Home News Releases John Burns: 88% Difference in Price Appreciation Explained by Supply and Demand

John Burns: 88% Difference in Price Appreciation Explained by Supply and Demand


by Erik Franks

Consider these trends:

  • Frothy markets: In 9 markets, home prices have risen faster than can be explained by falling mortgage rates and rising incomes.
  • Beat-up markets: In 2 markets, income growth has outstripped home price appreciation despite receiving a 44% boost from falling mortgage rates.

Income growth should drive home price gains. In a stable world of flat mortgage rates and balanced demand and supply, incomes and home prices should grow at the same rate because rising incomes are what allow people to pay more for a house. Yet, home prices have grown faster than incomes in 28 of the 30 largest housing markets in the country. To make the illustration simple, 0% on the chart below would indicate where home prices and incomes grew in tandem.

Falling rates have increased purchasing power 44% since mid-2001. Because borrowers can afford to borrow more when rates are low, falling mortgage rates push home prices higher, and vice versa. Many forget that the Federal Reserve dropped the Fed Funds rate from 6.50% in mid-2000 to 1.0% in mid-2003 in response to the recession and stock market correction at that time. Accordingly, 30-year fixed-rate mortgage rates have plunged from 7.2% in June 2001 to 3.9% today, allowing home buyers to qualify for a 44% larger mortgage purely due to falling mortgage rates! The black line in the chart below illustrates the price boost received from falling mortgage rates.

Demand and supply imbalances have also contributed to price increases/decreases. Prices in 9 of the 30 markets have experienced more appreciation than the sum of income growth plus the 44% mortgage rate benefit. Some of the markets, such as Los Angeles and San Francisco, have clearly become permanently more expensive places to live due to rising demand and shrinking supply. Other markets, such as Chicago, have become much less expensive places to live. In the chart below, we show the 9 markets whose appreciation exceeds income growth plus the benefit of falling rates.

The chart demonstrates how much prices have outpaced incomes since 2001.


In summary, while incomes and mortgage rates impact price appreciation, demand/supply conditions can impact home prices even more. As always, keep a close eye on the two demand/supply indicators we track most carefully:

  • New home demand/supply. The annual job growth / building permit ratio most closely represents the balance of new homes needed versus new homes supplied, with the caveat that the market needs to reach normal occupancy levels first.
  • Resale home demand/supply. The months of supply of resale homes on the market most closely represents the balance of home buyers and home sellers in the market, with the caveat that new technologies have probably permanently reduced the balanced level of demand/supply by 1–2 months.

Note the huge differences by market above. California homeowners have clearly been the biggest beneficiary of demand/supply imbalances, while other areas have lagged substantially due to lack of demand, high supply, or both.