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Could the ‘Wealth Effect’ Mean More Homes on the Market?

It's been something of an unpredictable past year for the housing market, but that will not stop economists and other experts from analyzing and predicting. First American Chief Economist Mark Fleming’s Real House Price Indicator (RHPI) data showed rising equity levels, which typically would lead to more homeowners willing to sell. But, Fleming explains in the report published Tuesday why equity won't necessarily spur many homeowners to list their homes for sale.

Equity can lead to the so-called "wealth effect," a phenomenon that typically prompts property sales, Fleming says, but in these market conditions, things are likely to be different.

“The rapid pace of annual nominal house price appreciation, just over 14% in February, begs the question: isn’t rapid house price growth good news for existing homeowners looking to move? According to a behavioral economic theory dubbed ‘the wealth effect,’ homeowners are more likely to move if they feel ‘wealthier’ because the value of their home rises,” said Fleming. "Yet, that homeowner would be entering the housing market at a time when all the other homes in the area have likely appreciated by the same amount. While the homeowner’s equity gains boost wealth, the equity gains allow the homeowner to keep pace with the housing market, rather than outpace it.”

The aforementioned situation is creating an environment heavy with first-time buyers.

“Wealthier homeowners may feel locked into their existing homes, but first-time homebuyers have no such financial lock. As of December 2020, nearly 50 percent of all purchase mortgages originated by Fannie and Freddie went to first-time home buyers. Additionally, buying a home is often prompted by lifestyle decisions more so than financial considerations,” said Fleming. “Despite a likely increase in the lock-in effect if rates continue to rise, we expect home sales will continue to remain robust, but it won’t necessarily be fueled by existing homeowners moving out and moving up as a result of the wealth effect.”

The three components of the RHPI, according to Fleming, are household income, mortgage rates, and a nominal house price index.

"The RHPI adjusts nominal house prices according to changes in income and interest rates, which together make up consumer house-buying power. When incomes rise, house-buying power rises as well,” Fleming explains. “However, when mortgage rates rise, house-buying power declines. Similarly, house-buying power declines when unadjusted nominal house prices rise."

What follows are several highlights from First American's report.

  • Real house prices increased 1.6% between January 2021 and February 2021.
  • Real house prices declined 1.3% between February 2020 and February 2021.
  • Consumer house-buying power, how much one can buy based on changes in income and interest rates, increased 0.1% between January 2021 and February 2021, and increased 15.6% year over year.
  • Median household income has increased 6.4% since February 2020 and 77.0% since January 2000.
  • Real house prices are 25.0% less expensive than in January 2000.
  • While unadjusted house prices are now 23.8% above the housing boom peak in 2006, real, house-buying power-adjusted house prices remain 47.2% below their 2006 housing boom peak.

Fleming goes on to break down these findings regionally, explain his methodology, and offer more market insights at blog.firstam.com.

About Author: Christina Hughes Babb

Christina Hughes Babb is a reporter for DS News and MReport. A graduate of Southern Methodist University, she has been a reporter, editor, and publisher in the Dallas area for more than 15 years. During her 10 years at Advocate Media and Dallas Magazine, she published thousands of articles covering local politics, real estate, development, crime, the arts, entertainment, and human interest, among other topics. She has won two national Mayborn School of Journalism Ten Spurs awards for nonfiction, and has penned pieces for Texas Monthly, Salon.com, Dallas Observer, Edible, and the Dallas Morning News, among others.
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