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Economist: Don't fret over high home prices

U.S. home prices moved even further ahead of the levels of the last market boom a decade ago, according to the S&P CoreLogic Case-Shiller index. San Francisco-based economist Ralph McLaughlin, founder of Veritas Urbis Economics and former chief economist at Trulia, spoke with Scotsman Guide News about the factors influencing price growth and why he’s not too worried yet about rising prices.

Were you surprised by the latest Case-Shiller index numbers for March that once again had home prices rising solidly, and particularly in some high-priced areas such as the San Francisco Bay area where you are located?

ralphmclaughlinNo. 1, I am not surprised by the Case-Shiller numbers. They continue to grow much faster than inflation month in and month out. The reason I am not surprised is twofold. Inventory is very low. Inventory in the U.S. of existing homes is near the lowest on record, and this is coming at a point when we are at the end of an economic cycle when demand tends to be at the highest. Low inventory and high demand means high prices. Second is that we just aren’t building homes like we used to. So, the supply of new homes in this country also is hovering around 65 percent of the 50-year average. So we are seeing low supply at a time of high demand, and that is a perfect recipe for home prices to continue to increase.

The Mercury News in April reported that a fire-ravaged home sold for $900,000 in San Jose, at least $100,000 above its asking price. Other condemned homes in the Bay Area have commanded even higher prices. Are sales prices like that a cause for concern?

I wouldn’t be super concerned about prices, even in very expensive markets, continuing to go up. They are not necessarily driven by what I would call bubble philosophy. That is very different from the housing market of 11 to 13 years ago. Yes, prices are high. Yes, many can’t afford homes in this state. But we have high demand, very strong job growth. The job growth we do have tends to be high-wage. Couple that with low supply. There is low inventory in California. California, almost more than any state, does a pretty terrible job of building homes. Personally, it is not great to live in a housing market where prices are expensive, but I am not necessarily worried because the evidence suggests that the economic fundamentals, rather than bubble thinking, is pushing home prices up.

Mortgage rates have come down a little bit this week, but rates are expected to rise to 5 percent and beyond. Is that a problem for the market?

Nationally, it is not a problem. Really, it isn't for two reasons. One is that rates tend to go up when the economy is good. So, all else equal, rates are rising because people have jobs. They have solid income, and that is why rates go up. So, I am not too concerned about rates from that perspective. Second, even if rates do continue to go up, the break-even point between buying and renting in the U.S. as far as mortgage rates are concerned, in some areas, is in the 7 percent to 10 percent range. However, there are a few select markets in the country; namely New York, San Francisco, Los Angeles, Honolulu and now even Seattle, where if mortgage rates were to go to the 5.5 percent to 6.5 percent range, homebuyers might not have as much incentive to buy a house because renting might cost about the same. Therefore, I am not really concerned about mortgage rates hurting the mortgage industry or hurting the housing market, but there are a few select places where you may see noticeable impacts from rising rates. Those tend to be in the most costly markets of the country.

Are people leaving high-cost cities in favor of other cities with lower costs?

No. 1, there is always in migration and out-migration in expensive markets. One of the reasons why they are expensive is because they offer a lot of jobs, a healthy economy and they tend to be big. Big markets have people coming in and people going out. So I am not so worried that these big markets are on the cusp of collapsing because of home prices. Home prices are a symptom of a healthy economy. That said, there is some recent migration happening into areas that are not the most expensive. In fact, if you look at the trajectory of home prices in this current economic cycle, early on it was the largest and most expensive markets in the country, especially places like San Francisco, places like Los Angeles and San Diego, even New York, that were leading a house-price race. Now it tends not to be those big, expensive markets. We are seeing second-tier markets leading the country with price increases. San Francisco has been back in the mix recently but, for the most part, it is Seattle, Denver, Las Vegas, Austin and Dallas. That does suggest that where demand is spiking these days isn’t necessarily in those [most expensive] markets. That suggests some migration to these areas.  

Would you say that the overall U.S. housing market is healthy?

Generally speaking I would say, yes, it is healthy, but we could absolutely use more supply --- both more existing-home inventory and new homebuilding. I would certainly continue to keep an eye on housing supply. That said, we don’t want to make the mistake as a national housing market that we did in 2004 through 2006, where there was a lot of excess supply in many markets. We need to find that healthy balance. Second, I would caution your readers to take note that this is one of the longest economic expansions on record. And so, it is likely that we are on borrowed time, and every day that passes is a day where the chance of recession occurring increases. In the next two or three years, I would say that we are going to be due for a recession and that will likely temper down demand for owner-occupied housing in the U.S. It is not likely to be as catastrophic as it was during the last recession, primarily because most economists don’t anticipate that the next recession is going to be caused by the housing market itself, which is what happened back in 2007 and 2008. Most housing markets in the U.S. during normal recessions aren’t hit that bad. You might see a slight decrease or flat prices, but they tend to recover after about a year or so. What we experienced this last time around was more the exception, rather than the rule on how housing markets perform during recessions.

Will it take a recession to drive down home prices, or are there other factors that may cause prices to fall?

Again, what is the least healthy in the housing market is the lack of housing supply. Yes, a recession could potentially lead to falling or flattening house prices, but that means that people are losing their jobs. That is not something that most economists advocate for. What I would advocate for is a concerted, strong effort to increase the supply of homes in places that we need it most. That includes these costly coasts, but also there could be efforts to bring jobs to people in places where there is affordable housing. What we have in this country is a mismatch between where housing is and where the jobs are. If we could help bridge that mismatch, we might be better off, and we might see prices appreciate at more reasonable levels. 


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