How not to interpret January’s housing data

After eight long years, America’s housing market is finally back on track. People are buying and selling houses at a healthy clip. The number of housing construction permits has risen by 8.1 percent over the past year; housing sales are up 3.2 percent over the same period. Best of all, the median existing-home price was nearly $200,000 in January—more than 6 percent higher than this time in 2014. Quite simply, the housing market is healthier than it has been at any point in recent memory. 

But not everyone thinks things are heading in the right direction. For instance: The National Association of Realtors just released its monthly housing report, with a statement that rising home prices are increasingly pricing new homebuyers out of the market. The association’s report has led to headlines that the housing market is “tight,” “depressing,” and even “abysmal.” 

{mosads}Policymakers, economists, and homebuyers should take these claims with a grain of salt—or better yet, the whole shaker.  

The doom-and-gloom view derives from one simple statistic: Existing-home sales fell by nearly 5 percent between December 2014 and January 2015. According to some, this stems from the fact that housing prices are rising, impacting affordability and crowding out first-time homebuyers. Underlying their argument is the assumption that rising housing prices are always bad for anyone looking to buy a house. 

But this isn’t true, for two simple reasons. First: The housing market always contracts in the winter months. Fewer people buy and sell homes when the weather is cold. This makes sense—who wants to buy and move into a new house when it’s covered in snow? While most economic models try imperfectly to account for this seasonality, this simple calculus affects the housing market this time every year, with sales typically falling during the coldest months of winter.  

Second, and more important: The data does not show a correlation between rising housing prices and declining housing sales. They actually show the opposite. Historically, home sales spike when prices rise. The opposite is also true: When prices fall, housing sales typically follow suit. 

What explains this? Simple economics. Rising housing values reflect a better housing market. That market can be divided into two categories: first-time and existing homebuyers, who respectively comprise approximately one-third and two-thirds of the total market. The latter group drives the entire system—but it can only do so when home values increase, thereby giving them increased equity. This equity growth is actually the driving force in the improving housing market.

And equity is increasing in a positive way. Housing values have risen by 4.5 percent over the past year. As this has happened, more existing homeowners have been able to sell their existing homes and purchase new ones. This has resulted in the positive signals that we’re seeing all around us in the housing market. To paraphrase the famous saying, “it’s the equity, stupid.” 

This isn’t to say that problems don’t currently exist in the housing market. They most certainly do. The housing market’s velocity has been slowed by the lingering problem of “negative equity”—when homeowners’ property value falls below the value of their outstanding mortgage amount. People in this situation are referred to as “underwater.”  

Underwater homeowners played a central role in the recent recession. At its peak, over 31 percent of all mortgage holders were underwater—a shocking statistic. Today, that number has fallen by nearly half; only 16.9 percent are currently underwater. Americans in this unfortunate situation are typically unable to sell their homes and buy new ones—they lack the equity that allows them to finance upgrades in the housing market. They thus cannot contribute to an improved housing market. 

But, this problem is also working itself out. Yes, nearly 17 percent of homeowners are underwater, but that number shrinks every fiscal quarter. This year, it’s expected to drop by roughly 1.5 percent with further declines in the years to come—and increasing home prices will be responsible for this drop. The housing market is slowly, but surely correcting itself. 

Politicians, economists, and homebuyers should keep this in mind as they seek to interpret—and then act on—the latest housing data. Worrying that equity increases are harming America’s housing market will only lead to poor decision-making and potentially limit future growth in the years to come. At the end of the day, the housing market is actually better than it’s been in nearly a decade—and claims to the contrary won’t do anything to help it improve even more.

Fleming is chief economist at First American.