A Red Hot Housing Market: Looking Behind the Rally

By: Udheesh Gaddipati

Driving through Austin in January of this year, it had become irrefutably clear that the demand for single family homes within the city suburbs was palpable. Lured in by the for-sale yard sign, over 150 potential buyers were lined up outside. I would later learn that the house we’d seen received over 400 offers and sold for $250k in cash over the asking price within 72 hours of listing.

This wasn’t an isolated incident as after the coronavirus induced recession, prices of single-family homes recovered extremely quickly, breaking into new highs. Nicole Friedman of the Wall Street Journal corroborates median existing-home prices rose 23.4% year-over-year to $363,300 in June. Additionally, the S&P CoreLogic Case-Shiller Home Price Index observed a record breaking 18.6% annual gain from June of last year.

So, What Caused This Sharp Increase in the Prices of Single-Family Homes Across the U.S?

First, Migration Induced Demand
Before the pandemic, data from Freddie Mac—a mortgage-financing company—suggested the United States was around 3.8 million single-family homes short of demand. Unfortunately, pandemic induced lockdowns exacerbated this situation; forced to stay home and compelled by flexible, remote work, urban areas saw a significant population leave for the suburbs. Melgar and Wu from the Wall Street Journal report “relocations to midsize and small metro areas from big cities rose 23%” as 7 million households moved counties.

Moreover, existing homeowners saw this as an opportunity to upgrade. The buying frenzy began as Redfin—a real estate brokerage—later reported a record-breaking 63% of buyers in January of 2021 made an offer without even seeing the home.

Second, Increased Affordability
The Economist reports that in order to keep bond markets liquid and boost economic recovery, the Fed began purchasing over $120 billion worth of assets each month, including $40 billion in mortgage-backed securities (MBSs). While the near-zero federal funds rate made it cheaper for loan-seekers to borrow money from banks, the purchases of MBSs boosted market demand for mortgage bonds. This forced 30-year mortgage rates to lower as borrowers did not need to offer competitive interest.

As a result, 30-year mortgage rates fell to their lowest: 2.78%. Erik Martin from The Mortgage Reports concludes, ceteris paribus, every 1% rate drop in mortgage rates could add $30,000 to one’s budget. NPR reported that in “1982, 40% of the country’s newly constructed houses were entry-level homes,” and by “2019, the annual share had fallen to 7%.” Despite this, falling mortgage rates created conditions that encouraged younger families and lower income individuals to enter the homeowner market.

Third, Supply Side Issues
Initially, production rapidly dwindled as the pandemic waned demand; however, as the economy rapidly re-opened, both developers and consumers pressured manufacturers to ramp-up production stressing supply chains. With understaffed factories, the price of raw ingredients rose. While the lumber bubble – which has now burst – added over $16,000 to the price of a new house at its peak, other raw goods like steel remain over 219% above their pre-Covid price. Additionally, construction costs for both dry-wall and concrete have gone up over 13% since January.

Unfortunately, exacerbated by a shortage of labor, availability of developable land, and the rise of input costs, many large developers—who remain in control over a large proportion of new development—are not able to sufficiently increase construction to meet demand. Friedman of the Wall Street Journal finds that “housing starts … climbed 29% in June from a year earlier, [while] sales of newly-built homes slid 19% in the same time frame,” creating a backlog of housing orders, constraining supply, and pushing up prices.

With Prices Rising So Quickly, Do We Find Ourselves in Another Real-Estate Bubble?

In short, no: the U.S housing market is not a bubble. Unlike the 2008 crisis where there was an oversupply of houses in relation to demand, the slow trickle of newly built homes suggests sharp price contractions are unlikely. Moreover, in the wake of ’08, a plethora of regulatory bills like the Dodd-Frank Act have encouraged better underwriting practices, ensuring mortgage defaults remain low. The market has also observed occasional price and demand contractions (as seen from Redfin’s Homebuyer Demand Index) – an indicator of a healthy bull run.

However, with the Fed expected to rein in excess liquidity next year and long-term interest rates beginning to rise once again, the prices and subsequent demand for homes will plateau. Given the divergence between median income and median home prices in the United States, one can fairly assume the demand for homes and their subsequent price is strongly correlated with interest rates. As rates rise, the cheap and favorable conditions for home buyers will wane, encouraging people to reassess an economy moving back in-person; this may adversely affect home demand.

Looking Forward

Given home prices will likely remain elevated because of the pandemic, rents are likely to follow as well. Nicole Bachaud—a market analyst at Zillow—corroborates that rents next year will likely cost upwards of 30% of tenant incomes, a new high in places across the South. This is likely to put upward pressure on inflation, and if wages do not keep up, increase inequality. Optimistically, however, elevated levels of construction coming out of the pandemic—further supplemented by Biden’s Infrastructure plan and proposal to increase the number of affordable homes—may help boost economic activity in the United States in the next couple of years. □

Work Cited