July 8, 2013
Exploring Seventh District Housing Markets
Bill Testa and Norman Wang
Throughout the Great Recession and the first few years of the subsequent economic expansion, the markets for homes and related building activity failed to contribute to national and regional growth. In fact, over the calendar years 2008–10, residential investment subtracted from overall U.S. economic activity at an average pace of 1 percent. More recently, however, residential real estate markets have begun to recover in many areas of the Seventh Federal Reserve District and the United States. House prices and sales have firmed, and the pace of new home construction has picked up, albeit up from very low levels.
In an effort to analyze residential real estate market developments in the Seventh District, we have developed an index that monitors its 54 metropolitan areas. This index is built from two distinct data measures of housing market activity in each metropolitan area. The first measure is residential building permits. Permits are obtained prior to the construction of both single-family homes and multi-family buildings, such as apartments and condos; and data on the issuance of these permits are collected on a monthly basis. The second measure is the Federal Housing Finance Agency’s House Price Index (HPI), which is a quarterly measure that tracks the movement of single-family house prices. A weighted repeat-sales index, the HPI reports the average house price changes as obtained from records of new mortgages and mortgage refinancings on the same single-family properties. By looking at both permits and HPI data for multiple metro areas in the Midwest, we can find broad directional trends in residential real estate in the Seventh District.
By examining the readings of the two measures (residential building permits and HPI) for many individual localities, we may be able to soon see the beginnings a broad-based housing recovery in the Seventh District. The overbuilding that took place before the 2008–09 recession varied in degree and timing across the Seventh District. Given this variation, we might not expect our metropolitan areas to reach bottom at the same time. And so, our compilation of these data on metropolitan areas may be telling of the Seventh District’s overall progress (or lack thereof) with regard to housing.
To derive additional information from these data, we combine them using what is commonly called a diffusion index. In constructing the index, we first record each metropolitan area’s readings of both residential building permits and house prices (according to the HPI) as a direction (rather than a degree) of change—that is, we record them as “up,” “down,” or “no change.” Next, we combine each metropolitan area’s readings of building permits and house prices into a single observation for each time period. More specifically, we count a metro area as a positive observation (indicating expansion) only if both indicators are up year over year. If both indicators are down year over year for a metro area, we count it as a negative observation (indicating contraction). Otherwise, if one indicator is up on a year-over-year basis while the other is down (or if either indicates no change), we record the metro area as a neutral observation (indicating no change or no conclusive direction). Further, all the metro area observations are then combined into an overall index indicating the breadth of the direction (either expansion or contraction). So, if all metro area observations were recorded as positive, the index value would measure 100, indicating expansion. And if all metro area observations were recorded as negative, the index value would measure zero, indicating contraction. Finally, if one half the observations were recorded as positive while the other half were recorded as negative, the index would yield a value of 50, indicating that the Seventh District’s residential real estate sector was, on the whole, neither expanding nor contracting. Accordingly, any index value greater than 50 (indicating that more observations are positive than negative) signals expansion for the Seventh District’s residential real estate sector.
The map of Seventh District states below shows the observations during the first quarter of 2006—a time of transition for many residential real estate markets across the nation and within the Seventh District. Those metropolitan areas shaded in red were experiencing declines in both building permits and prices of existing homes (on a year-over-year basis), while those shaded in green were still experiencing growth in both measures. The unshaded metropolitan areas were experiencing a decline in one measure with growth in the other.
Our housing index combines such observations into a single index value for each quarter. To help illustrate how we derive this quarterly value, we developed the chart below. This chart plots the total number of positive (or expansionary) observations of metro areas for every quarter from late 1988 through early 2013, as well as the total number of negative (or contractionary) ones over this span. Throughout the 1990s and the first half of the 2000s, it is seen that expanding residential market activities were widespread within the Seventh District (blue line). Moreover, that time period features many quarters when there were no contracting residential real estate markets in the Seventh District’s metropolitan areas (red line). A dramatic reversal began to take place during 2005, which is evident in the chart.
Our index combines these observations of individual metropolitan markets by simple subtraction. The difference in each quarter of the metropolitan areas with expanding residential real estate markets minus those with contracting ones is determined and then set to a base index value of 50. A chart of our Housing Market Index (below) displays the breadth of the expansion in residential markets before 2006. Since 2006, contractionary residential markets have largely been the norm across the Seventh District. Very recently, however, our index shows that residential markets are stabilizing in many of the Seventh District’s metropolitan areas. Moreover, an important benchmark (the index value of 50) has been breached during the first quarter of 2013; finally, the overall balance has tilted toward broad expansion in the District’s residential real estate sector—for the first time since late 2005.
To supplement the overall index, we have provided another mapping of our metropolitan area observations—this one for the first quarter of 2013. In general, such a display may also allow us to see any geographic patterns of recovery in residential real estate markets that relate to underlying economic trends—such as agriculture booms that are lifting the economies of small metro areas, service-sector-led economic growth in large metro areas, or automotive production recovery that is contributing to the economic growth of certain parts of the Seventh District with historical ties to the automotive industry.
Those of our readers placing too much confidence in the recent uptick in our index may do well to remember that it has been widely posited that the ongoing housing recovery is likely to experience many fits and starts. Formal inventories of housing that is available and listed for sale are currently tight. However, it is the large latent or potential supply of homes that can come onto the market with uncertain timing and amounts that may give rise to future market volatility. Included among such potential supplies are those homes that are unavailable because they are undergoing legal proceedings of foreclosure, or those that are temporarily owned by banks that have taken possession in default situations. Still other homes are delinquent in mortgage payments and that could ultimately fall into a foreclosure process. Presumably, most of these home owners cannot sell the properties at a price that would allow them to cover the existing mortgage and liens. And so, such properties are not listed for sale (i.e. they are not a part of the formal inventory).
The chart below illustrates the stock of homes that are either in foreclosure or that are delinquent in mortgage payments. This potential inventory has been falling rapidly in the Seventh District states, yet it remains far higher than historic levels in the late 1980s through the early 2000s.
Note: The levels above are made up of homes having delinquent mortgages plus other homes that are undergoing foreclosure. Inventory of mortgages in foreclosure refers to the total number of loans in the legal process of foreclosures started during the quarter. Some foreclosures included in a quarter have been started but have yet to be resolved.
Source: Haver Analytics/Mortgage Bankers Association.
In a similar vein, although existing home prices have recently been on the rise, many non-delinquent homeowners retain a mortgage whose liability value exceeds the expected sales price of the home on today’s market. An unknown number of such owners are unable or unwilling to list them for sale at the present time (despite their desire to move away) but they will possibly do so if home prices continue to climb. And so, such homes represent yet another potential housing supply that may arise as home sales (and prices) continue to improve. The chart below suggests that such home owner situations persist in some of the District’s large metropolitan areas.
It is clear that there are many crosscurrents afoot in housing markets. Our diffusion index will be a helpful way to observe how they are playing out across the Seventh District.
 Residential investment’s contribution to overall U.S. economic activity is measured in terms of real gross domestic product (GDP) growth at an annual pace, averaged over annualized quarters. (Return to text)
 The two data variables used to construct the quarterly index are measured as: (1) percent change in year over year (by month) residential permits, averaged within each quarter, and (2) percent change in year over year house price index (by quarter). The house price data are stated in real terms deflated by the national “core” PCE less food and energy (personal consumption expenditure deflator) as estimated and reported by the Bureau of Economic Analysis. (Return to text)
 The index is constructed as [(# MSAs observed) + (# of MSAs for which HPI is greater than one and for which permits is greater than one) - (# of MSAs for which HPI is less than one and for which permits is less than one)] / [2 x (# MSAs observed)]. (Return to text)
December 22, 2011
What’s Driving High Foreclosure Rates?
By Daniel DiFranco and Emily Engel Rotenberg
High and rising foreclosures are a big concern in the Seventh District (IA, IL, IN, MI, and WI) and in the country and will continue to be for some time. Our last guest blog on the Midwest economy digs into what reported foreclosure rates really identify. "Foreclosure starts" measure the pace at which homes are entering foreclosure. This rate reflects any deterioration in the ability of homeowners to meet their mortgage obligations for reasons such as job loss, inability to borrow against home equity due to falling home prices, or rising loan payments. Financial troubles may also be caused by life events, such as sudden medical expenses or divorce. Turning to a stock measure, the "inventory rate of homes in foreclosure" counts homes currently in the process of foreclosure. A high rate can reflect a high rate of past foreclosure starts on homes that have not yet been claimed and sold. However, it can also reflect high transition rates of foreclosure. That is, once a home enters foreclosure, it may linger there because process times are extraordinarily long.
To examine these foreclosures in the Chicago area, let's first look at the drop in home values as a widespread reason that many homes have entered foreclosure over the past few years. With property values in the Chicago metro area having dropped about 18% since the beginning of 2004, many homes are currently valued below the cost of their mortgages (meaning owners have negative equity). Being “under water”–the short hand term for a negative equity situation–on a mortgage limits the homeowner’s options to sell or refinance. If owners have to move or cannot afford their monthly payments, this can lead to a default on their loan. Some people may actually choose to default when the amount of their mortgage exceeds the value of their property; this phenomenon is often referred to as “strategic default,” since the borrower still may have the ability to repay the loan.
As seen from the table below, many lower income neighborhoods in Chicago have undergone stark declines in home values. In many neighborhoods, home buyers once snapped up homes in response to the general rise in area home values and in response to ready availability of credit. In some instances, new credit instruments brought in buyers under terms that seemed attractive at first, only to prove temporary or even fraudulent later on. Regardless, as the housing bubble burst, home values plummeted from their peaks.
Percent Change in Median Home Price in Illinois (Compiled by NHSRC Initiatives, Inc. from Multiple Listing Service data)
What about the stock of homes that are currently in foreclosure—that is, foreclosure inventories. Remember that the inventory rate measures the number of loans in foreclosure at a given time as a percentage of the number of active loans. This is typically referred to as the “foreclosure rate.” A high inventory rate can contribute to high uncertainty for potential buyers and sellers. On the buy side, potential purchasers can become reluctant, because they do not know the extent to which prices may fall further once homes in foreclosure are put up for sale. On the other side, sellers will be uncertain as to how to price homes for sale, or what prices to accept from buyers.
In comparing inventories across cities and neighborhoods, inventory rates can be a misleading measure of overall home market conditions. That is because high transition times (and inventories) may reflect either high start rates or simply long delays in processing homes that have entered foreclosure.
In Cook County, IL, high inventory rates may partly reflect the latter, where foreclosures are processed through the courts. For an overview of the process, see the timeline below. A foreclosure in Cook County takes about 360 days; in practice that time can actually be significantly longer. Some states, like Michigan, do not require foreclosures to go through the courts, which helps keep the backlog lower. The foreclosure process (either judicial or nonjudicial) varies by state.
Judicial & Nonjudicial Differences in Process Period in the Seventh District: (RealtyTrac)
Illinois is a judicial foreclosure state, which means that foreclosures must be processed through the courts. Court backlogs can lead to long delays. Additionally, during part of 2011 there were temporary freezes in foreclosures initiated by some major banks and mortgage servicers due to concerns about sloppy, or potentially illegal, paperwork in foreclosure cases. Additionally, in 2011 Cook County initiated a mediation program. The goal of the Mortgage Foreclosure Mediation Program is to assist homeowners that are in foreclosure to examine all options to stay in their homes or negotiate the best exit strategy.
Length of Foreclosure Process in Illinois (Based on Information from the NHSRC Initiatives, Inc)
Clearly, there are many issues working together to raise the high incidence of homes in foreclosure. The foreclosure process (and how we measure foreclosure rates) may be adding to uncertainty and delaying resolution. To learn more and for a current snapshot from county-level data that will be updated quarterly, please check out the Foreclosure Snapshot on our website.
October 6, 2011
What is the Foreclosure Rate?
Emily Engel Rotenberg and Daniel DiFranco
When we see reports of the rising foreclosure rate in the media, we get the general sense that the housing market is struggling. While this is generally true, many reports do not accurately characterize the varying struggles from one local housing market to the next. Though reports often use them interchangeably, there are multiple measures of foreclosure rate that offer additional information. In particular, it’s important to distinguish between three related housing market measures: the inventory, start, and transition rates. The last is perhaps the least talked about, though it provides important information that affects the foreclosure inventory significantly.
Let’s look at Cook County, IL, to illustrate the differences between these three rates. The inventory rate measures the number of loans in foreclosure at a given time as a percentage of the number of active loans. It is typically referred to as the “foreclosure rate.” In Cook County, this rate was 7.1% as of June 2011.
Behind this rate, however, are two metrics that reflect the two phases of the foreclosure process: 1) the start rate and 2) the transition rate. The start rate represents mortgages going into foreclosure—typically after 90 days of delinquency. Conversely, the transition rate is the rate at which foreclosed mortgages exit foreclosure.
A mortgage may transition out of foreclosure for a handful of reasons, such as a loan modification or a sale. If an area has a low transition rate, mortgages that enter into foreclosure stay in foreclosure for a much longer period. A low transition rate will increase the foreclosure rate, since more and more mortgage will continually be counted as loans in foreclosure. Conversely, if the transition rate is high, that means many loans are exiting foreclosure; thus, the foreclosure rate will be lower, since at any given time there are fewer loans in foreclosure. Cook County’s transition rate was 5.0% as of June 2011.
How do these two rates—the start and transition rates—affect the foreclosure (inventory) rate? If the start rate increases, there is a chance that the foreclosure rate will also increase, unless enough offsetting mortgages leave foreclosure. For instance, in Cook County the start rate was 0.5% as of June 2011.
To illustrate how these rates are related, we are going to examine Cook County, IL, and Wayne County, MI. If you asked most people which county had a higher foreclosure (inventory) rate, they'd probably answer Wayne County, MI (which contains Detroit). However, as you can see from the chart and data below, Wayne County's inventory rate is substantially lower than Cook County’s. The fact that Wayne County has been hit hard comes through only by looking at the start rate. Wayne County’s high transition rate implies that foreclosures have been moving through the system quickly. The main difference between the two counties is that Illinois uses a judicial system for processing foreclosures, whereas Michigan has the ability to use a non-judicial process, which tends to speed up the foreclosure process. Only by breaking down the inventory rate into the start and transition rates do we get a clearer understanding for why Wayne County’s inventory rate is lower than Cook Country’s. Conflating these three rates may lead to a mischaracterization of a county’s foreclosure conditions.
As shown, the foreclosure (inventory) rate is a function of both the start rate and the transition rate. The foreclosure rate, accordingly, reflects the trends in the latter two rates.
Please be on the lookout for our next blog entry on foreclosures, written by a guest blogger, that will focus on the triggers of foreclosure.
To get more information on foreclosures, check out the Foreclosure Resource Center on the Chicago Fed’s website: http://chicagofed.org/webpages/region/foreclosure_resource_center/index.cfm
This blog draws on three Federal Reserve items that are also recommended readings:
a. Robin Newberger and Daniel DiFranco, 2011, “Beyond the foreclosure inventory: The impact of start rates and transition rates in five counties,” Profitwise News and Views, Federal Reserve Bank of Chicago, April, pp. 2–7, available here;
b. Timothy Dunne and Guhan Venkatu, 2009, “Foreclosure metrics,” Economic Commentary, Federal Reserve Bank of Cleveland, April, available here; and
c. Charts created by the Federal Reserve Bank of New York, available here.
Due to the changes in sample data we are not reporting data before 2006.
August 12, 2011
Not Much House Lock So Far in Seventh District
By Britton Lombardi and Bill Testa
Two years following the end of the national recession, the national unemployment rate remains above 9%. Part of the explanation stems from the financial crisis element of the recession. In the past, aggregate demand (including new hiring) has tended to bounce back only slowly under similar circumstances, in which household wealth has declined sharply and traditional lending channels have continued to struggle. This time, other potential influences are being suggested. One point of debate is the potential impact of house lock, which is a decline in household mobility that is said to hamper job search. In particular, due to a high degree of underwater mortgages (where the mortgage debt level exceeds the current sales price of the home), working age adults may be constrained from long distance job-related moves by their inability to pay off their existing residential mortgage.
A new Chicago Fed Letter examines whether house lock has, in fact, contributed significantly to a higher than expected unemployment rate. To start, the authors lay out the background of concerns about house lock against the backdrop of the pickup in job openings during late 2009 and 2010 that has failed to translate into increased hiring rates.
To further analyze labor mobility, Aaronson and Davis compare the residential mobility of renters versus that of homeowners. The idea here is that, if house lock is important, the mobility of home owners would decline relative to that of renters, who are unencumbered by mortgages. In their analysis of the U.S., the authors define a household move as the relocation of a household across a state border. They further measure the migration rates of renters versus owners, in the preceding four months. In their results, they find no statistically significant changes over time in the difference between the tendencies of moving between renters versus owners.
To further explore this dynamic, Aaronson and Davis evaluated separately the five states that experienced the steepest house price declines (California, Florida, Nevada, Arizona and Rhode Island), postulating that the larger the decline in home prices, the more likely households would have negative equity, thereby reducing their ability to move. But even in these states, they find that homeowners do not appear to have changed their migration behavior relative to renters.
How does the Seventh District compare if we apply the same methodology as Aaronson and Davis? First, as seen from the chart below, the Seventh District seems to have had a varied experience in the past decade’s run up in home prices. In general, home prices did not rise as much as the U.S. average, though in some instances, the home price falloff was just as steep. In Indiana, Iowa and Wisconsin, home prices did not fall much from their peak. However, Illinois did experience a similar pattern to the U.S., and in Michigan home prices have actually fallen below their 2000 levels.
On average, did the Seventh District experience some level of house lock during the most recent recession? Aaronson and Davis were willing to run their methodology for the Seventh District states for us, and the results are shown below. The four-month migration rate for Seventh District homeowners fell from 0.0024 to 0.0017, a 0.0007 decline (annualized, this would be 0.0007*3=.0021 or just over two-tenths of a percentage point). At the same time, renter migration rates barely increased, moving from 0.01 to 0.012. The last row, called “Difference,” compares the patterns between renter and homeowners and shows that the difference between the two is relatively small over time and statistically insignificant for the Seventh District states.
And so, the experience of house lock in the Seventh District states appears to be consistent with that of the rest of the U.S. That is, while the continued home market weakness is detrimental in other regards, it does not appear to be a primary driver of lingering unemployment.
It is true that District homeowner migration rates fell slightly during the recession. This is consistent with past downturns; migration rates tend to be procyclical in nature, falling during recessions and rising during expansionary periods as job opportunities become more abundant.
February 4, 2008
Housing Construction Developments
The nationwide falloff in residential investment activity is unfolding along various channels and to varying degrees across U.S. regions. Falling residential activity is being felt in consumer spending, manufacturing production (e.g. construction equipment, appliances, and materials), the financial sector (e.g. mortgage and development financing), real estate (sales) and, of course, in home building itself. In home building activity, slow-growing regions such as those in the Midwest may be somewhat advantaged. That is because construction activity does not comprise as large a share of total regional employment in comparison to fast-growing regions. And so, a proportionate decline in home building activity does not tend to slow the region’s overall economy as greatly.
The table below reports payroll employment for the overall construction sector in major U.S. regions and in the Seventh District. States in the West and in the South such as Nevada, Arizona, California, and Florida report construction employment as comprising 6–11 percent of the state’s total employment for the year 2006 (see column 3). In contrast, the District’s construction industry makes up 4-5 percent of total payroll jobs—a share which lies below the national average of 5.6 percent.
Click to enlarge.
The upshot of these differences is that a falloff in construction activity can be expected to be felt more keenly in those regions whose work forces are more concentrated in home building. At least this is true if construction activity declines are proportionate across regions. And if the rate of decline in construction activity were more rapid in regions outside of the Midwest, this would additionally contribute to some favorable convergence toward the Midwest pace of economic activity. By some reports, speculative home buying activity had been running very hot in many coastal states in recent years.
Data trends also indicate that the pace of recent declines in Seventh District home building activity have been on par with the U.S. Constructed square feet of residences from the McGraw-Hill Construction Dodge reports currently indicate that home-building has in fact been declining about the same as the remainder of the U.S. Since January 2006, the pace of home building has averaged declines of 25 percent year-over-year on a monthly basis in the Seventh District versus 26 percent in the overall U.S. over the same time period. Similarly, the pace of housing starts in the graphs below indicates that Seventh District declines have largely paralleled the U.S. since 2006, though the U.S. level of activity had climbed to a higher peak over the decade. Accordingly, though the construction sector covers more than residential activity alone, steeper-than-average job declines reported in the table above (column 6) are consistent with greater drops in home-building activity in the top construction-job states.
On the flip side, however, in many parts of the Midwest lagging general economic growth has tended to limit home buying and associated construction activity. In particular, Michigan’s construction employment peaked long ago during the fourth quarter of 2004 (see table above, column 4) and has fallen by 16 percent since then. So, too, housing starts (above) have fallen more steeply in Michigan versus both the U.S. and other District states.
But aside from Michigan’s woes, the pace of national construction employment growth (decline) has been converging (on average) with that of the Seventh District over the 2006-2007 period. The chart below illustrates the year-over-year pace of construction employment growth in the Seventh District versus the nation.
Click to enlarge.
This convergence cannot be attributed to home building activity alone because construction employment includes the nonresidential sector as well. As measured by jobs, residential building and construction make up 43 percent of the total. However, available data on commercial construction activity also indicates a pace of growth in the Seventh District that is roughly coincident with that of the nation. Consequently, the fact that the Midwest economy has a lesser share of total jobs devoted to new housing construction is likely contributing in some small measure to convergence of District employment growth with the nation’s.
To be sure, this convergence of construction employment will not spare Midwest households from financial loss and dislocation associated with a slowing national economy. As economist Leslie McGranahan demonstrates in a recent analysis, local economic conditions are one of the primary determinants of home foreclosure in addition to a state's foreclosure procedures and the degree of subprime and FHA borrowing. Accordingly, because automotive industry structuring has been weighing heavily on the Midwest economy, home foreclosure rates in Seventh District states are now running ahead of national averages (see figure below). An expected slowing of national economic growth during the first half of 2008 will continue to pressure many Midwestern homeowners who are stretching to meet their mortgage obligations.
Note: Emily Engel and Vanessa Haleco-Meyer assisted this blog.
May 29, 2007
Seventh District Housing Market Update
For several years running, the national pace of investment in housing greatly exceeded historic norms. Accordingly, housing market observers speculated that strong rates of home building and price appreciation would falloff markedly at some point in the near future. Nationally, real residential investment growth averaged 9 percent from 2003-2005; average home prices rose by 6.8 percent in 2003, 10.7 percent in 2004, and 13.1 percent in 2005.
During the first half of last year, the pace of home construction and home price appreciation finally slowed. Since then, home building activity and sales have declined sharply and, by some measures, changes in home prices are now running in negative territory. Since the fourth quarter of 2005, U.S. residential investment has been declining, averaging over 11 percent on an annualized basis. The growth of the OFHEO measure of national average home prices has slowed to 5.9 percent year-over-year for the last quarter of 2006 (new data will be released on May 31).
During the current decade, home prices appreciated in the Midwest as well, though less so than in the nation and much less so than several southern and coastal markets such as San Diego, Las Vegas, and many parts of Florida. For this reason, during the years of strong price appreciation, some observers believed that the Midwest would be spared the eventual price and building falloffs that would unfold in other regions. So far, this does not seem to be the case. Most major residential real estate indicators currently show the Midwest region with comparable or weaker fundamentals than the national average. The chart below illustrates the pace of new home construction starts in the Seventh District states versus the U.S. Measured on a year-over-year basis, home starts in the Midwest have been running below the nation since early 2006.
For the most part, the weaker Midwest economy lies behind its weaker housing markets versus the national average. The current slowing of the U.S. economy has been accompanied by a marked slowing in manufacturing which has, in turn, softened the housing market in many local Midwest communities. In addition, ongoing structural upheaval in automotive-oriented communities is reflected in several housing market indicators including home purchases, home prices, and in foreclosures of existing properties.
Residential real estate market conditions are highly local. The maps below juxtapose home price appreciation and unemployment rates in Seventh District metropolitan areas. Looking at the top map, unemployment rates in many Michigan communities are notably higher than the general pattern in the other Seventh District metropolitan areas. Retrenchment in domestic automotive assembly operations and suppliers in Michigan has resulted in significant work force upheaval. Automotive-oriented communities in other states of the Seventh District—such as Kokomo, Indiana—have had similar experiences. After Michigan, Indiana is the second most automotive intensive state in the Seventh District.
The second map (above) displays year-over-year house price appreciation for the same metropolitan areas. To some degree, areas with a slack labor market are experiencing less home price appreciation. This is especially evident in Michigan and Northwest Indiana where the domestic automotive industry troubles are centered.
The linkage in these states between the local economy and the housing market is consistent with available information on home loans. The pace of loan delinquencies and mortgage foreclosures in both of these states are now running higher than both the nation and other states of the Seventh District.
Home price appreciation is stronger in Chicago and in many other metropolitan areas in Illinois and Wisconsin. In the Chicago area, job growth in business services, travel-tourism, and financial services industries have continued to expand. In other metropolitan areas to the west of Indiana and Michigan, manufacturing tends to be concentrated in more buoyant product lines, such as construction and farm machinery or food processing. As a result, home prices are generally holding up better in those areas.
Labor market conditions fare well in many Iowa metropolitan areas. Yet, average home price appreciation there is generally tepid. To some degree, home price appreciation has been very steady in Iowa over many years and the current pace of appreciation does not differ markedly from the norm of the past 15 years (see below).
Nationally, residential real estate activity continues to adjust downward to align with its rapid expansion of recent years. In particular regions and communities, the extent of adjustment varies with both the stock of existing housing and with local trends in economic growth which drive the demand for housing. Generally, new construction activity and price appreciation have softened in the Seventh District but local conditions can be seen to vary with local economic indicators.
September 20, 2006
Midwest housing market update
Following unprecedented home price appreciation nationwide in recent years, homeowners are much concerned about price reversal. In their current Economic Perspectives article, Chicago Fed economists Jonas Fisher and Saad Quayyum find that, on average, much of the recent surge in housing can be attributed to fundamentals such as rising income and favorable demographics, as well as innovations in home lending markets that have allowed renters to become homeowners. (Many of these innovations—such as interest-only loans and adjustable rate mortgages—were discussed in detail at the Chicago Fed's Bank Structure Conference this spring. The proceedings of the conference were summarized in the September issue of the Chicago Fed Letter.)
While such arguments may provide some comfort to those who worry about the possibility of a bubble in average U.S. home prices, experiences and current conditions differ widely from place to place. Should Midwestern homeowners be more or less concerned about the cooling of residential real estate markets?
Senior Business Economist Mike Munley has been tracking home price developments in the Midwest. Mike reports that, on September 5, the Office of Federal Housing Enterprise Oversight (OFHEO) released its estimates for home price appreciation in the second quarter of 2006. The report included data on the national average of home price changes as well as state averages.
Home prices for the U.S. increased at a 4.8% annual rate between the first and second quarters, the slowest quarterly appreciation since the end of 1999 and just below the average since 1980. As measured year over year, U.S. home prices were up 10% from the second quarter of 2005, which was also slower than the rate of appreciation has been—it topped out at 14% in the middle of 2005.
Recent home price appreciation here in the Midwest has also slowed noticeably, and the long term back drop has been much less robust. For the most part, home prices in the Seventh District states have been increasing more slowly than the national average of home prices (see figure 1). On a year-over-year basis, price appreciation in every District state lagged behind the national average in the second quarter of 2006, and Michigan had the lowest appreciation of any state in the nation. In comparison to the first quarter, home values in Indiana and Michigan actually declined. (Maine, Massachusetts, and Ohio were the only other states with declines.) However, home values in Iowa managed to rise slightly faster than the national average.
The city-level data told a similar story. Of the District MSAs (Metropolitan Statistical Areas) covered by OFHEO, only Michigan City-La Porte, IN, showed year-over-year appreciation (10.6%) faster than the national average. Of the bottom 20 MSAs in the U.S., 14 were in the Seventh District, and Ann Arbor, MI, was at the bottom with home prices, down 1.3% from a year ago.
The OFHEO home price data is only one of several sources of information about home prices for the U.S. and some cities. The National Association of Realtors (NAR) releases data on the median sale price of existing single-family homes. In general, the two data series tend to tell the same story—that is, the trends in both data series are similar over time. But, their results are often different in a given month (for regional and national data) or quarter (for city data). The NAR data tends to be more volatile. The NAR data set measures exactly what it sounds like: it is the price of the typical home sold during that quarter. Still, the median price depends on the mix of homes sold during that quarter. If, for example, a large number of inexpensive, starter homes were sold in the second quarter, this would lower the median sale price. By contrast, the OFHEO index is designed to track how the value of an individual home changes over time. OFHEO looks at the appraised value of homes each time a new mortgage is taken out—it is updated when a home gets sold or when the homeowner decides to refinance. OFHEO looks at the value of a large number of homes and is able to estimate the index quarterly. One drawback to the OFHEO index is that it only looks at home mortgages serviced by Fannie Mae and Freddie Mac, and those agencies only service mortgages that are less than $417,000—so the OFHEO index excludes most luxury housing.
The NAR publishes price breakdowns for regions and select metropolitan areas (but not states). In the second quarter of 2006, median home prices nationally were up 3.7% from a year earlier, while median sales prices in the Midwest (which includes the Seventh District, Ohio, and some plains states) were down 2.0%. Of the 24 District MSAs covered by the NAR, five (Chicago, Champaign, Milwaukee, Peoria, and Waterloo, IA) beat the national average, and 14 saw home sale prices down from a year ago. Although the NAR data are more volatile, this data series does confirm that home prices in the Midwest have been increasing more slowly than prices nationally.
There are a couple of reasons why home values have been rising more slowly in the Midwest than the rest of the country. Looking over the long term, the Midwest has generally seen slower home price appreciation since the early 1980s. As shown in figure 1, home values nationally have increased an average of 5.4% per year since then, whereas average appreciation in the District states has ranged from 3.5% in Iowa to 5.1% in Illinois. In part this difference reflects the slower population growth in the Midwest than in the rest of the nation. Since 1980, the U.S. population has increased an average of 1.1% per year, while population growth in Seventh District states has averaged only 0.4%. It follows that demand for housing in the District is not growing as rapidly, which in turn puts relatively less pressure on prices.
Regional differences in home prices also arise from the supply side of the market. In many metropolitan areas, available land for home building is limited by natural barriers such as mountains and waterways. In the face of rising demand for housing, such barriers to expanded supply tend to drive up land and home prices, especially for single-family homes. Further, some areas have chosen to place legal restrictions on home building by imposing growth boundaries or strict zoning requirements and building codes. In some cases where regulations are not well-crafted, evidence suggests that the effect is the same; rising demand for homes is met by rapidly rising prices rather than by expansion of the housing stock. A recent survey report of land use regulations verifies that the Midwest is not especially noted for manmade barriers to housing expansion. Over the long term, the elastic nature of home building in the Midwest region has likely contributed to less pressure on home prices.
More recently, much of the relative weakness in home prices can further be explained by the relatively sluggish economic growth in the region. As I discussed in my recent Mid-Year Jobs Report, job growth here has lagged behind national job growth. That limits income growth in the Midwest, which in turn restricts demand for housing. So while the U.S. has seen a sharp rise in home price appreciation in the past several years, the run-up in the District was less extensive or non-existent. (See figure 2.)
Among states, home price appreciation has recently been running in direct relation to the pace of economic growth. In particular, appreciation has been lowest in Michigan and Indiana, the two states with economies weighed down by structural change in automotive industries.
The figure below illustrates home price appreciation over the past year among metropolitan areas. Those metro areas experiencing depreciation tend to be found in Michigan and in central Indiana. A look back at the metropolitan area map of auto industry job concentration in figure 1 of last week’s blog shows a fairly close correlation between auto-intensity and weak home price appreciation.
The relative stability of home prices in some Midwest locations is a double-edged sword for the region. Homeowners in other parts of the country were able to cash in on the sharp increases in the value of their homes and use those funds to support their spending. Midwesterners weren't able to cash in as extensively, limiting growth in retail sales locally.
On the plus side, given all of the popular concerns about a home price bubble, steady appreciation helps abate those worries here. If a sharp run-up in prices is a warning sign of a potential bubble, that sign is largely absent in the Midwest. But this is not to say that the Midwest is immune from the risk of a slowdown in appreciation or price declines going forward. Certainly, overall economic conditions will feed into home prices, as they have in parts of Michigan.
Less appreciation in home prices can also be advantageous in that it keeps homes here more affordable. According to the NAR's affordability index, homes have historically been affordable in the Midwest in relation to other regions and recently this affordability advantage has improved. Midwestern cities can use this attribute to help attract new businesses and workers.