The 23-percent spike we have seen in home prices since the housing market began to climb out of the recession is not easily explained by inventory and increased competition, as has been widely reported. According to a new report by financial service company Standard & Poor’s (S&P), mortgage rates aren’t the main culprit, either.
The report, “The Economic Factors That Affect Housing Prices,” examined the market at a granular geographic level to gain insight into regional housing market dynamics and how they are affected by local macroeconomic factors.
Mortgage rates are not the culprit
Contrary to popular belief, mortgage rates have little influence over home prices, the report concluded. Instead, S&P’s analysis showed that home prices are generally impacted by five variables:
- Housing affordability
- Changes in shadow inventory
- Unemployment rates
- Population growth
- Measure of distress in credit markets
“There was a reasonably weak relationship between the mortgage rate and housing prices,” S&P’s report concluded. “It is reasonable to expect that as mortgage rates decline, home prices should experience upward pressure, and vice versa.
“Assuming that the average home buyer has a fixed budget, declining mortgage rates imply that home prices can rise until equilibrium is reached. Alternatively, certain higher interest rate environments are associated with stronger economies, which, in turn, should allow for home price appreciation. That we were unable to measure this relationship suggests that the interplay between mortgage rates and home prices is complicated by factors such as inflation and employment, making it difficult to capture through our linear regression.”
Different markets show a range of appreciation
The impact these variables have on home prices is highly dependent on specific metropolitan statistical areas (MSAs), S&P noted. Chicago, Boston and San Francisco are projected to appreciate at a greater pace — 45 percent, 29 percent and 38 percent, respectively — than the 25-percent forecast for the entire nation over the next five years.
Houston is expected to appreciate at the same pace as the nation, and New York at a slower pace of 20 percent. Raleigh, North Carolina, led all MSAs with a projected five-year home price increase of 54 percent.
But what goes up must come down, and in forecasting where home prices may go in the next five years, S&P suggested in its worst-case scenario that investors should prepare for a 25 to 28 percent decline in home values, with some of the more volatile MSAs predicted to experience even greater downturns.
By and large, markets that have shown the greatest sensitivity to the five factors noted by S&P will see the greatest volatility, the company said. Under its worst-case, most pessimistic scenario, S&P said Chicago could see a 33-percent decline in home prices in the next five years, which would be substantially more than the 25-percent recession the nation may experience as a whole.
New York, Boston, Houston and San Francisco are also predicted to see declines but won’t be as hard hit. The report forecasted that New York and Houston could experience a 17-percent regression; San Francisco, 19-percent; and Boston, a 2-percent decline.
Markets that have been most vulnerable in the past may see the largest five-year downturns: Las Vegas could experience a 67-percent decline; Phoenix, 68-percent; and Riverside, California, 69-percent.
As many analysts have recently touched on, S&P noted a strong correlation between the housing market and the currently super-competitive rental market.
“As housing prices become rich relative to rental rates, we would expect the affordability measure to decline,” the company concluded. “As more people are incentivized to buy rather than rent, demand will increase the prices until equilibrium is eventually reached. Conversely, decreasing affordability will incentivize people to rent rather than own, thus increasing supply and, in turn, forcing prices back down.”