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Will Inflation Hurt Bay Area Home Sales?

What rising inflation could mean for the Bay Area housing market

Inflation has been center stage in the news recently, and I’ve been getting questions about what this might mean for Bay Area housing.

The Consumer Price Index (or CPI, from the Bureau of Labor Statistics) posted a 7.5% annual gain in January 2022. This is a big spike, especially compared to the 2.47% annual gain in January 2021. Let’s take a look at what the CPI measures, and its implications for housing.

What the CPI measures
The CPI measures a “market basket” of real consumer products and services, and tracks their actual prices each month. It includes about 80,000 items from these categories: food, energy, transportation, shelter, medical care, cars, and clothing. Everything else is excluded (computers, soap, college tuition, pet food, etc). The CPI is built to measure specific consumer price trends, but it’s regularly used to presume broader price behavior.

It’s informative to look at the differences in price gains for each category of the CPI. The 7.5% 12-month increase is an average gain for everything in the basket. The biggest gains included oil (46.5% gain) and used cars (40.5% gain), pushing the average CPI up substantially. Other categories fell below the average CPI: food (7%), clothing (5.3%), and medical care (2.7%) are a few. When we adjust the CPI to exclude food and energy, it drops to 6%; if we look at just transportation, shelter, and medical care, we’re down to 4.1%.

It’s not unusual for oil to be an outlier in the CPI, but it is unusual to see this level of variation across the categories (ranging from under 2% to over 46%). We see a high increase for food and clothes (undoubtedly related to supply chain problems), surging increases for oil and cars, and no notable inflation for medical care. Especially now, we must be careful not to draw macro-level conclusions from data that is highly segmented.

Are higher prices here to stay?
We know that COVID played a huge role in disrupting supply, and rising prices are an indication that demand remains strong (new cars, for example, gained over 12%). Industries are highly incentivized to meet demand, and as the supply/demand balance is restored, prices will naturally fall. However, a lot of new cash entered the economy during the pandemic, and it’s now beginning to circulate. If unemployment remains low, incomes stay high, and consumer confidence is strong, we’ll see higher prices persist even as the supply/demand balance normalizes.

What inflation means for housing

real estate inflationIn past inflationary cycles, our economy was different than it is today. We’re in unprecedented times. Inflation is not a phenomenon that happens in a vacuum; it’s always the result of bigger dynamics, and those dynamics tend to underly other problems. For example, our last major inflation spike happened in 2008, at the height of the housing bubble. When the bubble burst, inflation screeched to a halt, along with home buying. The inflation was symptom of unhealthy dynamics, but it didn’t cause the crisis. Likewise, the rising prices we’re experiencing now are a symptom of bigger issues; namely, unmet consumer demand coupled with increasing money circulation.

Let’s take a closer look at how increasing prices could affect housing, through the lens of our current economy

The cost of renting is increasing
For landlords, the cost of renting homes has risen. Supplies and labor are scarce and costly, and “turning over” units is now more involved. Apartment complexes with pools or gyms now require sanitizing stations, extra cleanings, disposable products, and additional staff time.

When supply levels and COVID concerns improve, we hope these costs will also improve; but in the meantime, they are passed to tenants. Indeed, the CPI category “shelter service” (rent) is up 4.1% since January 2021.

Renters are currently dealing with higher rent, so a higher cost of homeownership won’t likely be a deterrent for them. In fact, a fixed monthly payment offers more price security than a rent payment, and many renters may be compelled to buy for this very reason.

Buyers want protection from inflation
Purchasing a long-term fixed asset, like a house, is the best way to protect wealth against inflation. This is especially true when interest rates are low, and can be locked in for long periods of time. Interest rates have gone up in the last year, but still remain near historic lows. Inflation in other categories, like food and gas, are much higher than increases in interest.

This point is emphasized by Ali Wolf, chief economist at Zonda: “If you have cash and are expecting inflation, you want to think through where you can put your money so it does not lose value. Housing is commonly looked at as a good inflation hedge, especially with interest rates so low.” Buyers understand that when they own a home, its value won’t decrease relative to the value of the dollar.

Home price appreciation is nothing new
Home prices have been rising for a long time, and in recent years we saw steeper appreciation as inventory levels hit all-time lows. Home appreciation is a form of inflation (a rising price), but homeowners don’t tend see it as negative, and buyers don’t tend to connect it to inflation.

Moreover, buyers are used to high home prices. In the San Francisco Bay Area, buyer demand has been so strong that we have a long way to go before affordability tips the scale. Housing tends to operate independently of consumer prices, as a function of buyer demand, affordability, and supply. Broad inflationary forces of course impact affordability, but rising home prices (in themselves) have not yet impacted demand severely enough to cause prices to fall or homes not to sell.

People will continue to move
Buyers who currently own a home but need to move are unlikely to cancel their move because of inflation. Our economic fundamentals remain strong (unemployment is low and incomes are high, especially in the Bay Area), and people will continue to want to upsize, downsize, or move into the area.

The bottom line for Bay Area housing
If you own a home in the San Francisco Bay Area, it’s natural to worry how inflation may affect its value. It’s true that inflation hurts purchasing power, and can tighten buyers’ budgets. This may stifle some demand on the lower ends of the market, but because demand is so strong, it’s unlikely to have a major impact on prices unless other economic hurdles develop.

We saw home prices surge more than 14% throughout the entire San Francisco Bay Area over the last 12 months, with no signs of cooling. Demand has been outpacing supply in our market for quite some time; this means that lack of affordability will need to knock out more than a few buyers before prices fall.

Having said that, I would encourage any homeowner who is considering a move to not hesitate. With interest rates steadily climbing and consumer prices on the rise, it’s possible we’ll see price appreciation decelerate in the future.

For an in-depth analysis of your home’s value in today’s market (or to discuss the dynamics we’re facing), give me a call today at 415-342-4537

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