Housing Prices Out Of Step With Fundamentals, Dallas Fed Says

Housing prices are “increasingly out of step with fundamentals,” with evidence pointing to abnormalities experts at the Denver Fed haven’t observed since the boom of the early 2000s.

“Reasons for concern are clear in certain economic indicators—the price-to-rent ratio, in particular, and the price-to-income ratio,” five economists write in a new analysis of the market.

“While historically low interest rates are a factor, they do not fully explain housing market developments. Other drivers have played a role, including pandemic-related US fiscal stimulus programs and COVID-19-related supply-chain disruptions and associated policy responses,” they note. “The resulting fundamental-driven higher house prices may have fueled a fear-of-missing-out wave of exuberance involving new investors and more aggressive speculation among existing investors.”

Price appreciation accelerated with lightning speed since the onset of the pandemic, but that in and of itself does not necessarily mean the market is in bubble territory. Instead, factors like changes in disposable income, the cost of and access to credit, supply chain disruptions and rising labor and materials costs are some of the economic reasons for price growth. 

But “real house prices can diverge from market fundamentals when there is widespread belief that today’s robust price increases will continue,” the report notes. “If many buyers share this belief, purchases arising from a ‘fear of missing out’ can drive up prices and heighten expectations of strong house-price gains. This self-fulfilling mechanism leads to price growth that may become exponential (or explosive), resulting in the housing market becoming progressively misaligned from fundamentals until investors become cautious, policymakers intervene, the flow of money into housing dries up and a housing correction or even a bust occurs.”

Since the onset of the pandemic, the price-to-rent ratio increased beyond what observed fundamentals alone can explain, the Dallas Fed economists say. The delta between the actual price-to-rent ratio and its fundamental-based level in the US has also grown sharply and started showing signs of “exuberance” last year. And “the exuberance statistic confirms that recent increases are far from ordinary,” they argue, while the ratio of house prices to disposable income “indicates that US real house prices may soon become untethered from personal disposable income per capita.”

But the Fed economists also note a housing correction would likely not compare to that of the Global Financial Crisis, since household balance sheets are in better shape than during the last recession. In addition, they posit that market participants, banks, policymakers and regulators are “all better equipped to assess in real time the significance of a housing boom.”