In this episode of the REconomy Podcast™ from First American, Chief Economist Mark Fleming and Deputy Chief Economist Odeta Kushi discuss how the fear of missing out (FOMO) and the fear of better options (FOBO) may impact housing demand.

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Listen to the REconomy Podcast™ Episode 27:

“Even if house price growth is expected to remain positive, it is expected to moderate. So, the FOMO I'm talking about with sellers is that sellers may be prompted to list their homes because of fear of missing out on getting the maximum price for their home. So, the concept of FOMO can be applied to both buyers and sellers.” – Odeta Kushi, deputy chief economist at First American

Transcript:

Odeta Kushi - Hello, and welcome back to another episode of the REconomy podcast where we discuss economic issues that impact real estate, housing and affordability. I'm Odeta Kushi, deputy chief economist at First American and here with me is Mark Fleming, chief economist at First American. Hey Mark. Today we're going to touch on a pretty universal concept, the fear of missing out, or FOMO, as it's commonly abbreviated. But before we get to that, can we first address the apple pie in the room? For those of you who listened to our last episode, there was a bit of a glitch where Mark kept repeating "the apple pie is in." What was that about, Mark?

Mark Fleming - I don't know. I'm not sure I've ever actually said those words in a podcast recording. But is there any doubt what kind of pie I had for Thanksgiving?

Odeta Kushi - It had had to be apple, right?

Mark Fleming - Indeed it was. Okay, back to business. No apple pies this time around. But something maybe a little more interesting. You do recall, we're going to talk about FOMO. But you recall that this is a podcast about housing right?

Odeta Kushi - Indeed, FOMO will tie in perfectly to a timely discussion of today's housing market. And I think I'll even be able to dust off some of my behavioral economics training in today's conversation. But first, let's define FOMO. In non-economics terms, FOMO is defined by Webster's Dictionary as the fear of not being included in something, such as an interesting or enjoyable activity that others are experiencing. So, for example, my friends may be going to a concert by a musician that maybe I don't even like or want to go to. But the fear that I might miss out on the fun prompts me to go. Can you think of any housing examples, Mark?

Mark Fleming - I think I could probably come up with one or two. But first, I have to say, I was interested in where the actual acronym FOMO comes from. It turns out it originated in 2004, in Harvard Business School's magazine, as well as a term called FOBO, or the fear of better options. Something I'm kind of worried about right now that we've made the decision to do a housing FOMO episode. But, more seriously, I think the housing example might have something to do with potential home buyers who fear that rates are going to increase and that makes them rush in and buy a home before they get any higher.

Odeta Kushi - See, I told you it wouldn't be difficult to tie FOMO to housing. That's exactly what I'm talking about. Now, we've all heard about the rush to refinance before rates increase. We can also see some of this behavior on the purchase side. We know that the 30-year, fixed-rate mortgage increased in September and October, and yet, so did home sales. Yes, you heard me correctly, new- and existing-home sales increased during a time of the year when housing activity usually slows, and during months when rates increased. Pending home sales in October, which are good early indicators of upcoming sales closings also increased 7.5% month over month. So there's more to come when it comes to housing demand. Now, it is important to mention that this demand for housing is not new. This is, of course, a continuation of a longer run trend towards homeownership that's being driven by millennials aging into their prime home-buying years, and accelerated by an improving economy and the changes brought about by the pandemic. So, specifically, we know that the pandemic untethered us from the office, it gave workers more geographic flexibility. It also highlighted the need for more space, because our home, now more than ever, is not just a dwelling, but also our office, a daycare and a gym. So, again, we want to highlight that demand for homes is a trend that preceded the pandemic and was maybe pulled forward by the pandemic, and is now once again being pulled forward by the prospect of higher rates. But, before we get into that, Mark, why does everyone think we're headed for higher rates?

Mark Fleming - That's a great question. We have seen rates increase to an average of just above 3%. And consensus forecasts now have rates reaching -- wait for it, wait for it -- 3.7% by the end of next year. If you could see me now, podcast listeners, I'm smirking. Because, to this day, I find it, shall we say historically ironic, that we are talking about rates rising to 3.7%. That said, yes, they're going up. Multiple factors point to modestly higher mortgage rates in the next year, including continued inflation. The Fed's tapering of asset purchases, which by the way, we found out from JP yesterday, may have been accelerated to deal more aggressively with inflation and, of course, the ongoing economic recovery. All of these factors are putting upward pressure on mortgage rates today. 3.7% is still historically low, though. And, if higher rates are combined with double-digit nominal house price growth, even if we hold incomes constant, then that results in declining affordability. So, it's not surprising that potential home buyers are saying, wait a second, I got to catch this now. Rush in and capture the low rates before I lose any more buying power. For existing homeowners, holding incomes constant, if one was contemplating a move in the near future, then no better time than the present.

Odeta Kushi - Right. And I did promise we would bring in an element of behavioral economics to this episode, so let's get into that. Now, behavioral economics is defined as a method of economic analysis that applies psychological insights into human behavior to explain economic decision making.

Mark Fleming - And, it deals most elegantly -- I might be a biased economist in saying this -- with the classical economic fundamental assumption of rational behavior. Really, rational behavior. Richard Thaler, who happens to have been a recent Nobel Prize winner for his behavioral economic research, once famously said, "We are more like Homer Simpson than we are like Spock."

Odeta Kushi - I love that quote, and in behavioral economics, there's also a concept known as loss aversion that may be helpful in describing the FOMO that some potential home buyers feel when they think that rates may go up. The concept of loss aversion has been elegantly summed up in an expression by Daniel Kahneman and Amos Tversky in a 1979 paper and that expression is, "losses loom larger than gains." So, it's thought that the pain of losing is psychologically about twice as powerful as the pleasure of gaining. So, how does loss aversion play into home buyers wanting to jump into the market before rates rise?

Mark Fleming - Well, this concept of loss aversion basically says that people want to avoid losses at all costs, we see that in gambling and your participation in the stock market. It happens in all kinds of different places. But, when it comes to housing, if you're a potential home buyer, you're thinking about, Well, how am I going to feel if I buy a home at a time in the future when rates are higher? It's going to cost more to do that. The mortgage will be higher than what it is now. And I immediately equate that with a loss. And so my fear of losing out here, I process that more expensive mortgage as a loss. And, in order to avoid it, I say right, I got to jump in and do this now. Loss aversion and loss avoidance all in one. But the fear of missing out on those low rates pulls forward your demand. Remember, they were still going to buy at some point, whether in the future or now. So, this FOMO, driven by loss aversion, isn't necessarily creating new demand, as much as it's pulling forward demand from the future.

Odeta Kushi - That makes a lot of sense. And by the way, the FOMO concept can be applied to home sellers as well. In the latest September S&P Case-Shiller Home Price Index report, we found that annual house price growth slowed for the first time since May in 2020. Context, just like with mortgage rates, context is important here, because the deceleration went from 19.8% in August to 19.5% in September, but consensus forecasts do indicate that house price moderation will continue through the end of 2022. Even if house price growth is expected to remain positive, it is expected to moderate. So the FOMO I'm talking about with sellers is that sellers may be prompted to list their homes because of fear of missing out on getting the maximum price for their home. So, the concept of FOMO can be applied to both buyers and sellers. But is it rational?

Mark Fleming - Yes. Are we more like Homer Simpson? Or like Spock? Should you, as a buyer, jump in now because rates may rise? Or for existing homeowners? Should you list your home immediately, while house prices are at their peak? What do you think I'm going to say about this? Odeta?

Odeta Kushi - I'm pretty sure you're gonna pull the economist "Get Out of Jail Free" card. In other words, I think you're gonna say, it depends.

Mark Fleming - Or the classic, on the one hand and on the other. I have to. So, for the potential home buyer, sure you could buy now while rates are still at 3%. But remember that affordability calculation, that concept of rates rising and the loss of affordability, which is driving your loss aversion in the first place, isn't just necessarily about rates. Incomes may increase in the coming months because the labor market remains historically tight. That's driving up wages. And we've already seen from the S&P Case-Shiller report that nominal house prices are beginning to moderate. So that's some good news, slowing down the pace of appreciation. So, it's not necessarily a foregone conclusion that rising rates alone makes home buying more expensive, but that's the rational economist in me speaking. There's also the question of inventory, which tends to increase in the spring and in the summer. So, while you may have FOMO, because of rising rates. Don't forget about FOBO. There may be a better option or options when there's more inventory.

Odeta Kushi - And what about for sellers? Right? For sellers? Sure, you may capitalize on getting that maximum amount for your home. But then, what will you buy? Most home sellers are also essentially potential home buyers. And so they're faced with FOMO and FOBO, too. Mark, I think you may have just posed more questions than you answered.

Mark Fleming - Yeah, we certainly have a tendency to do that. Not to mention I'm feeling pretty proud of myself here. We managed to talk about not just one, but two 'FOs.' Get it?

Odeta Kushi - I do get it. That's an accomplishment for sure. And maybe a good place to end. Thank you for joining us on this episode of the REconomy podcast. Be sure to subscribe on your favorite podcast platform. You can also sign up for our blog at Firstam.com/economics. And if you can't wait for the next episode, please follow us on Twitter. It's @OdetaKushi for me and @MFlemingEcon for Mark. Until next time.

This transcript has been edited for clarity.