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Why Are Home Prices Rising? 6 Reasons That Explain the Current Market

If you don't understand why home prices are rising, we're here to help. We unmask the price growth monster by identifying six sources of price growth.

April 11, 2022
April 11, 2022
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The scariest part of a horror movie isn’t the big monster reveal – it’s the hours of suspense leading up to it. In fact, it’s only after the monster is revealed that the protagonists come up with a plan to confront and defeat it.

The rapid price growth in today’s housing market isn’t so different. Rising prices are a big, scary monster for homebuyers. But by shining a light on it, homebuyers can get a better sense of what they’re up against and how to overcome it.

So let’s jump in The Mystery Machine and pull the mask off this monster.

Six reasons why home prices are rising so fast

First off, how abnormal is home price growth right now?

Well, it’s record-setting in a few ways:

  1. The national median home price grew at an all-time high 18.8% year-over-year in December 2021, according to the CoreLogic Case-Shiller National Home Price Index. In a healthy market, homes typically appreciate between 4-5% annually.
  2. Existing home prices have increased year-over-year in each of the last 120 months – a streak that began in February 2012 when Kelly Clarkson’s “Stronger” was #1 on the Billboard Hot 100.

For the visual learners, here’s what the last 20 years of home price changes looks like:

What’s causing this abnormal period of home price growth? A combination of factors. Some have been brewing for decades, others surfaced unexpectedly.

Here are six reasons for today’s rapid home price growth.

  1. Artificially low mortgage rates
  2. Low housing supply
  3. Millennial household growth
  4. Inflationary actions by the Federal Reserve
  5. Building costs and inflation
  6. Good old-fashioned FOMO

1)   Artificially low mortgage rates during the pandemic

Beyond a means to buying a home, a mortgage is a product. And for the better part of the pandemic, that product has been incredibly cheap due to policies enacted by the Federal Reserve to encourage consumer spending and stave off recession.

How cheap? Below is a graph of average mortgage rates for the last 20 years with a red box around 2020 and 2021.

Record low mortgage rates allowed homebuyers to get a better bang-for-their buck on home purchases. They spent less on interest and more on the purchase price of the home.

A $400,000 home may have been out of reach with a mortgage rate in the 4’s, but rates in the 2’s and 3’s allowed more buyers to enter the market.

And that’s exactly what they did. Homebuyers came out of the woodwork to lock-in historically low mortgage rates, creating a sudden burst of demand in the market.

And if you recall from Econ 101 or the lemonade stand you ran as a kid, when demand increases, so do prices.

With the Federal Reserve winding down its easy-money policies, mortgage rates are headed back up. But, as the chart shows above, rates in the 4’s are still very low for the 21st century (and even lower if you look back further).

2)   Low housing supply

In addition to demand, home prices are influenced by supply. And housing supply hit an all-time low in 2022, which is driving up home prices.

There are two main reasons for the severe lack of inventory.

First, there’s the decade of underbuilding that took place following the 2008 housing market crash (show in the red box below). Before the 2008 crash, homebuilders were completing homes at a rate well over 1.5 million homes per year.

After the crash, that rate dropped to as low as 400,000 homes per year. and still hasn’t fully returned to the 1 million homes per year pace.

So inventory was already going to be an issue in the early 2020’s. Then COVID hit.

The pandemic introduced three things to further decrease inventory:

  1. Pandemic shutdowns that completely halted construction for weeks or months, depending on the area
  2. Supply chain issues that slow the rate of building. These material shortages are still hampering buildings and, in some cases, getting worse.
  3. Record-low mortgage rates which further fueled demand and depleted supply.

The graph below shows the markets current supply of active listings. Pre-pandemic, there were typically above 1.2 million listings available at all times. As of January 2022, there were just over 400,000.

Again, think back to your lemonade stand. If you have one cup left and three people competing to buy it, you sit back and watch the bidding war drive up the price.

3) The millennial wave

Unfortunately, this is not a new TikTok challenge. The millennial wave refers to the massive group of Americans aging into peak homebuying years.

Millennials are the largest generation in America and the largest segment of that population, shown by the uptick in blue lines between 29-32, is just reaching the average age to buy their first home (33).

Just like the decade of underbuilding, this is a market force that has been brewing for decades and all but guaranteed high demand for housing in the 2020’s. It’s also a force that was accelerated by the pandemic, as low mortgage rates increased affordability for first-time millennial buyers.

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4) Inflationary action by the Federal Reserve

Ok, what does “inflationary action by the Federal Reserve” even mean?

Well, it’s more commonly referred to as “printing money.” And beginning in March 2020, the Federal Reserve started printing A LOT of money ($120 billion per month, to be exact) in order to encourage spending and steer the economy out of recession.

But when there’s more money in the market, the dollar loses value and it requires more dollars to buy gas, groceries, and homes – aka inflation.

From February 2020 to February 2021 the Fed increased money supply by 27%. By December 2021, home prices were up 18.8% year over year.

Check out the similarities in the money supply and home price charts below:

While rising home prices seem to indicate the houses are more valuable, they partially reflect the weakened state of the dollar due to inflation.

5) Inflated homebuilding costs

What happens when you combine a desperate need for housing inventory and inflation? Some pretty darn expensive new homes.

Facing shortages of lots, labor, and materials, homebuilders are spending more money to build new homes, and passing those costs onto homebuyers.

The chart below shows how much single-family home construction spending (blue bars) has increased during the pandemic, and how that increased spending is not necessarily translating into more homes.

It’s translating into more expensive homes.

In January 2022, homebuilders were spending at a rate of $435 billion per year to complete 990,000 homes per year.

That means each single-family home cost on average $480,000 to complete — up from $381,000 the year before.

6) Good ol’ fashioned FOMO

FOMO – or fear of missing out – is a hard thing to quantify. But people are pack animals by nature and are prone to follow trends (how else could the Pet Rock have been a business success?)

FOMO seems especially more potent in the age of social media. If someone buys their dream home, you’re going to hear about it on Facebook, Instagram, Twitter, TikTok, and then Instagram again for good measure.

And then there’s the fear of missing out on a record-low mortgage rate. It took a global pandemic to drive mortgage rates below 3% – something that had never happened before – so they were likely a once-in-a-lifetime opportunity.

The fear of falling behind peers, missing out on mortgage rates, and the urgency to jump on scarce supply all fuel emotional demand. Here’s what that looks like in 2022:

Challenging, but not impossible

The six forces listed above have combined to drive up home prices and created a difficult market for homebuyers.

But buying a home is not impossible. Price growth varies by location and some markets have been much less affected than others. And once homebuyers do seal the deal, price growth becomes their friend in the form of home equity.

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