Slow wage growth limits home price appreciation
The fundamental driver of home price appreciation is wage growth, and the housing market is stalling due to slow wage growth and weakness of the US economy.
Financed buyers complete most home sales, so the borrowing power of financed buyers generally sets the prevailing price levels in most real estate markets. The ability of financed buyers to raise their bids and push prices higher depends on the amount of savings they have, their verifiable wage income, allowable debt-to-income ratios, and mortgage interest rates. Because wages are central to the lending equation, growth of wages is the strongest determinant of long-term housing market prices.
For the housing market to really improve, the fundamentals underpinning the market must improve because manipulating inventory and interest rates can only carry the market so far. The recent house price rally had little or no fundamental support. What the housing market needs to get back on track is growth in jobs and incomes because people who get high paying jobs form new households and often buy houses. Although the job market has been steadily improving since early 2010, the rate of job growth has been relatively weak when compared to previous recessions, and the quality of these jobs has been suspect at best.
Ordinarily, incomes rise over time as the economy expands and workers can demand higher pay for their services. However, in an era of high unemployment, wages generally do not rise because workers do not have the leverage to demand higher pay. In fact, in many industries, wages actually go down as the supply of workers exceeds the demand for their services and those who wish to remain in the field lower their expectations. As a result, stagnant wages are a problem for the economy in general and specifically for housing.
Rising interest rates reduce the buying power of prospective house shoppers because their incomes can’t be leveraged into large loans. The only way to offset the reduced borrowing power is to increase income or debt-to-income ratios. Lenders can’t increase debt-to-income ratios due the 31% cap on GSE loans that dominate the market and recent qualified mortgage rules that cap back-end debt-to-income ratios at 43%. This leaves only rising incomes to push prices higher, and many are concerned that won’t be happening any time soon.
By Michael Madowitz, October 6, 2014
… Starting with August’s report, where revised data added 38,000 jobs to a disappointing report, additional revisions added another 31,000 new jobs to the economy in July. The three-month average job growth is now 224,000 jobs. …
The bad news is that we don’t see any signs of wage pressure and shouldn’t expect wage increases anytime soon, especially with this many prime-aged workers on the sidelines.
… the employment-to-population ratio was flat overall at 59% …
Economists from the left and right — along with reporters — pointed to the percentage of working-age Americans without jobs and the tepid wage growth seen in Friday’s numbers as a sign of considerable slack remaining in the labor market. …
A recent federal reserve study indicated the decline in labor participation rates is largely due to retiring baby boomers. If this is true, the number of prime-aged workers sitting on the sidelines is small, and wage pressures may come sooner rather than later as the supply of unemployed is absorbed. However, if the federal reserve is wrong, and if most discouraged workers will come back to the labor markets if given the chance, then wage pressures will be weak for much longer.
The only notable wage pressure over the last 15 years is among the highest wage earners. Apparently, those with valuable and special skills are in high demand.
The depth of the recession remains a challenge for the Federal Reserve, which must weigh an economy that added almost one-quarter-million jobs last month against a shadow army of unemployed estimated at more than 6.3 million — on top of the 9.3 million people officially counted as unemployed.
This is why the Fed is less hawkish about inflation than it otherwise would be with today’s unemployment rate and why it’s now using a much broader set of labor-market indicators to judge when the recovery warrants tighter money.
In other words, the federal reserve will keep applying stimulus, and interest rates will rise later rather than sooner. Nobody should be surprised by this. The federal reserve will not raise rates until forced by several quarters of inflation being above their target rate. The current consensus opinion is that rates will rise in mid to late 2015. I doubt we will see interest rates rise above zero percent until mid 2016, perhaps later.
For workers, the good news is that hiring really is picking up steam, and the Fed isn’t — and shouldn’t be — hitting the brakes. …
As you can see, there will be considerable pressure on the federal reserve not to remove the punch bowl until everyone has a drink.
Absent action from lawmakers, we will need a string of job reports like this one before we see wage growth start to reach most Americans, which is a real problem for an increasingly squeezed middle class.
For policy makers to do anything to slow things down in the short-term would be more than tone deaf; it would be irrational.
Not to worry, there is no chance the federal reserve will do anything other than give lip service to raising interest rates any time soon.
Wage inflation does not cause housing bubbles
At some point, the pressure of an expanding economy and productivity growth will force employers to bid higher to obtain and retain key employees. That’s when wages rise. If the federal reserve prints enough money, they will stimulate the economy, and they will also likely stimulate inflation.
Real wages — wages adjusted for inflation — are flat. If the federal reserve revs up the economy with printed money, real wages may still remain stagnant even as nominal wages rise significantly. Rising nominal wages will allow both renters and prospective homebuyers to raise their bids for real property, and depending on how bad inflation gets, both rents and house prices could rise at a very brisk pace. However, this would not be a bubble.
As long as the bids are based on stable, amortizing mortgages with a reasonable debt-to-income ratio, the price increases would be normal and sustainable. Many people point to the 1970s as evidence that house prices can rise in an environment of inflation and rising interest rates. This can only occur if debt-to-income ratios get out of control. That’s what drove up prices in the 1970s. Since debt-to-income ratios are currently capped, unless that law is changed, house prices will rise along with wages, but no faster.
Real estate can serve as a hedge against wage inflation causing the general level of prices rising, but only if interest rates don’t go up even faster as the federal reserve raises rates to combat inflation. With the likelihood of stagnant wages and rising interest rates, the primary impetus to push prices higher will be effectively muted.