Why Are Real Estate Prices Rising in the Middle of a Recession?

A short while ago, I noted that an analysis by Redfin found list prices had already dipped by 6.4% from March to April. This was, as many thought, the first sign of a general decline in housing prices. It turns out that that’s not what has happened (thus far, at least).

The Wall Street Journal reported:

“The economy is shrinking, businesses are closing, and jobs are disappearing due to the coronavirus pandemic. But in the housing market, prices keep chugging higher.

“Home prices plunged during the last recession after a housing crash caused millions of families to lose their homes. Home values could start to erode again, especially when mortgage forbearances end, some economists warn.

“But that hasn’t been the case so far. The median home price rose 8% year-over-year to $280,600 in March, according to the National Association of Realtors.”

As for May, the story was similar. From Realtor.com:

“Median home list prices still jumped up 3.1% year over year last week, according to the most recent Realtor.com data of the seven days ending May 23. That’s about double the 1.5% annual rise from the previous week ending May 16.

“Last week, home prices increased in about three-quarters, 77, of the largest U.S. metropolitan areas.”

So what’s going on?

Why Housing Prices Are Rising

For one, Redfin data were misleading because they only had to do with the list price of properties being put on the market, not with the sales prices of properties that actually sold.

Furthermore, all of the early data that came out right as the pandemic was starting to hit the United States were also misleading. Properties are usually under contract for at least 30 days before closing. Thus, the sales data from March came from properties with contracts signed in February, when COVID-19’s impact on the U.S. was minimal and many doubted it would become a serious problem.

But more importantly, there are two major reasons that real estate prices continue to rise:

Supply has shrunk.
Unprecedented federal action has been taken.

Reduced Supply

Even that Redfin study from late March found a massive decrease in week-over-week new listings across virtually the entire country. This ranged from -17% in Tampa Bay, Florida, to an astounding -63% in Philadelphia.

Only Phoenix was positive, at 5% (somewhere, Ben Leybovich is having a chuckle).

The Wall Street Journal’s piece quotes Zillow’s senior principal economist Skylar Olsen, noting that, “Demand absolutely just got a kick in the gut, but at the same exact time, so did supply.”

Indeed, so did supply.

For example, as the same article points out, mortgage applications for home purchases were down “20% from a year earlier,” according to the Mortgage Bankers Association, and total listings of homes for sale “hit a five-year low,” according to Redfin.

Realtor.com points out just how massive the drop in supply has been:

“The number of listings was down 22% year over year in the week ending May 23. That’s because many sellers pulled their properties off the market or held off on listing as they didn’t want strangers walking through their homes in the middle of a public health disaster. When there are more buyers competing for a very limited supply of properties, prices tend to go up.

“Meanwhile, the number of new listings fell about 20% annually. While that sounds bad—and it is—it’s much better than the 28% drop the week prior.”

Zillow’s data concur. Further, Zillow expects that this trend will continue both in terms of pricing and inventory. They expect prices in the third quarter of 2020 to have “a 0.13% decline year over year, followed by a 1.18% decline in Q4.”

But this will come along with a massive reduction in inventory sold: “The forecast continues to predict that the number of homes sold will fall as much as 60% this spring.”

People are scared to list their house right now—or at least believe it is better to wait. So those that can wait are waiting.

Federal Action

Whatever you think of the federal government’s response in 2008, they were at least a bit squeamish about it. Not so this time around. The government has poured money into the markets in an absolutely unprecedented manner both with fiscal and monetary policy.

The Federal Reserve has lowered its benchmark interest rate to 0%, and it is likely to stay there for quite some time (that is if they don’t find a way to push it into the negative). The government has pushed through a $6 trillion stimulus deal ($2 trillion in direct money to households, businesses, and corporations and $4 trillion worth of buying securities through the Federal Reserve). And more is likely to come.

All of this money, of course, is not sitting around in the Treasury. It is either borrowed or, as they say, printed (but more accurately, brought into existence when the Federal Reserve buys securities with newly created, digital money).

If everything else is equal, more money means higher prices. This can be seen by Milton Friedman’s famous quantitative theory of money:

M x V = P x Y

In other words, M: Money (money supply) multiplied by V: Velocity (how fast money is spent) = P: Price (how much things cost) multiplied by Y: Production (how much is produced).

When a mortgage is foreclosed on, money is destroyed (for the mechanism behind this, see here). But there has not yet been a wave of foreclosures, so the money supply was relatively stable prior to the stimulus. Velocity and production are obviously down (less is being produced and people are spending less than they were before), but if the money supply is expanded enough, that can prevent prices from falling. And here’s how much the money supply has been expanded:

fredgraph — *Growth in M1 Money Supply: Federal Reserve Bank of St. Louis*

Of course, if velocity and production pick up, we will have major inflation and likely stagflation (high inflation with no or negative growth). And to get out of such an inflationary spiral would probably require the Federal Reserve to substantially raise interest rates like was done in 1982 in order to “break the back” of the high inflation that had been haunting the United States throughout the ’70s. Doing that caused a deep recession.

In addition to fiscal and monetary stimulus, the federal government also put a 60-day hold on all foreclosures with FHA, Fannie Mae, and Freddie Mac loans. Furthermore, many courthouses have been closed for months as part of the lockdown, which has prevented any foreclosures from being filed. And banks have (wisely in my judgment) been more proactive in seeking forbearance agreements with borrowers who were at risk of default than they were in 2008.

All of this has helped counter the downward pressure on real estate prices.

How Long Can This Last?

Predictions are something to be handled with caution. Daniel Kahneman referenced a study in his book Thinking Fast and Slow regarding 284 predictions made by political and economic experts. The results were, well, less than inspiring:

“The experts performed worse than they would have if they had simply assigned equal probabilities to each of three potential outcomes.”

With that important caveat in mind, it’s hard to see the recent increase in housing prices as anything but a head fake. There were strong signs that Americans and American businesses were overleveraged even before the coronavirus (record national debt, record mortgage debt, record credit card debt, record student loan debt, etc.). And now we have 13.3% unemployment, down just slightly a recent high of 14.4%—a rate not seen since the Great Depression!

Many small businesses and a decent number of large firms have gone bankrupt. Already, 2020 has seen 13 noteworthy retailers declare bankruptcy (whereas in 2019, it was 17 for the entire year). This includes household names such as J.C. Penney, J.Crew, and Pier 1.

To make matters worse, food is seeing historic price increases due to the lockdowns.

And remember, it takes a long time for a default to become a foreclosure and for those foreclosures to begin dragging down the housing market. By some early (and in my opinion, overly pessimistic) predictions, mortgage holders are bracing for up to 15 million defaults.

While the number likely won’t be that high, it will still be high. Yes, inventory will remain low, but as people go into default or simply need to move, large numbers of properties will eventually hit the market. With reduced demand, this will put downward pressure on housing prices.

When will this happen?

It’s impossible to say. But it would seem highly likely it will happen to one degree or another.

The only ways I see this not happening would be either a “V-shaped recovery,” which is very unlikely now, or the federal government pushing so much money into the economy it somehow keeps housing prices afloat. But this would only be in a nominal sense, as inflation would quickly get out of hand in that scenario.

Regardless, the lesson is to avoid being overconfident, despite the fact that housing prices are still increasing. In all likelihood, this will only be short-term. And while it does not mean you should sit by on the sideline twiddling your thumbs, it does mean you should demand better deals and be more cautious with your investments going forward.

What are your predictions for the housing market?

Give your best guess in the comments below.

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