23 Feb Why is Housing Inventory so Low?
To prevent long-term high inflation, the Federal Reserve must engage in activities known as demand destruction. They must cool the economy, part of which involves slowing down the hot housing market. The housing market includes purchases of home and rentals. Current rent rates affect up to one-third of many inflation readings.
A problem for the Fed is that when they enact policies that help lead to higher mortgage interest rates, they both cool the housing market and heat it up. How? Roughly 6 out of 7 mortgage loan borrowers currently have an interest rate below 6%. Most home sellers intend to buy another home (right away too, since they need somewhere to move into after they sell!). If someone has a 3% or a 4% interest rate, they are less likely to want to sell and then buy a home with a 6.5% interest rate or higher. So, they continue to live in their current home. When there is low inventory, the current buyers must compete with each other and therefore bid prices up.
There is another big reason why housing inventory is historically low. Over the past 10 years, about 12 million new households were created in the U.S. Home builders constructed about 7 million new homes. There is an approximate shortfall of 5 million homes. Since it takes time to develop land and build homes, it could take a few years for enough new homes to be built to ease the shortage.
The roots of the lack of newly built homes date back to the Great Recession of 2007 to 2008. Many home builders went out of business. Those that survived built very few homes from 2007 through 2014. The financial pain felt by builders due to a housing glut (there were up to 4 times more homes on the market then than now!) caused builders to be cautious.
The Millennial Generation (a.k.a. Generation Y) tended to buy their first home later in life as compared to prior generations. The average age of a first-time homebuyer today is 36. The Millennial Generation is even larger than the Baby Boomer Generation. Now that Millennials are buying homes, demand is high. Also, many Baby Boomers are retiring and seeking to downsize from the McMansions that were built for them in the 1990s and early 2000s. Many Boomers want a ranch-style home, which is also what many Millennials with young children want. You can even count Generation Z (in their 20s now) as wanting starter homes and one-level houses.
Another reason for the housing shortage lies with what builders have constructed in recent years. After getting crushed in the Great Recession, some builders elected not to build smaller, less profitable homes. They built larger homes. The lack of smaller, starter homes has hurt first-time homebuyers and those who can afford less. With many Millennials not buying until their mid- to late-30s, a lot of builders focused on constructing apartment buildings to house all the renters. After all, people need to live somewhere. In 2021, there were about 1.6 million new housing starts but about half a million of those were apartments instead of single family homes.
Supply chain disruptions have also hampered building projects. Builders who cannot receive lumber, fixtures, and other materials on time have to delay completion of their projects. Delayed construction further exacerbates the inventory situation.
The COVID-19 pandemic jump started a tectonic shift in where people work. Prior to 2020, the typical step-up homebuyer purchased a home within about 18 miles of their previous residence. Per a National Association of Realtors survey in June 2022, the average homebuyer purchased their home a median of 50 miles away from their prior residence. With more people working remotely and with some not wanting to be in an urban setting, demand for suburban and rural homes jumped. This shift further strained inventory levels in many areas.
The rapid rise in real estate investors and in hedge fund firms buying houses to rent also limited inventory for move-in homebuyers. After the Great Recession, some hedge funds and large enterprises started buying tens of thousands of houses to rent. Why not? Well-managed real estate in growing areas is a path to wealth. Also, the rise of the stock market and the stimulus money from 2020 to 2021 helped more people get into real estate investing. Many investors compete for starter homes and slightly larger step-up homes, which push first-time homebuyers into competitive situations or out of the market entirely. As mentioned above, many builders aren’t building starter homes so the supply isn’t growing fast enough.
The confluence of these factors has led to multiple years of low inventory and high demand. The Fed is damned if they do and damned if they don’t. By engineering higher interest rates to tamp down inflation and cool the housing market, the Fed is simultaneously causing housing prices to hold firm in many cities.
The Fed doesn’t directly control mortgage interest rates. By increasing the Federal Funds Rate, banks raise interest rates on credit cards, auto loans, home equity loans, and business loans. The stock market cools off for a time as company earnings go down since many public companies borrow money and now have to pay more for that money. Another reason the stock market may go down is that investors move their money out of stocks and into bonds like U.S. Treasuries. The residential mortgage interest rate is closely associated with the yield on the 10-Year Treasury Bond. When the yield rises, mortgage rates tend to follow almost instantly.
Zillow expects housing prices to increase slightly in 2023. So, even though the Fed is directly and indirectly increasing the rate of borrowing, the large number of buyers are fighting for limited inventory and driving housing prices up. For now.
Tai DeSa is a graduate of The Wharton School of the University of Pennsylvania. He became a full-time real estate investor in 2004 after serving in the U.S. Navy. Tai made colossal mistakes in investing (and learned some things along the way). Tai has coached hundreds of entrepreneurs, real estate investors, and real estate agents on how to increase their income and net worth. He has helped hundreds of homeowners avoid foreclosure through successful short sales. Check out Tai’s books on Amazon.com. Tai may be available for coaching and speaking engagements on a variety of real estate topics. Send an email to tai@investandtransform.com.
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