Home Prices Continue to Rise—But Has the Market Reached Its Peak?

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This week brings the latest round of S&P CoreLogic Case-Shiller Indices, which measure the average selling price of single-family homes nationwide. In short: Selling prices have not slowed down or flattened out this summer. Instead, prices continue to rise non-linearly in a rather spectacular fashion. The year-over-year national average rose 16.6% in May, expanding from a 14.8% year-over-year reading in April.

The managing director and global head of index investment strategy at S&P Dow Jones Indices, Craig J. Lazzara, had this to say: “A month ago, I described April’s performance as ‘truly extraordinary,’ and this month I find myself running out of superlatives … the 16.6% gain is the highest reading in more than 30 years of S&P CoreLogic Case-Shiller data.”

In April there were five metros that recorded their all-time highest reading. In May, five more cities—Charlotte, Cleveland, Dallas, Denver, and Seattle—recorded all-time high prints.

But frankly, there’s no region of the country being left behind anymore: Year-over-year price gains in all 20 metros were in the top quartile of historical performance. In 17 out of 20 metros, price gains were in the top decile of all-time readings.

The West Coast had the three splashiest numbers, with San Diego, Seattle, and Phoenix all coming in with more than 23% increases in average selling prices over the past year.

What is Case-Shiller?

As a quick primer, the U.S. National Home Price NSA Index measures the 20 largest metro areas in the U.S. and is computed with a three-month moving average. More specifically, the Case-Shiller measures the 20 largest metropolitan statistical areas, or MSAs. Urban areas and the surrounding suburban counties are grouped into one MSA.

The moving average part is key to our discussion here: Everything we see in newly-released figures is already backward-looking by quite a bit—not only for the two-month lag itself (for example, May prints come out at the end of July)—but also factoring in the moving average of the past few months.

It’s important to have this context when looking at a metric that is rising non-linearly. Here is a chart of the Case-Shiller over the past 14 months:

And here’s the vantage point if we widen the aperture to the 12 years following the Great Recession of 2007-2009:

Key takeaways

The steady rise that was maintained through 2020 was great and sustainable. Interest rates were historically low, and personal incomes were rising along with jobs growth. The supply of homes available for sale remained a bit too low, given that Millennials were starting to hit their prime home-buying years. They became the single largest demographic of real estate purchasers by the end of the 2010s.

But this curling up of the tail in the past year is not sustainable—that’s an objective mathematical certainty. The average selling prices of homes is rising faster than any of the pillar metrics can keep up with. Wages aren’t rising non-linearly. Interest rates have been skirting along a floor level for a couple years now, and can’t really slide any lower (especially given that inflation is running at its fastest pace in over a decade).

In short, affordability metrics are moving in the wrong direction: south. We could read the tea leaves back in May, when we noted the sticker shock that was hitting the faces of prospective homebuyers.

Estimates vary between lenders and different investment sectors, but a fair consensus is that median home-buying power rose by about 8% in the past year, thanks to rises in incomes and slightly lower mortgage rates. But that pales in comparison to a 16%-plus rise in average selling prices.

Here’s where to point fingers

There are some important factors pushing up prices that are hopefully one-offs and will soon dissipate. The pandemic has been the biggest of these. COVID-19 initially sent city-dwellers scampering for a way out of the city and into the suburbs. Their white-collar employers largely promoted this swing as the Zoom economy got into full swing.

It’s hard to gauge how much of the work-from-home trend will have staying power once COVID-19 finally recedes as a national health concern. But certainly enough companies are still riding the remote work train as I type this to motivate a large demographic of people to seek homes in suburban and rural areas.

This is one half of the reason why the Midwest region has fastest sales pace of anywhere in the U.S. The other half of the reason: The Midwest has the lowest average selling price of any region in the country—and folks are begging for anything affordable, anywhere.

The ripple effect of higher prices

We’re already seeing one of the simple, yet major effects of home prices that are rising too fast: People stop wanting to pay them.

Many people have shrugged and continued to rent, semi-content to wait and see if prices will come down. This is a powerful psychological factor given that most of us remember not-too-long-ago when house prices went down… a lot.

The ingredients that caused the big crash back in 2007 through 2009 aren’t in place now, so it’s a very remote possibility that a similar outcome could unfold today. Today’s mortgages aren’t issued without income verification. Standards put in place by the government and the country’s biggest lenders make a pretty sturdy firewall against worst-case outcomes.

But sales can and might slow to a crawl, despite so many prospective buyers. We’re already seeing this in the new home sales information put out by the U.S. Department of Commerce. The report for June had the U.S. hitting a 14-month low in sales, its third straight month of declines. The 676,000 sales reported was a big miss from the expected number of 800,000. May’s initially reported figure was also revised down by 45,000 homes—another sign of deterioration between handshake stage and the signature stage.

The data is divided into four regions—and only the Midwest saw a net increase in sales during June. The East, South, and West (where prices are highest) all saw declines.

Some pressures easing

Those hoping to see an increase in new-home construction may see one glimmer of hope: Lumber prices fell by more than 50% over the past few months. In addition to supply shortages in molded fixtures, copper derivatives, and labor, lumber prices were a major crimp for homebuilders. Input costs rose even faster than home selling prices, leading to a big drop in building permits, which hit a nine-month low in June.

The lower input costs should quickly work their way into the construction markets and help keep the necessary flow of new properties humming. But despite improvement in the months’ supply of homes, it’s still not enough to meet the needs of Millennial buyers nor the flow of remote workers seeking larger homes away from cities.

This is why average selling prices keep hitting new records despite the solid uptick in available inventory.

It’s always good to keep an open mind when dealing with something unprecedented. There’s no modern precedent for COVID-19—certainly not in a digital economy—so we don’t know just how pervasive the “flee to the suburbs” trend will become. There’s also no precedent for all the stimulus and intervention we’ve had over the past couple of years, and the possible subsequent effects on inflation and mortgage rates.

But don’t be a chaser of an incremental property to add to your portfolio—not at these levels. Homes cannot and will not act like stocks, crypto, or any other asset class. All those other things can be purchased by someone with just a few hundred or thousand bucks to toss around. That is not the case with single-family properties.

Once price gains are double that of purchasing power gains, the party’s about over. Expect to see a plateau as the overall sales pace slows down mightily until inventories can keep up with the rampant demand. And that will take some time—12 to 18 months at minimum, given the extreme lag times in construction.

Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.