What is Going on with Real Estate?

Update on the Residential Real Estate Market

May 30, 2023

Residential real estate is top of mind after attending the MEREDA (Maine Real Estate & Development Association) Spring Conference and reviewing the Q12023 Case Shiller Index report. Residential real estate is a critical piece of the inflation and economic story because it is 34% of the consumer price index (CPI)[1] and 15%-18% of GDP[2].

Conventional wisdom says there is a severe supply and demand mismatch. Supply of newly built homes has been constrained since the great financial crisis[3] and supply of existing homes constrained more recently by homeowners reluctant to give up a historically low mortgage rate by selling[4]. Demand strength is due to millennials looking for their first home, baby boomers looking to downsize, and remote work opportunities post-COVID.

Looking at the Case-Shiller index, nationally, prices are .7% higher than March of 2022. Interestingly, however, the 10-city composite was down .8% and the 20-city composite down 1.1%, perhaps suggesting an urban-rural divide. The regional divide is obvious. Seattle (-12.4%) and San Francisco (-11.2%) are at the bottom while Miami (+7.7%), Tampa (+4.8%) and Charlotte (+4.7%) are at the top.  

Looking at the MERDA Index, the weakest part of the residential market was permit applications, down 32% on an annual basis in Q4 2022 from Q4 2021 and cut in half from Q1 2020[5]. This is a major reason why in all 16 Maine counties the median sale price increased while the numbers of homes sold declined. Not surprisingly, sale prices were up 18% on an annual basis over the same timeframe.[6]

Price appreciation in this environment is a deadly double-edged sword. If it continues on an aggregate basis, housing’s oversized weight in the CPI will keep inflation elevated above the Federal Reserve’s target of 2%. CPI is currently 4.9%. If inflation does not come down to target, the Federal Reserve will continue to raise interest rates and perform quantitative tightening which will further crimp supply of existing homes for sale because owners won’t trade their mortgage rate, worsen affordability by pushing mortgage rates above the current 7% rate, and sew more economic uncertainty in the homebuilding industry thereby crimping supply of new homes.  

So how will supply and demand come into balance? In Maine, it could hinge on rural and out of state demand. According to Leanne Nichols with Keller Williams, the percentage of out of state zip codes buying homes in Maine increased from 27.4% to 34.4% from pre COVID to 2022. Several rural Maine counties saw robust sale price growth in 2022 (Androscoggin 15%; Hancock 10.79%; Sagadahoc 11.62%; Washington 22.22%)[7]. Nationally, the demand question appears to hinge on continued net out-migration from large cities and the west to net in migration to small cities and the southeast.

Time and more predictable interest rates could prove to be the most powerful salve for supply issues. More time will allow the supply of labor and materials to normalize and bring down construction costs. More time will allow the flow of people migrating to settle into a normal rate. More time will allow the demographics of the baby boomer generation to aid the supply of homes on the market. More predicable interest rates will allow both home builders and buyers to make long-term plans with a sufficient degree of certainty. Unfortunately, inflation waits for no one and the Federal Reserve is on a mission to bring it back to target.