This summer will it become, “These prices are crazy, let’s wait and see”?
My working theory is the Fed started the house price boom when they slashed interest rates again last year after cutting them throughout 2019.
In addition, Covid increased demand for houses.
In addition, Covid also cut spending on restaurants and travel so people were saving a lot more than usual. At the same time, the 3 stimulus packages may have helped some potential first-time homebuyers pay off their credit card debt, save up more down payment money, and generally become a bit more ready to buy their first house.
But, I think, the second most important reason for fast-rising house prices this year is fast-rising house prices. Some economists call this price feedback loop, “extrapolative expectations.” People just extrapolate out recent price increases and expect them to continue into the future, so they buy when they expect price increases which causes prices to increase, and so on.
You can then get a “rational bubble.” If you think prices are crazy high but you also expect them to continue increasing fast, it’s rational to buy as an investment.
Mortgage rates bottomed out in January. Those 2 years of falling mortgage interest rates are still driving up house prices but their impact is diminishing. On the other hand, house price increases have been increasing this year. That’s why I think the extrapolative expectations phenomenon kicked in this year and may very well be the main driver of the huge price increases we’ve seen so far in 2021.
Expectations vs. Seasonality
I’m also thinking that price trends driven largely by expectations, can change quickly.
What happens when the high season ends in Phoenix in May? Will the typical ~10% fall in house sales in June have an unexpectedly large impact because the market is being driven so much by expectations rather than hard fundamentals?
The fundamental changes in demand for houses caused by Covid are in the past. So is the fundamental fall in mortgage rates. They both still increase demand but their impacts are decreasing over time.
Prices Plateau this Summer?
If house prices plateau this summer, as they typically do, that would eventually change expectations for future price increases.
In this scenario, we could very well move from a market psychology of,
These prices are crazy but they’re increasing so fast, let’s buy something ASAP!
to a market psychology of
These prices are crazy, let’s wait and see.
And when people in other metros start to see what’s happening to Phoenix prices, it would have some impact on their expectations for future prices in their own metros.
New Data Point
The Cromford Report recently reported that list prices (per square foot) of houses that are under contract to buyers in metro Phoenix plateaued in mid-April after increasing extremely sharply the previous 11 months (up 37%).
That suggests prices on house sales closed in June will be similar to May. The trend is only 1 month old but since we typically see a seasonal slowing of house sales in the summer anyway, I will extrapolate that one-month trend out into the future, and expect it to continue.
The Phoenix real estate market is many, many months away from “normal,” but today my expectation is that it will start moving strongly in that direction this summer.