4 Reasons the Housing Market is Red Hot

One can’t look at the current state of the housing market without fretting just a little bit. Even though it has been almost 15 years since the real estate bust in 2008, the memories of that debacle are still fresh in investor’s minds.

Will there be a similar crash this time around? Let’s hope not, as it took years to recover the losses sustained that last go around.

So why is the housing market soaring again?

Let’s take a look at four reasons the housing market is red hot to see if any changes are on the horizon:

Historically-Low Interest Rates

Low interest rates are desirable to home buyers. Many people buy homes based on affordability, which doesn’t mean the cost of the house; it means the amount of the monthly payment.

Take, for example, a couple with a housing budget of $2,000/month. If mortgage rates are 5%, the most they can afford to finance is $372,600. However, if mortgage interest rates fall to 2.875%, all of a sudden, that same couple with the same budget can afford a mortgage of $482,053.

Lower interest rates may incentivize people to buy a home and raise the value of a house they can afford. With more people in the market with a greater range of choices, prices may be pushed higher.

According to Nerdwallet, the average interest rate for a 30-year mortgage is 3.03%, and the average rate for a 15-year mortgage is 2.2%.[1] In comparison, mortgage rates were between 7% and 10% in the 1990s, between 5% and 8% in the early 2000s, and between 3.5% and 5% in the 2010s.[2]

We can thank the Federal Reserve’s near-zero key interest rate policy for the ultralow mortgage rates right now. Currently, the central bank is buying $120 billion of securities, including mortgage-backed securities, that fuel the housing market boom of today.

All of that buying helps keep rates at low, attractive levels for the real estate market. While there has been some talk regarding a reduction in central bank buying, for now, the policy continues. That means investors can expect historically low rates to persist.

We believe the only caveat is inflation, so keep an eye on prices for signs that rates may be moving higher.

It’s All About Supply and Demand

Another reason possibly contributing to the heat of the housing market is a matter of simple economics. Demand for housing is far outstripping the available supply.

Low mortgage rates may have ignited a home-buying frenzy across the country, especially among first-time homebuyers. Consider this: Nearly 50% of the homes sold in April were “pending” within one week of being on the market, and 76% were “pending” within a month.[3] Homes are flying off the market so fast that some folks are putting an offer down sight unseen.

This surging demand for new and existing homes has created a historically low supply of houses on the market. There is currently only a 2.4-month supply of homes on the market, compared to a four-month supply 12 months ago. The National Association of Realtors reported that there were only 1.16 million unsold homes on the market at the end of April or a 20.5% year-over-year decrease.[4]

Part of the supply problem dates back to the housing collapse in 2008. Homebuilders have yet to get housing starts back to pre-crash levels. According to Bankrate, housing starts are still 23% below January 2006 levels.

Increasing the supply of homes to meet this demand is not so easy. One must acquire land, create plans, hire labor to build a new home. It’s a process that takes time. But building new homes is further hampered by the rising cost of building materials. If you’ve been to Home Depot anytime recently, you’ll know that the cost of virtually all building materials has soared in the past year.

That reinforces the contention that the supply/demand dynamic in place today will persist for some time.

Fear of Missing Out

Investor behavior can often be driven by emotion. In the housing market, we believe there is most definitely a fear of missing out phenomenon that is fueling the rapid rise in housing prices in 2021.

In the current market, whereby there are far more buyers than sellers, we see bidding wars and other actions by individuals looking to get a leg up in the market. According to the chief economist of the National Association of Realtors, the average home is seeing 5.1 bids, with some getting as many as 20-30 offers.

The advice of the Neighborhood Assistance Corporation of America is that people don’t get caught up in the frenzy. We believe the problem is that prices keep going higher, which may reinforce the fear amongst investors that they may be missing out.

Patience will be the key as it may take some time for the froth to leave the market. That is far easier said than done, so we shall see how the drama plays out.

Yield-Hungry Buyers Are a Game-Changer

Historically-low interest rates can create a massive problem for investors looking to generate higher yields. One response is to buy real estate using income from rising rents to fund returns.

That is precisely what is happening in the current housing market and with huge impacts on demand and rising prices.

The Wall Street Journal recently reported on a bidding war in the city of Houston, Texas, at a subdivision built by D.R. Horton, but the sale was not for a single dwelling. Instead, the company that built the project, 124 homes in total, rented them out themselves at first and then put all 124 on the market for sale.

In so doing, according to the article, D.R. Horton made double the money they make when selling to individuals. How so?

Because the price paid was that much higher. Magnify that across the country, and these institutional, yield-hungry buyers are a big reason the housing market is red hot.

To the extent interest rates stay low, these buyers may be omnipresent, and the red hot housing market will continue to power forward.

The National Association of Realtors noted that half of the houses on the market are being sold above their list price. It’s not too surprising then that the median home price in the U.S. soared 19.1% year-over-year to $341,600 in April, or a new all-time high.

Will that trend continue down the road?

That’s anyone’s guess. The good news is that unlike 2008, mortgage underwriting is far more restrictive today than during the last housing boom. In addition, buyers can afford monthly payments given the increase in living standards over the previous 10-15 years.

That would suggest that any sort of collapse in the market is far less likely than it was in 2008.

If you would like to know more of our thoughts on housing and how it may impact your financial planning, please give me a call.

Please click here for important disclosures.

[1] https://www.nerdwallet.com/mortgages/mortgage-rates

[2] https://www.rocketmortgage.com/learn/historical-mortgage-rates-30-year-fixed

[3] https://www.zillow.com/research/days-to-pending-april-2021-29511/

[4] https://apnews.com/article/lifestyle-health-coronavirus-pandemic-business-759e4be8a35fda7eaa4b728674a37961