Forecasters spend a lot of time analyzing trends in data for a simple reason: Those trends form the foundation of their projections. And for buyers, the trends in housing prices are alarming. After rising faster than incomes for seven consecutive years, home prices took a sudden and surprising jump upward across Montana in the wake of the pandemic outbreak, pressing affordability for buyers in some areas to the breaking point. So, the question becomes, what lies ahead?
Ultimately, the price of housing, like most goods and services, depends on the interaction of supply and demand in each regional market. But there are many unique aspects of housing that lie behind those familiar concepts. Since new housing takes time to plan, develop and build, surges in demand, like what we saw in late 2020 through 2021, are reflected mostly in prices. Since housing is expensive, it is usually financed with borrowed money, making interest rates a critical factor for demand.
But housing’s uniqueness in our economy goes much further than that. Shelter is a basic human need, and economic and political systems that fail to house their populations are judged as failures. That fact no doubt accounts for what is possibly the most unique aspect of housing, and that is the dozens of policies and regulations imposed by governments at all levels that support, modify and in many cases restrict its production. The future of housing depends critically on the future of those policies as well.
Market Responses to Higher Demand
The COVID-19 pandemic served up plenty of surprises, but few were bigger than what happened to housing markets. The Great Recession of 2007-09 hammered real estate markets, but the COVID-19 recession did just the opposite. After a March and April 2020 period when the economy virtually froze, buyers emerged with a new desire for residential space that surged across regional markets that were already supply constrained. The result was an acceleration in housing prices in almost every market in Montana, as well as in the entire country.
As shown in Figure 1a, price growth that was averaging about 7% per year in the nation as a whole between 2013 and 2019 surged up to a stunning 23.6% annual rate in the summer of 2021. In some markets, price growth was even higher. Gallatin County median sale prices were just under $700,000 in 2021, up 30%.
No one predicted this outcome, yet in hindsight it is easy to see some of the forces that combined to bring it about:
- The quick adaptation of the real estate industry to social distancing, using video showings and e-closings that effectively widened the market to a national pool of potential buyers.
- The quick transformation of what had been a slower affordability migration from higher priced states to places like Montana to an accelerated surge as physical space needs and crime concerns changed attitudes about density in major cities.
- The reluctance of sellers to list their homes, either out of fear of contagion or concern that the supply of housing to serve their changed needs would be inadequate.
- The decline of offices and the rising incidence of working from home and its impact on space needs.
Yet there were two more familiar and arguably more impactful forces that helped propel housing demand and housing prices to stratospheric heights in 2021 – mortgage rates and income. As Figure 1b makes clear, conventional 30-year mortgage rates fell below 3% at the same time as prices were surging. And unlike previous recessions, the COVID-19 recession saw heady increases in consumer incomes.
But mortgage rates are about to move up as Federal Reserve policy finally reacts to higher inflation across the economy – and the impacts on housing demand could be profound. Real estate brokerage Redfin is predicting that higher mortgage rates will produce much slower price growth nationally by 2023.
Policy Responses to Housing Affordability Declines
Housing markets are ultimately local, even if national forces affect them. The effects of high prices have been felt locally, giving rise to everything from long distance commutes to people living in RV parks in some Montana markets. And local governments impose a complex, overlapping web of building codes, zoning classifications, development and impact fees, and other policies that collectively impact how much, what kind and what places housing is built. As the evidence that slow building rates affect affordability mounts, is there any likelihood of a reexamination of those policies?
Policy actions clearly have impacts on markets, but the process that sustains or possibly modifies them is essentially political. Here we must squarely confront the less remarked upon fact that superheated housing markets in Montana, as elsewhere, have created winners, primarily existing homeowners who avoid disruptions in their neighborhoods as their housing wealth skyrockets.
The median voter hypothesis is a simple idea which holds that in a democratic government, it is the view of the voter squarely in the middle of the distribution of viewpoints on any given issue that prevails. And research says that many of the local policies that restrict housing supply, such as single-family home zoning, parking space requirements and building codes mandating things like windows in bedrooms are quite popular. Even those who are shut out of neighborhoods because they can’t afford to live in them say that they would prefer to live in older neighborhoods with tree-lined streets and backyards.
Yet if policies affect prices, perhaps the inverse may someday be true as well. Markets are producing outcomes in some local housing markets that threaten to transform communities, pushing those who work in service jobs to the periphery as those with the means to afford housing – and consume many of those services – enjoy what their policies preserve. Better information on exactly how the overlay of local housing regulation translates into affordability might yet bend the trajectory of increasing roadblocks to housing growth.