(This is a 3 part series blog post on the housing economy. This is the second of the series of articles. The first article talked about the demand side. The second article talked about the supply side. Please read the 2 articles before you read this article. )
Regular readers of my blog know I don’t like to write articles about any specific point of time because I wish to keep these timeless, but I wish to use this time period (Mar 2023) as an illustration of how to use the framework I provided in the previous articles, along with some context.
To understand the current state of the housing economy, you need to look at both the demand and supply indicators I have written about. Specifically for the US, many see the demand factors and often start prophesizing the future of the market. But purely looking at only the demand side never tells you the entire story as I explained in my earlier articles.
Warning alert: This article is going to be filled with visuals. So get ready to see a lot of charts 🙂
What is happening with demand on the housing side?
Long term factors – Demographics:
Lets begin with the long term factors like demographics. In the US, overall population has been growing but at a slower % increase over time. Population increase (or decrease) is fundamentally driven by births, deaths, and migration (both domestic and international). But remember what I said – real estate is local. If you zoom in on certain parts of the US, the story will be completely different. There has been a migration in the US from Midwest and Northeast to more to the south and west. So depending on which part of the country or even more specifically which cities/towns you look at, the population trends will be very different. If you want to see more data on population and migration in the US, the US Census Bureau website has a lot of rich information. https://www.census.gov/en.html . Whichever part of the world you are in, you can identify similar data to your local market.
Source: https://www.freddiemac.com/research/insight/20210128-population-growing
Short term factors – interest rates:
Unless you have been living under a rock, I think its pretty common knowledge that US mortgage rates have significantly increased since mid-2022. That has had a sizeable impact on demand. Below is a chart from Freddie Mac showing US mortgage rates over the last 10 years. After over a decade of super low interest rates, the rates have finally gone up significantly influenced by FED actions. This has definitely reduced demand for housing. This article from the National Association of Home Builders in the US summarizes this well – the difference between a 3% mortgage and a 7% mortgage is $1000 per month in increased mortgage costs!
So, overall if you look at the demand factors, you may be like – this shows a crash coming in the housing market – right? Wrong. As I said, the demand side is only part of the story. If you read the rest of the article, you will realize why a crash is not going to happen anytime soon. However, remember this story is different based on the local market.
So what is happening on the supply side?
Supply side factors – new home builds:
The story in the US is fundamentally a supply story. After the 2008/2009 crisis, new home constructions dramatically reduced with many developers going out of business and not building new homes. New home construction during that decade was almost half of what it was during the prior decades. Meanwhile, the US population continued to grow during this period. So long term demand continued to slowly increase. The below chart from the US White House shows this very clearly:
Then came the 2020 pandemic and things got completely distorted. Supply dramatically dropped for a bit including existing home sales due to the pandemic. In 2021 and 2022, labor was severely constrained, materials became more expensive making the supply situation worse. On the demand side, the pandemic forced everyone to start looking for bigger homes and upgrade. This was all in the backdrop of record low interest rates and some significant money being injected into the economy in terms of stimulus. So, demand became suddenly unusually high. This has since changed at the time of writing this article where demand has cooled quite a bit since the frenzy of 2021.
Supply side factors – Interest rates:
The impact of higher interest rates while reducing demand, also reduce supply. This is the uniqueness of the housing market. This is because a large majority of buyers of homes are also sellers – meaning, many people who are looking to sell their homes are also looking to upgrade to a new home. Given the high interest rates, existing homeowners who were looking to upgrade are sitting out of the market. While this reduces demand, it has an even bigger impact on supply because 80% of the housing supply comes from existing homes.
The intersection of demand and supply – reducing demand but even bigger reduction in supply
Think of this as the perfect storm – supply simply could not increase for a bit and demand increased during the pandemic which has since cooled quite a bit. Using the same demand supply visual, we can see the new demand supply curve and what happened to price here – it simply went up. Over the last decade, demand has stayed strong (even though recently it has cooled down – it has not fundamentally come down), but supply has reduced significantly for reasons I have explained. So prices still remain high. Don’t nitpick on how accurate this visual is – I am simply trying to explain the concept here.
This article from the US Whitehouse summarizes this in different charts in their blog post. If you are hungry for more data and details, go ahead and read this. The below chart beautifully summarizes the housing supply situation and the resulting impact on prices.
At the time of writing this article, while there is reason to believe while some of the demand factors are reducing demand, the supply situation has not changed dramatically. New multi-family home construction has taken off in the recent years but it will take a while for all that to hit the market. So, in the near term, prices will remain high. The craziness of multiple offers well above list price and houses being sold within hours is probably behind us. But don’t expect prices to go down any time soon. Having said this, this is very different depending on the local market you operate in. Some markets in the US saw ridiculous price increases in a short span and those markets are seeing corrections while a lot of other stable markets will not see much of a change. This article from Redfin provides more detail by local markets as of Jan 2023.
So what do I do with all this knowledge? Our personal example.
I will rehash what I said at the beginning of this article series – a house is the single largest personal finance investment one will make. So understanding the fundamental economics of home prices is important. [Note: buying a personal home is never just about price and there are many other factors – I am simply trying to make sure you understand the market background when you buy a house.]
When we were buying our first home back in 2016, everyone said the prices were too high and the market was hot. But looking at the demand and supply situation, it was clear to me that while prices were high, there was no reason to believe they were going to drop anytime soon. So we bought the house at the time. Everyone now tells us we were ‘lucky’ to have bought the house at that time at that price. 😊
Fast forward to 2021, in the midst of the craziest run up to housing prices and bidding wars, my wife and I were keen to upgrade to a larger house. Our local city has strong demand side factors and supply was very much constrained. So, prices were through the roof. Everyone around was talking about an upcoming crash but to me, it was plain as daylight that no such crash would come anytime soon because of the supply situation. We saw a home that I felt the price was just right and not over-priced. We closed on it without any competition because they wanted an extended closing into winter. We locked in a 30 year mortgage rate of 2.8%. A lot of people looked at us and said we were crazy to be buying at that time at the ‘peak’ of the market. Fast forward to Mar 2023 at the time of writing this article, and we again look like maybe we made a good decision, because housing prices have gone up even more and mortgage rates are as of today north of 6%. Of course, my goal was not to try and make money on the house – but just to ensure we could buy something that fit our needs without exceeding our budget. Who knows what the future holds? Maybe the crash will come and we will look like chumps for buying at the price we did – but my basic analysis tells me thats unlikely. Time will tell.
Why do I explain the above examples? Because people often feel they need to be clever in terms of timing the market. People have been waiting for a ‘crash’ in prices for a while now. But if you took the time to examine the demand and supply forces in your local market, you might realize a crash is not coming any time soon. It might happen in the future. Of course, each local market is different and you want to ensure you understand what is happening in your market.
Your house is the single biggest personal finance investment you might make. So I wanted this rather long but hopefully interesting explanation on assessing the housing market.
Thank you for reading and I wish you success in your personal finance journey.
Disclaimer: I am not a financial advisor and all the information in my articles are from my personal experience and are for informational and educational purposes only. Please consult with a financial advisor or CPA for professional advice.
