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As with many things, Covid has turned the real-estate market topsy-turvy. Rather than the more typical fall in housing prices in a recession, this time prices are up. Here in Las Cruces, for example, the August median home price increased by 27 percent compared to a year previous.
Analysists have given several reasons for this, from city folk fleeing pestilence-infected urban centers to reluctance to having virus-laden potential buyers trapsing through otherwise sanitary homes. Regardless of the reason, it is the strength in the real-estate market that have motived many economists to predict a rapid recovery.
While real estate is the hero in the current recovery, at other times, it has played a less beneficial role. In the 1990s, the collapse in Thai property values triggered the Asian Currency Crisis. Closer to home, the Great Recession was caused by the collapse of residential housing, ultimately resulting in a financial panic. Given for this: It is not surprising that a vast literature on housing has emerged. Recently, a consensus has begun to form on how housing markets work.
First, the slow adjustment of housing supply to changes in demand means that real-estate prices are very persistent. There is considerable momentum; housing bubbles are common. And importantly, we can use this price momentum to predict what will happen. Price rises last year can predict price increases next year. A clever real-estate investor can craft a strategy that can generate extra profits. This is in contrast to stock and bond markets where even predicting tomorrow’s prices is very difficult.
A second lesson: rents are not a good predictor of housing prices. The thought would be that higher rents makes owning a home more valuable. The owner can live in the home so as to escape high rents. Alternatively, the owner could rent the house to others thereby benefiting from the high rents. Either way, higher rents make home ownership more valuable, so you would expect higher prices. But this is not what we find.
The reason for this is the slow adjustment of rents compared to housing prices. Rents are set by leases that last months or even years. Add to this the reluctance to raise rents on incumbent tenants and you can see that rents only slowly adjust to reflect higher prices.
A third lesson is: Credit conditions are key to understanding housing prices. Any inflow of credit makes it possible for marginal buyers to purchase homes driving up demand. And given the slow adjustment of housing supplies, this means higher prices. The housing bubble of the mid 2000s was driven by credit inflows. Similarly, the rising prices during the pandemic was pushed by stimulus checks.
Finally, spatial differences in prices are explained by differences in the responsiveness of housing supply. Locales like Las Cruces with a great deal of empty land on which to build homes have more stable housing prices and are less subject to housing bubbles. Locales like southern California with a shortage of developable land and with strict zoning laws that restrict construction are much more likely to have housing bubbles.
Chris A. Erickson, Ph.D., is a professor at NMSU. He recently purchased a new home. The opinions expressed may not be shared by the regents and administration of NMSU. Erickson can be reached at firstname.lastname@example.org.