"All These Factors Are Compounding": A Discussion of the Housing Market


Tom Heintjes: Welcome back to 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, Regulation, and Credit Division. I asked Domonic to talk to us again today because there's so much going on in the housing market—even more than usual—and I thought it would be good to get him to share his thoughts on the housing market and the economic implications of everything. Welcome back to the podcast, Domonic. It's good to have you back in the studio.

Domonic Purviance: It's good to be back.

The Atlanta Fed's Domonic Purviance. Photo by Ted Pio Roda

The Atlanta Fed's Domonic Purviance. Photo by Ted Pio Roda

Heintjes: Domonic, there's a lot to talk about today, so let's dive right in. First off, we've talked before about the red-hot housing market, but I guess it's maybe a little less "red-hot" right now. Is it even hot? How would you characterize it?

Purviance: I would say that the housing market has significantly cooled off. As everyone is probably aware, the driving force of that hot housing market was historically low interest rates. At the trough, interest rates dropped to 2.65 percent—and that's obviously the lowest that interest rates on a 30-year, fixed mortgage have ever been, and may ever will be. A lot of people took advantage of that opportunity. They refinanced their mortgages. There's a large amount of people who have locked in at a low rate, who refinanced over the past few years. There's also a significant amount of people who took advantage of the enormous amount of affordability that very low rates created—people could afford a whole lot more house because rates were very low. But as many people know, inflation has hit a 40-year high. The Federal Reserve has responded by raising rates, and that's had a considerable impact on mortgage rates, and that's caused the housing market to slow. So almost every indicator—whether it's home sales, mortgage originations, homebuyer sentiment, homebuilder sentiment—everything has significantly cooled off.

Heintjes: I've read a couple of descriptions of the current state of the housing market. One is that it has cooled to prepandemic levels—in other words, more along historical norms—and one is that it's actually in recession. During the pandemic, you had historically low mortgage rates, as you mentioned, coupled with heightened demand when everyone was wanting a house away from everyone else, or so it often seemed. What's your take on, in general, where the housing market stands?

Purviance: It depends on where you stand. [laughs] I guess what I mean by that is, it depends on what part of the country you're in. One of the hottest housing markets during the pandemic was Boise, Idaho. Last year in Boise, the year-over-year increase in home prices was maybe over 30 percent. Today, it's about 8 percent. If you look at the month-to-month trends, home prices are declining on a sequential basis. If you're in a market like Tampa and in several markets in our district—Tampa, Orlando, Nashville, Jacksonville—all lead the nation in home price appreciation. Now those markets are slowing, too, but we're not experiencing as sharp of a slowdown as some of the hotter markets like Austin or Phoenix or, as I mentioned, Boise. So I think if you're just looking at it market by market, there are some markets that have cooled significantly in what you could characterize as a recession. There are some markets that are doing a little bit better, but if you just look at the overall trend, it seems obvious to me that some of those leading markets—like a Boise—may be an early indication of where the housing market is going in general. And so markets in our district may in fact be lagging, where some of the hotter markets are already experiencing a slowdown.

Heintjes: So just to be clear: it sounds like you're talking about a slowing rate of price appreciation, and not actual declines in prices?

Purviance: Right now, we're experiencing a slower rate of appreciation. If you look at the overall US last year, in 2021, we had record levels of home price appreciation where prices were up over 20 percent nationally, year over year. That's higher than rates of appreciation we saw in '08. Today it's down to about 10 percent, so it's a reduction in year-over-year increases in home prices. That's a more moderate level of appreciation, but you have to project where we're headed, and that's where a lot of people are thinking, "Okay, we're seeing the headwinds in the housing market—higher interest rates, declining demand, inventory is starting to build, days on market is getting a little bit longer to sell homes, homebuilders are experiencing record levels of cancelations." If you add all of those things together, even though the rate of appreciation is slowing, it will eventually make it to a point—and most likely it will get to a point—where home prices actually decline on a year-over-year basis nationally, in certain markets—especially those markets that had very high appreciation over the past few years.

Heintjes: You touched on inflation a little while ago, and that prompts me to ask you about the supply chain and the issues surrounding the supply chain in general. What role does the supply chain play today, in home prices and affordability?

Purviance: It's always a moving target. Really, this has a more direct impact on new home construction. One of the reasons why new home construction costs have increased has been because of supply chain issues—not being able to get materials—or because there's a labor shortage, and that raises the cost of labor. I heard an interesting story. I was talking to a builder last week and he was saying he was ordering a certain-sized refrigerator to put in one of the units he was building, and he was told that he couldn't get that refrigerator until like April of next year. And so, when you have those kinds of delays—just because a manufacturer maybe is not back to full operations yet, or we're missing a component, a part that may come from China or someplace that has a plant that shut down—when you have those kinds of disruptions, it not only slows down the timeline to finish a unit, it also raises the cost for the builder and the consumer. Earlier in the cycle, because rates were so low, builders were able to push off that cost to consumers, they were able to absorb it because their interest rates were very low. But that's not the case today. I will say there are some improvements—like lumber costs have come down and some other components are seeing improvement—but some parts of construction still have major issues in the supply chain. So it's still with us, and it's causing upward pressure on price, for sure.

Heintjes: You mentioned mortgage rates before, which of course I want to dive more deeply into with you. Can you give us a sense of how increasing mortgage rates directly affect affordability? Say someone is looking at a $300,000 home. How big of a difference does that make in mortgage rates at 3 percent versus 7 percent, in terms of a monthly payment? Obviously it's different, but how big is this difference?

Purviance: If you were buying a $300,000 home, assuming you could put 20 percent down on the mortgage, and say you had a mortgage rate of 3 percent: your mortgage would be somewhere around $1,300 or $1,400 a month.

Heintjes: PITI?

Purviance: Principal, interest, taxes, and insurance—all in. At 7 percent, your mortgage is somewhere around $1,800 to $1,900 a month. That's a $500 or $600 a month difference, and for some people that's prohibitively expensive, and they're priced out of the market. It certainly affects people who have more moderate incomes more, because they just don't have the bandwidth to stretch to be able to afford. And just tack on to that the fact that inflation is 8 percent, so you're paying higher at the grocery store and perhaps in gas, and so it just makes it almost impossible for households to absorb the higher cost. That increase, from about—I think at the beginning of the year we were at about 3.5 percent, and now we're close to 7—that's happened in a very, very short period of time, and so people who could afford a house perhaps when they had it under contract—say, if it's a new build—by the time that house is finished, and if they didn't lock in a rate, they no longer can afford it at the new rate. That's leading to a lot of cancellations on the new home side, so it's a big issue.

Heintjes: Well, inflation is higher than we'd like and, as you mentioned, the Fed has been raising interest rates to combat it. As a result, mortgage rates have increased along with that. But is that the biggest factor in a housing slowdown, or are there other factors at work—like unaffordability—that are just as significant? Or is it "all of the above"?

Purviance: It's "D," all of the above. All these factors are compounding on one another, and so you have inflation, you have already high home prices, and then you add on rapidly rising interest rates—these things are all compounding together to make it very difficult for a lot of people to afford to buy. So today, if you were to buy the median-priced house, you would be spending greater than 45 percent of your annual income on your principal, interest payment, taxes and insurance, just for the house. The threshold for affordability is 30 percent.

Heintjes: Wow—so, half again over.

Purviance: Yes. And it seems like that may continue to rise because, of course, we know inflation remains high. The Fed has communicated, FOMC [Federal Open Market Committee] has communicated, interest in getting a handle on inflation. We may continue to see rates go above 7 [percent]. They may get to—it could be as high as 8 or 9 or 10 [percent]. We've seen this before, in the early '80s, when interest rates got close to 14 percent. I'm not suggesting that we'll get there, but the risk is there. And so right now, all of these factors combined together are creating a significant strain on housing demand, and that's likely to continue based on everything that we're seeing. That means that demand will continue to contract more, and we will see some downward pressure—perhaps some significant downward pressure—on home prices.

Heintjes: The low availability, relatively speaking, of housing stock was a factor in price increases, and thus worsening affordability. It's basic supply and demand. But the current situation can't be providing incentives to builders, surely, as you mentioned. How big a factor is weakening builder sentiment in the current market?

Purviance: You said a couple of things there. Initially, the reason why home prices went up as fast as they did is there just wasn't enough inventory to keep pace with demand. That was an issue prior to the pandemic—it just accelerated during the pandemic. As rates declined, more people were in the market to buy. Combine it with investors, people that had a whole lot of equity that were cashing out, and so it was just way more demand than supply. Moving forward, let's just take supply in two components—two sectors—of supply. There's existing home supply and new home supply. In existing supply, there still is, relatively speaking, a shortage of supply. The months' supply is still below four months, which is considered balanced levels. And moving forward, there are so many people who refinanced their mortgages over the past several years—in fact, the majority of mortgages today have an interest rate that, I believe, is around 4 percent or between 4 and 4.5 percent. And as rates go higher, those households will be disincentivized to put their house on the market to sell because, number one, they'd have to buy something else, and they'll have to go from a 4 percent interest rate to a 7 percent interest rate, and it would just be unfeasible for a lot of households. So a lot of people are staying put, and the more people stay put the less inventory that's available on the market. And so, you have this tug of war happening. Rising interest rates are impacting demand, but they're also impacting supply, and whichever one is more adversely impacted is going to determine what happens with home prices.

On the new home side, builders were ramping up construction to take advantage of the shortage of supply and a lot of demand, but it takes a while to build houses. And so, they're in supply chain issues that have prolonged the process. What's happening now is builders are delivering product that they may have sold several months ago to people who no longer can afford to buy them. And so, cancellations—the last I've read—were about 20 percent on new homes being delivered. And there is a glut of new homes that are scheduled to be delivered the end of this year and into first quarter of next year, in a market that's seeing a strong contraction in demand. That will create some pressure for builders to offer a whole lot of incentives. There was a story in the Wall Street Journal a couple weeks ago about builders selling inventory in bulk to investors at a 10 percent or 20 percent discount. And starts have declined significantly as a result, because no one wants to be building and delivering more inventory in a market that's seeing a significant contraction.

And so, I would say a balanced level of supply is a moving target because it all depends on the level of demand. And so, yes—a year ago we had a shortage of supply because demand was so strong. We were selling six million homes a year. But when we're selling four million homes a year, supply levels start to become more imbalanced and may become oversupplied—and that's when you have that downward pressure on price. And we're seeing that—the longer you have to put your house on the market and it's not selling, the first thing that a seller is going to do is they're going to lower that price. And the more and more they lower the price, the stronger downward pressure on home values is being created in the market.

Heintjes: Domonic, you touched on the months' supply of housing, which of course is a commonly watched metric. How has that metric moved in recent months? Slowing sales must increase the months' supply, right? Is the Southeast different from the rest of the US, in terms of months' supply of housing?

Purviance: Yes. So, the overall months' supply is still around—it's less than four months. I've seen it as low as three to as high as like 3.5, so somewhere in that range nationally. If you look at markets in the Sixth District, like Nashville and Tampa, Orlando, Atlanta—the months' supplies are all below two months' supply, so we are a lot better than the nation as a whole. As I mentioned earlier, a lot of that has to do with the fact that demand remained stronger in our markets because we drew a lot of people who were coming from high-cost markets that had a home they could liquidate and take that cash and put towards purchasing a new home. As people lose the ability to sell their home in New York or California, they're not going to have the capacity to come and buy homes in Nashville or Atlanta or Tampa as readily as they previously would. And even in our markets, even though we lag the rest of the nation, the months' supply is rising and it's lagging some of the other markets in the country. But we do expect that to continue to rise as demand contracts.

Heintjes: While we're talking about the Southeast specifically, I want to ask you: how is the housing market—prices, affordability, trends, availability, all that—in the region compared with the rest of the US?

Purviance: The markets in our district are still experiencing significant—if you just compare to last year—home price appreciation. It's starting to slow, just like the rest of the nation. But for example, Tampa has the highest home price appreciation in the nation. Home prices went up 25 percent year over year in August. If you look at July, Tampa was 28 percent, so you're seeing it slow. But we see very, very strong home price appreciation. As I mentioned, though, a year ago it was Boise that had the strongest home price appreciation, so we do see other markets slowing down faster than we are. But right now, as of today, home price appreciation still remains strong. Because we have high home price appreciation in our district, we also have the sharpest declines in affordability, so all of our major markets—as I mentioned, Tampa, Nashville, Atlanta—our markets have experienced the sharpest declines in affordability over the past year, and it's simply because we still have this—relatively speaking—strong price appreciation. But what's likely to happen as affordability becomes a problem for more and more potential buyers, the rate of appreciation is likely to slow and either moderate or decline in many markets.

Heintjes: In light of everything we've been discussing today, in your view what is the biggest risk for the housing market in the coming months? Is it tightening credit, rising delinquencies, worsening affordability…something else, all of the above?

Purviance: Credit might tighten. That's sort of a natural impulse in a market where demand is declining. But I will tell you, credit has remained very strong—80 percent of the mortgages that have been originated over the past few years have had FICO scores of 720 or higher. A lot of those buyers are locked in, as I mentioned, at a very low interest rate, and so the concerns about an increase in delinquencies and foreclosures is not as urgent as what we may have seen in 2008—with the caveat that rising inflation is causing an increase in short term delinquencies, like 30 days, not just in mortgages but in almost every loan category. If there's a recession and there's widespread layoffs, of course, that may precipitate higher delinquencies and higher foreclosures. But because the majority of people who bought are locked in at a low rate—and many of them have a significant amount of equity, and they have strong FICO scores—I don't necessarily think delinquency is the biggest risk. My concern is the potential for us to see a significant contraction in home prices. If you think about it: prior to the pandemic to today, home prices nationally are up over 50 percent.

Heintjes: Wow.

Purviance: We have never seen anything like that before. If you compare where we are today to previous cycles, even in 2008 we didn't see this level of price appreciation. And so, when you have prices go up that rapidly in that short of a time and then you have this major correction caused by rising interest rates, it just increases the risk for a major correction in home prices nationally. Just to put it in perspective, in 2008 home prices nationally—now, we had some markets like Miami where it was a bit higher, but nationally—home prices declined by 9 percent, maybe 10 percent max. We could see something of that magnitude or greater, simply because of how sharp prices have increased or how low affordability is, that we talked about earlier. The median income household is spending greater than 45 percent of their income to afford the median-priced house. The affordability threshold is 30 percent. How do you get back to 30 percent? How do you get back to a normal housing market, where the median-income household can afford the median-priced house? One or two things can happen. The first thing that can happen is you see some sort of correction in home prices. And the reason why home prices is the likely variable is, you could see incomes rise—but because of inflation, we're offsetting any improvement in wage growth that we are seeing. We are seeing improvement in wages, but inflation is wiping that out. You also can see interest rates decline, but as we mentioned, because we're dealing with high inflation, the likelihood of us seeing interest rates decline in the next year is low. So, the only way you can get back to the affordability threshold is if you see some correction in home prices, and all indications are that that's where we're headed. If you look at the share of homes that are selling with price drops, it's at 22 percent—which is an historic high. In markets like Atlanta and Tampa, over 30 percent of homes that are currently selling are selling with some sort of price drop. That, to me, is an indication that we will experience some significant downward pressure on price, and perhaps a pretty significant home price correction in the next year. And that's what I perceive is the biggest risk.

The other thing that could happen is the whole nation could be like—I hate to put it this way, but…in Los Angeles and San Francisco and some of your coastal markets, people who make the median income aren't buying the median-priced house. They're not buying a house, they're renting. We may get to a situation where the share of home ownership declines simply because the median-income household can no longer afford to buy. Those are some of the scenarios that I'm paying attention to, and that to me poses the biggest risk right now.

Heintjes: Well, you sort of anticipated my next question. You know, I couldn't have you on here without getting you to take out your crystal ball, and I can't end our conversation without asking you to look down the road. So looking ahead, how do you see the housing market: flat, declining slightly, declining significantly—as you mentioned, prices correcting? What do you foresee?

Purviance: Well, demand is already declining significantly. The economist from the National Home Builders Association is already calling this a recession in the housing market. I don't necessarily use that language, but there are a lot of people who are directly involved in the sector that are considering current conditions recessionary. So on the demand side you'll see sales drop sharply. In terms of home prices, as I mentioned, I think we're in for some significant downward pressure, mostly because of high interest rates. As the FOMC responds to high inflation by raising rates, that's going to take mortgage rates higher. And the higher mortgage rates go and the longer they stay, the more downward pressure we can expect to see on home prices. I think before I was on here, I was talking about a lot of people kind of seeing somewhere in a 10 percent range. It could be higher than that nationally. If interest rates go higher, demand contracts further, it could create sort of a domino effect where we see home prices decline at record levels—record levels compared to what we've seen in recent history, like going back to 2008. I think the highest, as I mentioned, was nationally home prices declined around 10 percent. We may see price declines on that level or higher if we continue to see interest rates rise the way they have over the past few months.

Heintjes: Okay. Well, thanks for that, and I do appreciate you taking out your crystal ball for us again. Domonic, this has been a really great 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 I hope you'll be back on the podcast again soon.

Purviance: Thank you. It's been a pleasure.

Heintjes: And before we finish today, I want to briefly mention the Home Ownership Affordability Monitor, one of the data tools that Domonic oversees for the Atlanta Fed. It's always interesting—and these days, especially so—and I encourage you to check it out. We'll have a link to it on the web page. And that brings us to the end of another episode of the Economy Matters podcast. Again, I'm Tom Heintjes, managing editor of Economy Matters 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.