US house prices have climbed over 6% in the past year, pushing the value of homes nearly 3% above their peak from June 2022. This increase came despite the Federal Reserve’s aggressive interest rate hikes aimed at curbing rampant inflation. Clearly, the traditional models for predicting house prices are no longer reliable.
Supply and demand dynamics
Historically, predicting average US house prices was straightforward: consider mortgage rates and the supply of new homes. Mortgage rates typically reflect demand—higher rates usually mean lower demand—creating an implicit supply-demand graph.
However, recent trends challenge this model. Over the past 18 months, US 30-year mortgage rates surged from 3% to 8%, yet house prices remained surprisingly resilient. While the model predicted a nearly 15% drop in prices year-on-year, actual changes did not dip into negative territory. In absolute terms, prices decreased by only about 5% from peak to trough.
The model currently suggests another significant price drop. This delay in reflecting higher interest rates in the housing market, similar to the labour market, implies that the full impact of rate hikes takes time to manifest. Thus, focusing solely on recession probabilities may be misleading.
Interestingly, high house prices have a silver lining. Homeowners often experience a boost in consumer confidence with rising property values, as their homes represent their largest source of wealth. This confidence is particularly welcome when “excess savings” have been exhausted.
Scarcity and stagnation
Two main factors distort the relationship between mortgage rates, supply, and house prices. The first is scarcity. Insufficient construction of new homes, a global phenomenon mirrored in the Netherlands, keeps prices artificially high, disadvantaging those not already in the market.
The second factor is homeowner inertia. Many people avoid moving to prevent locking in high-interest rates. As a result, sales of existing homes are near a 30-year low. With so few people moving, prices don’t adjust to reflect the higher rates.
The Federal Reserve’s eagerness to cut interest rates and homeowners’ awareness of increasing market scarcity suggest that the current status quo will persist. When mortgage rates eventually fall, house prices are likely to surge even faster. It’s time to develop a new model that incorporates market scarcity, as no end to this trend is in sight.
Jeroen Blokland analyses noteworthy charts on financial markets and macroeconomics in his newsletter, The Market Routine. He also manages his own multi-asset fund and previously served as head of multi-asset at Robeco.