![]() The takeaway is that demand will continue to fall for many months–regardless of mortgage rates–because people are slowly lowering their expectations for future house price increases. Today, the future-price-expectations part of demand is a lot smaller than it was last spring and it will continue to fade as long as prices aren’t increasing. Expectations for future price increases started to shrink. The music stopped and the punch bowl was taken away. ![]() Then in 2022, mortgage rates skyrocketed. We probably had a lot of herd instinct kick in as well, “Everyone’s offering tens of thousands of dollars over list price, you have to too!”. Many people were just extrapolating out the past price increases. House prices continued to rise in 20–in large part because people expected them to continue to rise even though many of the underlying fundamentals were no longer bullish. Many potential live-in homeowners wanted to buy before prices increased even more, fearing they might be priced out of home ownership forever. Many investors who had made a ton of money on house price appreciation doubled down, borrowed as much money as they could, and bought more houses. Nevertheless, house prices continued to skyrocket until May 2022. The work-from-home movement was old news by then too. Interest rates stopped falling in January 2021. Changes in the other fundamentals caused by the pandemic further stoked the demand for houses. Starting in late 2018, mortgage rates fell for two years, driving down monthly payments and driving up house prices. When you’re borrowing for 30 years with a small down payment, mortgage interest rate changes have a huge impact on your monthly payments. Mortgage rates are one of the most fundamental of all housing market demand drivers. The point is, whether prices are moving up, down, or sideways, many people will expect the current price trend to continue into the future and those expectations can be a big part of the current demand for houses. Perhaps that’s why economists don’t call price expectations fundamental: It’s just too hard to explain that, with houses, the secondary effect of price changes (their impact on future price expectations) can sometimes temporarily overpower their textbook effect. It’s true higher prices will reduce demand in the long run–but if higher prices make people think prices will go even higher in the near future, higher prices can cause demand to increase in the short and medium run. Higher prices are supposed to reduce demand. This is the opposite of standard economic thinking. When prices go up lenders also tend to extrapolate the increasing prices and their increasing profits out into the future, and in turn, they may become more willing to lend money leading to more money chasing houses, higher house prices, and so on in another feedback loop. It’s not just house buyers and sellers who are affected. If you expect house prices to be lower in the future, you’re more willing to sell, less willing to buy now, and less willing to pay current market prices for a house which creates a negative feedback loop of lower prices leading to lower prices. To some degree, higher prices lead to higher prices. That expectation causes house prices to go up even more rapidly, which causes people to become even more confident prices will continue to go up, so prices continue to go up, and so on in a feedback loop. The general idea has been called: price expectations, price extrapolation, biased expectations, adaptive expectations, diagnostic expectations, irrational exuberance, learning from prices, momentum trading, and other names.ĭespite all the different names, the idea seems obvious: If you expect house prices to be higher in the future, you are, naturally, less willing to sell now, more willing to buy now, and more willing to pay above the current market price for a house. Unfortunately, they call it a ton of different things–which is very confusing. For some unknown reason, economists don’t consider people’s expectations for future house prices to be a fundamental factor determining current house prices–but they should.Įconomists have done a ton of research on this general idea. Economists say “fundamental” economic factors, such as interest rates and household income, determine house prices.
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