The 2000s and the 2020s both saw housing price booms, but rents skyrocketed only during the most recent spike. Why were things different this time? Federal Reserve Bank of Boston senior economist and policy advisor Paul S. Willen answers that question in the latest episode of Six Hundred Atlantic.

In the interview, Willen says housing is often seen as an investment. So, its prices can move like stock prices and are influenced by variables including interest rates. Rents tend to be driven more by things that affect housing as a place to live, such as local demographics or population growth. But during the most recent boom, both housing and rents went up at the same time. Willen said that may mean people buying housing were prioritizing the same things consumers often emphasize when renting.

In the interview, Willen also talks about the challenges consumers face when prices rise in both markets at the same time. He discusses surprises in the data and highlights some unanswered questions about the changing housing market and the evolution of cities.

ALLISON ROSS:

Hello, and thank you for joining us for this episode of Six Hundred Atlantic. I'm your host, Allison Ross, and I'm here to talk about housing, specifically the cost, which is obviously a big concern in areas like this one where housing affordability is such a major issue. Now, some believe that the recent spike in housing prices occurred because buyers expected prices to rise, similar to what happened with the housing bubble of the 2000s. But according to a new working paper, that likely is not the case here. Paul Willen is a senior economist and policy advisor at the Boston Fed, and he is the coauthor of a new study titled “House Prices and Rents in the 21st Century.” Welcome to the podcast, Paul.

PAUL WILLEN:

Thank you for having me.

ALLISON ROSS:

So just to start, what are some of the biggest factors that can cause fluctuations in the price of homes and the cost of rent?

PAUL WILLEN:

So, it's important to distinguish between things that drive prices and things that drive rents. When we think about the demand and supply of housing as a service, as a place to live, those are the things that drive rents. So, things like demographics, population growth is always a big thing in terms of driving … more people means higher demand for housing and higher rents. And then people focus a lot these days on supply issues, how many houses, how easy it is to build. And those types of things are really things that should affect, or at least in theory should affect, rents. Whereas, prices are about housing as a financial asset. And so, prices when you buy a house, you're not just buying a place to live right now, you're buying a place to live for the rest of eternity. And, in particular, you're buying something that you could sell in the future. And so, the drivers of prices, as opposed to rents, are things like interest rates. As I said, it's an investment, but also, and this is the crucial one for a lot of questions about house prices is, beliefs about where you think prices are going to go in the future. And so, in that sense, when you think about buying, the price of houses, it's sort of like a stock price.

ALLISON ROSS:

Where do fluctuations in rent play into the boom-and-bust cycles around housing? And also how are they different from actual housing?

PAUL WILLEN:

Ok, so I think the question here is about the demand for rental properties, as opposed to demand for owner-occupied properties. And I think investors, in general, are more sensitive to the question of how much they can sell the property for. So, if you're buying a place to live and you expect to live there for a long time, you're really not thinking intensively about, “How much can I sell the property for?” But if you're an investor, you really are. And so, you know, what we see, certainly in the 2000s, we see a lot of big increase in investor activity and, and a lot of that was people basically buying with the intention of selling fairly quickly. Whereas with this time, we did not see as much of an increase in investor activity.

ALLISON ROSS:

And so, let's go there. Starting off in the mid-2000s, that was around the financial crisis that we're kind of talking about now. What was the driving force behind the fluctuations of rents and those home prices?

PAUL WILLEN:

So, there really was no fluctuation, that's one of the big surprises about the 2000s, was we saw big increases in house prices, but we did not see corresponding increases in rents. So, in that sense, there wasn't a big increase in demand for housing as a place to live. There was demand for housing as an investment. Now, that doesn't mean that it didn't affect owner-occupiers. It did. And you know, you used to hear in Boston in those years, people saying, “Oh, I can buy a house, prices are rising so fast, I can live rent-free.” Meaning that the appreciation of the house was so big that … that it covered all the expenses that they had on the house. And so, that was a common, so people said, “You have to buy, because you can live rent-free.” So, it did affect owner-occupiers as well as investors.

ALLISON ROSS:

Moving to the 2020s, what is driving the increase in prices of homes and the cost of rent?

PAUL WILLEN:

We saw both rents and prices go up this time. What we infer from that is that this was an increase not in housing as an investment, but as something, as a place to live. And so, the question of where that came from, I think our take on this was that it really was kind of a change in the taste for housing. You know, during the pandemic, people were working from home, people were spending a lot more time at home, and so they were willing to increase the share of their budget that they allocated to housing. When you were in the 2000s. And you're asking, “Why are house prices going up?”, you couldn't point to anything. Whereas in 2020, end of 2020 and 2021, people were living in a very different world. That's our theory as to why, but, again, it's, you know, we can't be sure, but that seems to be the best guess as to what happened. And as some evidence of that since, so it's outside of our.... after our data, but we've seen house price growth slow a lot in 2022, and people attributed that to higher interest rates. But actually we’ve seen rent growth slow by almost as much as house price growth has slown. What it suggests is that the pandemic has eased, there was a slightly hysterical demand for people wanting housing. And the second thing I think we've also mentioned is there was a big increase in demand for second homes.

ALLISON ROSS:

Which went back to your original point that parents, and I think a lot of families, felt all those tiny, small spaces when they couldn't get away. So, I think a lot of people can understand that. Now, you did a lot of research here, so what was surprising to you?

PAUL WILLEN:

Well, so, when you go back to the 2000s, what we knew was that the price indexes were going up, and rent indexes were not. But at the time, I think this was the innovation of our work was that we really, at the time, so in the 2000s, the data we had was on prices on owner-occupied properties and rents on renter-occupied properties. So, at the time, it was kind of plausible to believe that those markets were so different, that what was happening was not, did not have to do with this distinction between housing as a consumption good, as a place to live, versus as an investment, but had to do with just the fact that the renter-occupied market and the owner-occupied market were just totally different. And so, what was happening was, for example, changes in financial markets had made it easier for people to own, and so people were less likely to rent, which reduced the demand for rent properties and increase in demand for owner-occupied properties. And there was no way to tell that, apart from the fact that, that basically, people were becoming more optimistic, and that's why they were willing to pay more, because they believed they could sell it for more in the future. And we couldn't really tell those two things apart because of the limitations of our data. And so, I think I was kind of sympathetic to the idea before we started working on this that really these were just two different markets. What surprised us was basically when you go to the data, you see the prices of the renter-occupied properties are rising at exactly the same rate, in fact faster than the price of owner-occupied properties. And so, I think what was surprising to us was how similar it turned out in the renter-occupied and owner-occupied markets are.

ALLISON ROSS:

Now, you don't have a magic eight ball, but given your research into those trends in 2008, and also during the pandemic, are there any trends that you would highlight in the current housing market?

PAUL WILLEN:

To some extent, this has been going on for a while, the pandemic really accelerated it, but in the 2000s when prices went up, if you wanted to buy, that was a pretty big burden on people's budgets, but you had an alternative which was you could rent. In 2005, the house prices are going crazy, then we have 2008... 2007 and 2008, house prices are crashing, and then kind of the market recovers. And since then, prices and rents have been much more in step than they were before. And I think one of the challenges we face now is that rental option is not cheap anymore. And so, it's not the case that you can say, “Alright, well, house prices are crazy, I'm just going to rent.” I think one of the challenges we face now is that this now affects everyone. It doesn't just affect people who are trying to transition into homeownership.

ALLISON ROSS:

And what should people consider right now if they're questioning should they rent or should they buy?

PAUL WILLEN:

Both renting and owning are expensive. You know, then it just comes back to the usual thing, how long do you plan to live there? You know, do you have kids or are you planning to send them to school? Things like that if you want to lock in the price of housing, and you're not that concerned if it goes down. But I think now, in a way, it's somewhat easier than it was in the past, at least in this part of the country.

ALLISON ROSS:

What are your future research plans for this area? So what questions do you still think are important for any researcher?

PAUL WILLEN:

So, in general there's a strong positive correlation between prices and population growth. What's puzzling is that there are … so you know, if you plot the two, the line slopes up. But there's a lot of deviations from that, and Boston is a perfect example which is a city with a high price relative to rents, but very low population growth. And then there are cities like Houston, which have very high population growth, but relatively low prices. And so, there are questions about why it is we see that and what we can learn about the evolution of cities, and what people believe about what will happen to cities over time. You know, for example, in Boston, it's not so much that people's incomes have gone up in Boston. I think to some extent, it's more that people with high incomes have been moving to Boston, and so there’s been sort of sorting of people into a city like Boston. Despite the fact the population isn't growing, the people who live here are getting richer and richer and displacing people. And that's the kind of thing we can learn from looking at this sort of data.

ALLISON ROSS:

Important information. Paul, thank you and thanks so much for joining us on the podcast.

PAUL WILLEN:

Thank you for having me.

ALLISON ROSS:

As always, you can find more information on everything discussed today on our website. Don't forget to check out bostonfed.org/sixhundredatlantic, where you can listen to interviews, as well as our podcast seasons. You can also subscribe to our email list to stay up to date on new episodes. And don't forget to rate review, share, and subscribe to Six Hundred Atlantic on your favorite podcast app. I'm Allison Ross signing off on another episode of Six Hundred Atlantic. Thanks for listening.