Tuesday, May 23, 2017

Housing: Part 230 - Supply and Demand during a housing boom.

One aspect of a hot real estate market that is thought to lead to cyclical volatility is the wealth effect of rising prices.  Existing homeowners get an income boost from rising capital gains in their homes.  This shifts the demand curve out because existing home owners can use their newfound equity to buy up into the hot market.  It also shifts the supply curve down because some households who might have had to sell their homes due to temporary financial stress can now tap home equity in order to continue making mortgage payments.

These are legitimate factors that might feed a bubble.  But, I think there is a significant mitigating factor - outmigration.  I think this factor might be overlooked, because we tend to model markets in a ceteris paribus framework, and the way that this factor mitigates the bubble is through a shift in the market itself, as former homeowners sell and move away from the local market.

This first chart is the estimate of population shifts from IRS data.  This is net domestic migration into and out of the Closed Access and Contagion cities since 1995.  This roughly matches the net domestic migration we see in the ACS data that begins in 2005, specifically for homeowners.  There was a buildup of migration, peaking around 2004 or 2005 at 1.5% or more of the local population.

In the Closed Access cities, this means that at the peak of prices and sales, there was selling pressure that amounted to more than 1.5% of existing units each year.  That's a hefty mitigating factor.

Usually, home sales volume runs about 5% of the existing stock.  (I'm not sure why the Zillow measure shown here shows such a decline in 2016.  NAR existing home sales haven't declined like this.)  That bumped up to about 7% during the boom.  Sales turnover was higher in the Contagion cities, but the Closed Access cities tended to run near the national average.

Data from Zillow
This means that about 1/4 of home sales in the Closed Access cities were from homeowners selling out of the market and moving out of town.  That's a lot of selling pressure.  This doesn't include households that might have sold properties and remained in the city as tenants.

There was a sharp jump in privately securitized mortgages in 2004-2006, and there was a jump in home price appreciation in 2004 and 2005, which leveled off in 2006.  We tend to attribute those 2004-2005 gains to the new, more flexible mortgages, and certainly they were a factor.

But, the degree to which that new demand from buyers flowed to price is dependent on how elastic this migration-related supply was.  Maybe prices would have gone up another 30% if this outmigration hadn't kicked in.  Or, maybe one reason prices accelerated in 2004 and 2005 was that the "low hanging fruit" had been picked out of Closed Access markets, and the homeowners who were easily induced to migrate had already sold and left, and supply shifted out less over time as the population of potential movers was tapped.  Or, maybe we overestimate the effect of demand on these markets in general, and home prices at the MSA level are more bound to the present value of future rents than we give them credit for.  The quantitative answers to these questions are beyond my abilities, but they seem to be questions that have not been asked nearly enough because changes in the mortgage market have taken center stage while the sharp shifts in migration during the boom were less directly visible.

In any case, it seems to me that the degree to which Closed Access prices remained close to a reasonable valuation vs. being pushed to unsustainable or irrational levels, depends more on the elasticity of supply coming from those existing owners than it does on the new demand that might have been facilitated by the new borrowers.

The Contagion cities are the mirror image of the Closed Access cities, so their markets were characterized more by new demand.  But, we can see this migration-supply factor coming along even there, beginning in 2005.  The first shift in migration in the Contagion cities in 2005 was an upshift in out-migration, even as migration from the Closed Access cities remained strong.  Then, in 2006, even while the private securitization boom remained strong, net migration really dropped in Contagion cities, and home prices leveled out there.

We can also see a mitigating factor across cities.  Portland, OR took in a lot of California migrants during the boom, like Phoenix, but its total population growth was more subdued and home prices there were less volatile.  This is mostly because home prices there started out higher.  They peaked about the same level in Phoenix and Portland.  This is what we would expect to see if migratory shifts on the margin, regulated by the cost of housing relative to the Closed Access source cities, were an important factor in finding an equilibrium price.

Added:  Another comparison we might make with the 1-1.5% rate of Closed Access out-migration is that first time homeowners tend to represent just over 1% of households per year.  (It has been lower than that during our decade of demand deprivation.)  And, during the housing boom, homeownership was rising by about 0.5% per year.  It has fallen at about that same rate since then.  The rate of out-migration from Closed Access cities during the boom was larger than either of those measures.

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