A weekly analysis of timely economic strategy issues from Wells Fargo Investment Institute.
Michael Taylor, CFA, Investment Strategy Analyst
Luis Alvarado, Investment Strategy Analyst
What’s Driving Regional Home-Price Appreciation?
- Home prices in the U.S. continue to rise. Yet, the extent of price increases appears to be uneven across regions and metropolitan areas.
- The two main drivers of home-price appreciation and sales growth are increased demand and limited supply, particularly in select metropolitan areas.
What It May Mean for Investors
- The U.S. housing market remains solid. An active housing market should contribute to economic growth and benefit the Consumer Discretionary and Financial sectors as banks lend to new buyers.
In past reports on the U.S. housing market, we discussed supply-and-demand dynamics, the importance of a home’s value on the wealth effect, and the ability of the housing sector to sustain economic growth. Last week, we discussed the relationship between interest rates and the housing market. This week, we consider whether rising U.S. home prices could be leading to the formation of another housing bubble. According to the latest quarterly report from the National Association of Realtors (NAR), U.S. single-family home prices rose 5.3% in the fourth quarter of 2017 (year over year), to a median value of $247,800. Furthermore, home-price appreciation was fairly widespread, as 92% of the metropolitan statistical areas that were measured showed sales-price gains for the same period—and 15% of areas were at all-time highs. Yet, the degree of home-price increases appears to be uneven across some regions. In this week’s report, we consider regions and cities that have experienced much of the price appreciation and discuss key drivers of the home-price increases in those areas.
Based on recent data, U.S. home prices continue to rise. We expect this trend to persist for the foreseeable future, and rising home values should continue contributing to economic growth. However, not all U.S. regions and cities have experienced the same levels of home-price appreciation. The NAR compiles data on a regional basis. In Table 1, we have summarized some of the latest findings of the most expensive—and least expensive—housing markets in U.S. metropolitan areas (as of year-end 2017).
Regionally, the West has the highest sales prices and price-growth rates (along with the Midwest), which comes as no surprise—as the five most expensive metropolitan areas are located in California and Hawaii. Meanwhile, home prices in the Northeast, South, and Midwest have lagged behind the West, and the Northeast and South have shown lower sales-growth rates. Today, many West Coast cities remain the most expensive metropolitan areas for single-family dwellings, while cities in the Midwest and parts of the Northeast are among the least-expensive metropolitan markets in which to purchase homes.
For our analysis, we also considered the S&P CoreLogic Case-Shiller Home Price Index to observe the behavior of home-price increases in select metropolitan areas. According to the latest reading of this national index, single-family home prices increased 6.2% year over year in January 2018, in-line with the finding from the NAR. We then selected nine metropolitan areas from the index across various regions to examine home-price behavior in more detail.
The results from Chart 1 also align with the findings from the NAR report. Five of the cities that displayed the highest index levels are situated on the West Coast—Seattle, San Francisco, Los Angeles, San Diego, and Portland. Yet, home-price increases, albeit smaller, also were evident in select cities in the South, Midwest, East, and Northeast. One interesting observation from a comparison of these regions was that cities such as Dallas, Denver, and Charlotte did not experience large price spikes ahead of the housing crisis, while several other cities like San Francisco and Seattle exhibited pronounced pre-crisis price increases.
Drivers of price growth
Today’s market conditions differ from those prior to the housing crisis. At that time, both supply and demand were rising, along with home prices. Demand continued to rise even though prices were rising and supply was growing. By contrast, today, we see prices increasing as demand grows; yet supply remains constrained. This combination is more consistent with the notion of scarcity—prices that rise should eventually drop, once supply eases the shortage of available homes.
We have detected two principal drivers that appear to be fueling sales and price growth for the housing markets of the cities above:
- Increasing demand: After the Great Recession and the housing-market bubble, the metropolitan areas in Chart 1 have attracted an influx of new residents, due to better job and income prospects, particularly for working-age adults, including millennials. Additionally, but with a smaller overall impact, major metropolitan areas mainly near the coasts experienced strong demand from overseas buyers, particularly during early stages of the recovery. And more recently, the aftermath of Hurricane Harvey has led to an increase in demand in Southeastern Texas.
- Limited supply: Housing supply has been reduced both by a rise in demand and a cutback in home-builder activity. The inventory of new and existing homes remains at depressed levels, driving home prices to record highs in these markets. Yet, we are seeing a pickup in building activity. According to a National Association of Home Builders (NAHB) report, of select cities, Dallas and Houston led the number of residential building permits for 2017, at 61,700 and 42,670 respectively, while Atlanta was slightly under 33,000. In the Northeast, New York City, Northern New Jersey, and Long Island also experienced an increase in building activity.
Tax reform implications for the housing market
Now that the tax reform has been passed, it is possible that this will impact home prices and regional migration trends. The new tax law limits the deductibility of property taxes and interest paid on mortgage debt. These two reductions in tax incentives, along with an increased standard deduction, may dissuade some prospective buyers from purchasing a home. The NAR has made some preliminary estimates on projected home price increases for 2018 that take the new tax law into consideration.1 Overall, these estimates anticipate an average nationwide increase of just under 2% (versus a nationwide increase of more than 5% over the past five years). Some states will grow more than the average, while others are expected to see a negative impact on prices.
Overall, we believe that the U.S. housing market remains solid. Spring and summer months are generally a popular time for buying or remodeling a home. Despite the fact that some regions and cities are showing stronger home-price growth than others, we do not expect a widespread housing bubble to form in the near term. Using the most recent housing-market crash as a gauge, we do not detect the signs that historically have preceded a bubble bursting—consecutive declines in building-permit growth, loosening of credit standards along with falling interest rates, and rising inflation-adjusted home prices—to anticipate another housing crisis in any of these cities in the foreseeable future. In fact, we would expect the opposite to occur. As rates continue to rise gradually and inventory levels remain tight, prospective buyers should expect increased competition throughout the year.
Although the recent tax changes may weigh on the housing market in the near term, we believe that a strong labor market and a healthy economy could help to offset the impact.2 As demand drives home prices higher in many regions, the wealth effect (the impact that changes in household wealth have on consumer-spending patterns) should add to consumer sentiment and spending. Looking ahead, we expect home-builder activity to continue to rise and fixed-residential investment to contribute positively to economic growth. An active housing market should benefit the Consumer Discretionary and Financial sectors as banks lend to new buyers.
1 National Association of Realtors, “Tax Reform Impact and Home Price Outlook”; January 9, 2018.
2 See our Global Perspectives report, “Tax Reform’s Likely Effect on Housing”, February 13, 2018, for more details.
Each asset class has its own risk and return characteristics. The level of risk associated with a particular investment or asset class generally correlates with the level of return the investment or asset class might achieve. Stock values may fluctuate in response to general economic and market conditions, the prospects of individual companies, and industry sectors. Real estate has special risks including the possible illiquidity of underlying properties, credit risk, interest rate fluctuations and the impact of varied economic conditions.
Sector investing can be more volatile than investments that are broadly diversified over numerous sectors of the economy and will increase a portfolio's vulnerability to any single economic, political or regulatory development affecting the sector. This can result in greater price volatility. Risks associated with the Consumer Discretionary sector include, among others, apparel price deflation due to low-cost entries, high inventory levels and pressure from e-commerce players; reduction in traditional advertising dollars; increasing household debt levels that could limit consumer appetite for discretionary purchases; declining consumer acceptance of new product introductions; and geopolitical uncertainty that could impact consumer sentiment. Investing in financial services companies will subject a portfolio to adverse economic or regulatory occurrences affecting the sector.
An index is unmanaged and not available for direct investment.
S&P CoreLogic Case-Shiller® Home Price Indices: The S&P/Case-Shiller® Home Price Indices measures the residential housing market, tracking changes in the value of the residential real estate market in 20 metropolitan regions across the United States. These indices use the repeat sales pricing technique to measure housing markets. First developed by Karl Case and Robert Shiller, this methodology collects data on single-family home re-sales, capturing re-sold sale prices to form sale pairs. This index family consists of 20 regional indices and two composite indices as aggregates of the regions.
Housing Marketing Index (HMI): The National Association of Home Builders (NAHB) Housing Market Index (HMI) is a weighted, seasonally adjusted statistic derived from ratings for present single-family sales, single-family sales in the next six months and buyer’s traffic. A rating of 50 indicates that positive responses received from builders is about the same as the number of negative responses; ratings higher than 50 indicate more positive responses.
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