in our district are at two months or below. So it’s a pretty significant issue.

Heintjes: Right. Well, actually, you teed up my next question very nicely—thank you!—because I did want to talk about mortgage rates. That’s a very obvious trend in housing right now and has been in the news a great deal lately. Mortgage rates recently topped 7 percent for a 30-year fixed mortgage, and I wanted to ask you: what effect do higher mortgage rates have on the housing market, apart from the obvious effect of making mortgages more expensive? Of course, I’ve heard the term “lock-in effect” used to describe this situation. What do you see in terms of the mortgage rate and its effects on the market?

Purviance: We can talk about affordability in a second, but the biggest impact of higher rates—at least on the housing market—number one, it is driving down affordability and it’s driving down demand. But one of the other effects, as you mentioned, is the so-called “lock-in effect.” I’ve also heard the term “golden handcuffs”—which is new, I had never heard that before. Essentially what it means is if you have a mortgage that is a low-rate mortgage, you’re locked in as rates go up because you’re disincentivized to sell, because if you sold, not only are your home prices much higher today but you would also have a higher interest rate, so your mortgage payments would end up being higher. And so today, because rates at their trough were below 3 percent, which is an historic low, and so many people refinanced their mortgages over the past few years—so much so that over 50 percent of our mortgages in America have a sub–4 percent interest rate—if you refinanced or you bought a house and you’re locked in at a low rate, when rates go to 6 percent or 7 percent, that’s a disincentive for you to actually sell.

In many cases, some people aren’t able to sell. I remember a few years ago I was in Dallas, and I was taking an Uber to the airport and my driver was explaining his situation. He had a house that had a lot of equity, but he couldn’t sell it because if he sold it his housing costs would go up—because number one, he would have to buy a more expensive house at a more expensive mortgage [rate]. And so, we tend to think higher rates make it less advantageous for people to buy, but it also makes it less advantageous for people to sell. In some situations, people aren’t able to sell because whatever they buy is going to be far more expensive than what they currently have.

Heintjes: And I’m sure what you heard in Dallas translates all over the country, but let’s look at the situation closer to home. How has housing demand been in the Southeast, compared to other regions in the country?

Purviance: Well, the Southeast is doing a little bit better. Relatively speaking, if you’re comparing to markets where people are coming from—like New York, or California—this market, the Southeast, is still more affordable. And if you’re selling a house, if you liquidate an asset in New York or California and you’re moving to the Southeast, even though demand has declined year over year, we’ve seen a little bit more stabilization and demand than when you compare it to other markets. So, markets like Atlanta, or South Florida in particular, have done very, very well, even with rates going up as high as they have. I mentioned—if you think about just the capacity of people to sell a house that is far more expensive in, say, California—they come to our market with a considerable amount of cash. What we would consider expensive based on what incomes are here, are inexpensive if you’re coming from a higher-cost market. So overall, we’ve done fairly better than most regions in the country.

Heintjes: Yes, I guess affordability is somewhat a matter of perspective.

Purviance: Obviously, houses are more expensive, but if you’re paying cash, the interest rate isn’t that much of an issue. And we’ve seen the share of cash sales—particularly in a market like South Florida—reach near 50 percent, and that’s because so many people were able to cash out of existing homes that had a lot of equity.

Heintjes: Right. I wanted to follow up on a point you made earlier: you mentioned the shortage of existing homes, and the problems it presents for buyers. What does that imply for the new home market? Is it reasonable for us to conclude that building new homes has slowed down in the face of higher mortgage rates?

Purviance: Not at all—it’s sort of the opposite. What’s happened is, because so many people are locked in at a low rate, they can’t sell their house—there’s a shortage of existing home inventory. And that has actually been a boon for home builders. Because they have the ability to produce more homes, there’s more demand. If you just look at the share of total inventory that historically was new home supply, it’s normally about 14 percent. Today, somewhere around 25–30 percent of all inventory is now new inventory. And that’s purely a byproduct of the lack of existing home inventory. And so, builders today have increased supply—particularly spec inventory—in order to meet the demand.

Heintjes: Do builders have to take any unusual steps to move houses they built with the mortgage rates higher, or is that not necessary?

Purviance: When rates began to rise last year and through the second half of last year, we saw a pretty significant increase in incentives, so builders are offering cash to buyers that they can use at their discretion. It’s gone down a little bit, but the use of incentives is still pretty well elevated. And the incentive that’s used most often, obviously, is the buying down of interest rates. Buyers are able to buy down rates and still be able to afford to get in a house at a reasonable payment, and there’s several different options that are available. Some options, you can buy down the rate for maybe a year or two and then it adjusts to a normal rate, or in some instances, you can buy down the rate for the length of the loan. And that’s been a significant help, particularly in the entry-level side of the market, where people are a little bit more strained. In some instances, this comes at a cost to the builder. I talked to one home builder a couple of weeks ago—he’s sort of in that “entry level”—and entry level for new homes is now about $300,000–$400,000, just given today’s market. And he said that rate buy-downs are costing him about $35,000 per house. His average home price is about $350,000–$400,000, so that’s about a 10 percent discount on the house. Of course, builders don’t want to lower the price, and it’s more advantageous for the home buyer to buy down the rate than actually have the price lowered. And so that’s really what you’re seeing in terms of demand and sales on the new home side: there’s a considerable amount of incentives that are supporting the increase in new home sales—especially as there’s a shortage of existing supply, and all of that demand is going to new homes.

Heintjes: It’s been so long since I’ve shopped for a house. I was not aware of this at all.

Purviance: I will add, rate buy-downs for new construction are pretty common, but I was—occasionally, this is what real estate analysts do on the weekend—I go looking at open houses, just seeing what’s on the market in my neighborhood. And one particular house I went to, we toured the house and as we were leaving the agent said, “This isn’t advertised, but if you decide to buy the seller is willing to offer an interest rate buy-down.” And so, it’s pretty common for new homes, but I don’t know how common that is for an existing home seller to offer rate buy-downs. I know they pay for closing costs and things like that, but that could end up being a significant discount to a buyer of an existing home. I’m not sure if that’s common—that’s the first I’d heard of it.

Heintjes: We’ve talked a lot about single-family housing. I don’t want to focus solely on single-family housing, because I know that multifamily housing is an important part of the housing market. And I wanted to know, what trends do you see in multifamily housing? And how are they different from single-family housing, if in fact they are different?

Purviance: There are some differences. But in the same way that since the 2008 crisis we’ve underbuilt the single-family home sector—if you just look at household formation and job growth, they didn’t match the level of building permits both on the single-family side and the multi-family side. So we started this cycle, in the pandemic, with a shortage of inventory both in new homes and existing, and multi-family. And so the shortage in multi-family units led to this big spike in rents during the pandemic. Last year we saw rent growth over 20 percent, the same rate of increase we actually saw in home prices. Now, that’s come down a little bit—the multifamily market isn’t as hot as it was a year ago. We’re not seeing the double-digit rent growth. We’re seeing occupancies come down a little bit. A lot of that has to do with a lot more inventory that’s being delivered in markets, and so the more inventory you have, it creates some downward pressure on rents. But the situation is still true that we’re undersupplied in all kinds of houses, whether it’s multifamily or single-family. And that’s leading to some pressure on housing costs for consumers.

Heintjes: Domonic, you mentioned the pandemic, and that prompts a good question. The optimists among us think we’re in a postpandemic period. Whether that’s true or not is another matter, but do we still see reverberations in the housing market from the pandemic? And is that something you still see as an analyst?

Purviance: The builders I talk to, their view of the market is it’s returning to normal—so, it’s a return to normalcy in most cases. There are still some issues there, but the big impact—particularly on the new home construction side—during the pandemic was supply chain disruptions. We couldn’t get materials to finish homes on time, and that led to a spike in prices. In most cases, supply chains have normalized, and we’ve seen some stability in costs. Now, costs are starting to rise today on the construction side, mostly because there’s just a spike in activity. Any time activity spikes and we don’t have the labor and access to other materials, that causes prices to go up a little bit. But for the most part, I would say it’s normal in terms of the buyers. I would also say there is still some desire to move out of some markets, because work from home and being able to work remotely is still…I mean, that was a part of the work equation prior to the pandemic, but it’s more so the case today. People are still interested—if they can work remotely, if they can move to a cheaper market, they’re going to do it. That’s one of the effects of the pandemic that I think is permanently with us: The ability to work from home or work remotely, or not have to come to the office every day, means that people can live further away from the office. And the other aspect that we’re still contending with is the negative impact on the office market, because there’s less demand for office space than there ever was before.

Heintjes: That’s a whole other episode of the podcast.

Purviance: That’s a big issue.

Heintjes: OK, we’re going to take a break for a moment to listen to this important message from the Atlanta Fed, and we’ll come right back.

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Heintjes: And we’re back with Domonic Purviance, who is here on the Economy Matters podcast talking about housing and the residential real estate market. Domonic, I want to pick back up by talking about housing affordability, which we touched on previously. I don’t imagine that higher mortgage rates—which, of course, mean higher monthly payments—have helped affordability. What trends are you seeing in housing affordability, whether it’s regionally or nationally?

Purviance: When rates peaked last year, we saw affordability decline. In fact, housing affordability, in about October of last year, reached its lowest level on record. The Atlanta Fed has an index that we track housing affordability with called the Home Ownership Affordability Monitor [HOAM], and our index looks at what the median-income household can afford, given the median-priced house and the current interest rate. And so we’re looking at if the median-income household were to purchase the median-priced house, what share of income would they need to spend per year in order to afford that house. Thirty percent is considered affordable. In October of last year, the share of income needed to afford the median-priced house jumped to about—I think at its peak was about 43 percent, or just over 43 percent. When we saw the reprieve at the end of last year, rates came down, affordability improved a little bit. As of recently, we’ve seen affordability decline pretty significantly—a combination of rates over 7 percent, as well as home prices inching back up to their previous peak experience last year. So today, if you make the median income, you’re going to spend at least 43 percent of your income to afford the median-priced house. And so based on what I’m seeing, I wouldn’t be surprised in the next couple of months if we see affordability hit its lowest level on record, given where rates are going and where home prices are going. And just to put it in perspective, the median-income household makes about $75,000 a year, nationally. In order to afford the median-priced house, which is around $380,000 using our numbers, you would have to make at least $108,000 a year, and that’s 43 percent higher than what the median-income household actually makes. What’s interesting to me—and obviously, there are some cyclical effects of higher rates and higher home prices—but I am not sure how we really resolve this affordability issue long term. It used to be, historically, if you make the median income you can afford to buy the median-priced house, almost in any market across the country. That’s no longer the case anymore. In order for you to buy the median-priced house, almost in any market, you have to make well above median income. And that’s an extraordinary change for our economy—it means that if you want to own a house, you’re going to have to make above the median. If you want to enter the middle class, it’s going to take more than just median income in order to achieve that. That’s new.

Heintjes: Yes, those are really striking numbers. Wow—when you put it like that, it really hits home. Well, let’s consider all this, and let’s consider elevated mortgages, rising home prices, slowing wage growth. I don’t want to be overly dramatic, but are we perhaps looking at an inflection point of some sort in the housing market? What is recent homebuilder sentiment like?

Purviance: In my view, I do think where we are is not sustainable. And you’re right—if you combine higher home prices, higher mortgage rates, a slowdown in wage growth—all of those things together, one of two things could happen. Either we just see a contraction in demand, as more people are just priced out of buying a house, or home buying becomes concentrated in higher income households. You’re actually seeing a combination of both of those trends today. If you look at the average household that’s buying a house, they have above the median income, they have stronger credit profiles, and they more than likely have some cash to make a down payment to buy a house. And so, it’s not the case—as I mentioned before—that the typical median-income household is going to be in the market for the average-priced house.

Heintjes: Well, Domonic, being in the Southeast as we are, we’re always aware of severe weather events—whether it’s hurricanes, droughts, what have you—and these weather events affect insurance premiums for homeowners, especially in coastal markets. And we have a lot of coastal areas in our region. Can you discuss higher premiums, and their role in housing market dynamics? I don’t want to put you on the spot, but what do you foresee for housing in higher risk areas going forward?

Purviance: Yes, this is a significant issue, especially in the coastal markets—like Florida and the coasts of Alabama, Louisiana, and Mississippi—in our district. We’ve seen, as a result of significant weather events, a pretty sharp increase in insurance premiums in many of our markets. In some cases, insurance premiums have quadrupled over the past several years. And so part of our analysis of housing affordability is not just looking at the principal and interest payment. We intentionally include taxes and insurance, because that, in many cases, is a prohibitive barrier for people to be able to afford a house. And a lot of the increase in insurance costs is in part driven by the exodus of insurance providers in some of these states. If you have fewer insurance providers there’s less competition, and more of the risk is put on fewer providers—and that raises your premiums. There’s also been some, in the case of Florida, increased litigation around insurance that’s actually increased the potential costs and the risk that’s associated with providers. Those things combined have led to higher premiums for not just home buyers but also businesses in those markets. It’s a critical issue as we enter into hurricane season. It’s something that’s certainly at the front of everyone’s minds, living in those markets that are most impacted by it.

Heintjes: OK, thanks for that. Domonic, this has been a really great and thought-provoking conversation, and I want to thank you for being back in the studio to share your research and insights with us. It’s always great to talk to you, and we’ll have to have you back on soon.

Purviance: Yes, thank you.

Heintjes: But before we finish today, I want to briefly mention the Home Ownership Affordability Monitor, which Domonic mentioned earlier—one of the data tools that Domonic oversees for the Atlanta Fed. It’s always interesting, especially these days, and I encourage you to check it out—we’ll have a link to it on our website. And that brings us to the end of another episode of the Economy Matters podcast. I’m Tom Heintjes, managing editor of the Economy Matters digital magazine, and I hope you’ll check out Economy Matters—as well as the entire Atlanta Fed website—at atlantafed.org. Thanks for spending time with us today, and let’s get together again next month.