EXCERPT: I want to warn you from the top, this is a highly speculative post in multiple directions at once. I have a theory as to what is holding back the housing market, and another theory as to why that might be a good thing. There isn’t a lot of data to back up either claim, and I wouldn’t elevate other above conjecture at this point. But stick with me anyway.
To start with, single-family housing remains in a sluggish recovery from the housing bubble bust. New houses are being built slowly, and prices in most places are gradually and only somewhat recently moving above the housing bubble peaks on a nominal basis. In the top 100 metro areas, Trulia found that only 34.2% of home values are above the pre-recession peaks. Yet at the same time, it’s really hard to buy a house right now because inventories are extremely low, meaning few houses are for sale.
So what gives? If housing demand is strong enough to quickly absorb supply, why aren’t prices rising faster and luring more sellers and new construction into the market? Why is supply low and price growth slow? Here is my first conjecture: appraisers are very conservative in the wake of the housing bubble, and are effectively keeping prices below their market levels.
In the wake of the housing bubble, regulations including Dodd-Frank have forced more independence into the appraisal process. As a result of these rules, banks are more likely now to outsource the process of hiring independent appraisers to so-called appraisal management companies. As Ding and Nakamura argue, there is a risk of bias in the non-arms length appraisal process:
“Buyers, sellers, and real estate agents, as well as lenders who do not bear the risk of originated loans, all have a vested interest in getting an appraisal that is not less than the contract price and completing the sale.
The way to ensure the deal is for the appraisers to assess slightly higher than (or equal to) contract prices. Much anecdotal evidence suggests that such bias exists
And indeed, empirical evidence from before the new regulations suggested over-valuations happen relatively frequently, and undervaluations were quite rare. So this is why regulators have targeted the relationship with more rules since the housing bubble.
My conjecture is that with less incentive to just rubber stamp, appraisers are now constraining house price appreciation. In addition to the new independent rules, appraisers who lived through the housing bubble may be more conservative about what kind of price movement is reasonable. Anecdotally, I am hearing examples of sales where buyer and seller agreed on a price and appraisers shot it down. If buyers and sellers are constrained to below market prices, this would give you the conditions we are seeing in reality: low days on market, underwhelming house price growth, and scarce inventory.