The Overinflated Fear of Being Priced Out of Housing

Rising home prices set off fears that real estate will become even more expensive, making it impossible ever to buy a home in a given city.

It’s easy to understand how such worries spread, but the historical record suggests that these fears are generally exaggerated. Cities with steep price increases today will probably have much smaller upticks in the future. And for the most part, differences in price increases among cities are well explained by short-term variations in employment growth.

Consider some recent trends. In the year ended in March, cities like Denver, Seattle and Portland, Ore., had employment growth of more than 3 percent, according to the Bureau of Labor Statistics, along with double-digit home price increases, according to the S.&P./Case-Shiller indexes. At the same time, employment growth has been relatively tepid in cities like Boston, Cleveland and New York, and so have home price increases.

This is not rocket science. When businesses in a city have an unusually successful year and hire a lot more people, new employees arrive, but initially there aren’t enough homes for them. Home prices rise immediately so that demand effectively equals the existing supply, inevitably causing ripple effects. Someone with a new, high-paying job will outbid someone else, who will have to lower her sights and accept a less attractive house. People much further down the ladder will end up living with their parents or with roommates.

On a national scale, this suggests that weak employment growth of the kind shown in May’s jobs report, with only a 38,000 increase in nonfarm payrolls, could eventually hurt home prices across the country. That’s possible. But even without a national price slowdown or decline, there is reason to believe that double-digit increases won’t continue for long in individual cities. Short-term variations abound, but for the most part, the differences in long-term home price increases in individual cities are about plus or minus one percentage point annually. (Exceptions include San Francisco and Portland, whose home prices have grown almost two percentage points above average annually since 1987.)

Cities with big home price increases recently have issued more building permits per capita. This supply response has the potential to reverse at least some of the prices: When housing supply increases, it tends to bring high real estate prices down, though that takes time.