|27 Jul 2023|
|Context Summer 2023|
By Kevin C. Gillen, Ph.D
Let’s start with an overview of current conditions: it’s definitely a different market right now than it was during the last several years. But, while the latest numbers may not be great, they’re really not all that bad either.
• The tough part: sales activity has dropped dramatically over the last twelve months. The total volume of arms-length house sales in Philadelphia are down a whopping 51% from a year ago. A combination of increased unaffordability, limited supply and increased interest rates are to blame.
• But, on the plus side: price declines have been very modest … at least so far. While sales have plummeted, prices have held relatively steady. Controlling for season and quality, the general level of house prices has declined by only 1.7% from their peak of less than a year ago.
• Both raw house prices and regression-based analysis indicate only very modest price adjustments. According to both public records and Zillow, the median house price in Philadelphia peaked at $217,000 last July, and now stands at $213,300; a 2% decline.
• This trend is true nationally, as well as locally. During the same period, Zillow reports that the typical U.S. house price declined by only 1.1%.
• But keep in mind that this decline is especially modest when compared to the longer-term trend of the current cycle. House prices have been rising ever since bottoming during the last downturn, which occurred in 2012. In Philadelphia, house prices are up 78% from just over ten years ago. So, even with the recent declines, that is still 78 steps forward and 2 steps back!
• Also, bear in mind that Philadelphia’s house prices tend to be somewhat less cyclical than other major U.S. metros. Compared to most other large U.S. metros, Philadelphia’s house price do not rise as much during the boom times, but they also don’t fall as much during the bust times. As I like to say: we don’t party as hard during the good times, but our hangovers are much milder the next morning.
• Inventories—the number of homes listed for sale—remain exceptionally low. Approximately 12,000 houses are currently available for sale across the Philadelphia region. This is half of the average historic level of nearly 25,000 homes — and is also one of the main reasons that prices have shown so little decline despite a softening market and economy.
• But Philadelphia’s house price growth in recent years has exceeded the economy-wide general rate of inflation. The chart at right compares the house price index (HPI) for Philadelphia County to the national consumer price index (CPI) since 19501.
THE DECADE DIFFERENTIAL
• The break point is the year 2000. From 1950 to 2000, the value of the typical Philadelphia house essentially grew at the same rate as national price inflation. But, since 2000, Philadelphia’s house price growth has substantially exceeded the nation rate of inflation.
• Philadelphia’s annual rate of house price growth since 2000 is approximately 1.5 times its annual rate of house price growth before 2000. From 1950 to 1999, the typical Philadelphia home appreciated in value by 4.7% per year. Since then, it has appreciated in value by just over 7% per year.
• While that difference may not initially seem large, when compounding is taken into account over several decades, the resulting difference is very large. For example, consider that the median Philadelphia house price in 1950 was $7,000. A home purchased at that price would be priced at $191,100 today if it appreciated at 4.7% annually. But that same home would be priced at $913,545 if it appreciated at 7% annually: a $722,445 difference! Which one is more affordable, especially in a city where the median household income is just less than $53,000?
• Philadelphia’s house price growth has also exceeded its income growth. One of the most common—and simplest—measures of housing affordability is the ratio of house prices to household incomes. As should be obvious, the higher this ratio, the greater degree is a market’s unaffordability. Federal guidelines generally suggest that a ratio less than 3.5 indicates a relatively affordable housing market; i.e. typical local house prices are no more than 3.5 times local annual incomes. The following chart shows the ratio of median house prices to median incomes since 2000 for Philadelphia County, Philadelphia’s suburbs2 and the U.S. as a whole.
IN THE REGION
• As can be observed, housing unaffordability has grown significantly in recent years. Philadelphia’s price-to-income ratio currently stands at 3.7, while in its suburbs it is 3.9. These currently exceed the federal government’s suggested affordability threshold of 3.5.
• But, while unaffordability has increased, it should be understood in context…even if the trend is concerning. Not only is the margin by which Philadelphia’s ratio exceeds federal guidelines fairly small, it is still less than the national average, as well as below its previous peak during the “Housing Bubble” years of the mid-2000s. Philadelphia’s ratio of 3.7 is also well below such high-priced cities as New York, Boston or San Francisco, where price are 7-8 times annual incomes.
• However, there is significant variation in housing affordability across our region. The chart at left shows the price-to-income ratio for each county in the Philadelphia MSA.
PAYING THE RENT
• Perhaps surprisingly, the relatively wealthier counties show greater unaffordability while the relatively lower-income counties have less unaffordability. All of the Pennsylvania counties (plus New Castle, DE) have affordability ratios exceeding 4.0, while all of the New Jersey counties (plus Philadelphia) have affordability ratios less than 4. Three New Jersey counties have ratios either at or below the federal government’s suggested affordability ratio of 3.5.
• The reason for this is mathematically simple, if a bit economically counter-intuitive. House prices in Bucks and Montgomery counties are among the highest in the region, and so are their typical household incomes. The opposite is true of Gloucester and Salem counties. But the degree to which prices exceed incomes in the former is far greater than in the latter. Here’s why: during Covid, house prices grew by more in the region’s affluent counties than in its less affluent ones.
• Similar increases in housing unaffordability are also seen in rents. The chart above shows the median monthly apartment rent over time for each county in the Philadelphia metro area:
• Since Covid began in early 2020, the level of rents has risen an average of 27% across the region. However, there has been some moderation in the last twelve months. This shows a similar pattern as house price movements.
• Philadelphia is unique among large cities for how diffuse the ownership of its rental properties is. The chart below compares the degree of ownership concentration of rental properties in Philadelphia to other major U.S. cities3.
• In Philadelphia, the top 20 largest firms own only 9.1% of all multifamily (i.e. apartment) properties. This is significantly less than the approximately 40% average in other large U.S. cities (for which data was available).
• Such a significant diffusion of ownership implies that Philadelphia’s rental market is quite competitive. In theory, this implies that rental increases over time should generally be lower than those in less competitive markets like Seattle or San Francisco, since landlords in Philadelphia are less able to shift increases in costs on to their tenants.
• But the fact that rents—like prices—have significantly increased in the multifamily segment of Philadelphia’s rental market implies that there are larger and more fundamental forces at work. That is, it is highly unlikely that significant increases in rents can be blamed upon “greedy landlords”, especially at a time when the supply of new multifamily product has been expanding significantly.
WHAT TO EXPECT:
• Going forward, almost every market indicator continues to signal short-term deceleration but longer-term increases in unaffordability. This is true both locally and nationally. The short-term culprits behind both declining sales and prices are a combination of higher interest rates, decreased housing affordability and an overall cooling economy. However, despite dire predictions from many forecasters, no major price declines have yet to occur either locally or nationally (or at least not on par with the last “housing bubble” downturn).
But that doesn’t mean further declines won’t or can’t occur. In fact, fundamentals indicate that some further price declines are ahead. Inventories and interest rates are the key leading indicators that will determine the extent of any future declines. Lastly, keep in mind that some modest depreciation in house prices has its plus sides: it increases housing affordability (and therefore, accessibility) while restoring some rational semblance of balance between supply and demand. However, recent history indicates that even a typical cyclical price correction will have only a modest and temporary impact on both the city and region’s overall housing affordability. Local house prices fell by a whopping 23% locally during the last housing downturn, yet they are now pushing against the limits of affordability barely ten years later. Since the current correction has been much milder, expect longer-term trends to eventually resume … and probably sooner than you think.
Kevin Gillen received his Ph.D. in Applied Economics from the Wharton School at U. Penn., concentrating in urban economics and real estate finance. He is currently a Senior Research Fellow with Drexel University's Lindy Institute for Urban Innovation, as well as an Adjunct Professor of Finance with Drexel's LeBow College of Business.
1. The house price index measures the change in the average house price of houses in Philadelphia, after adjusting for seasonal effects and the composition of homes that sold.
2. This includes all counties in the Philadelphia MSA, minus Philadelphia County and Cecil County, MD.
3. The “Concentration Ratio” is a commonly used industry metric to measure what percent of an industry’s market share is owned/controlled by the industry’s largest firms. It is commonly used in antitrust cases to define how competitive (vs. monopolistic or oligopolistic) an industry is. High values of the ratio indicate a relatively uncompetitive market, while low values indicate a relatively competitive one.
To view this News Article