Updated: Jun 16, 2021
The COVID Housing Market
COVID-19 cases and deaths have thankfully been declining in the United States with the so-far successful distribution of several FDA-approved vaccines. However, the economic downturn from the pandemic has continued to hinder essential industries and create hardships for lower-income Americans. One such industry is real estate, which has seen historic spikes in evictions and foreclosures. The country was suffering from a housing affordability crisis pre-pandemic, which reached new heights amongst the virus-induced shutdown and subsequent socioeconomic turmoil. Another notable development has been an exodus of buyers fleeing the cities to suburban areas. This movement has coincided with price increases, not only in the suburbs but on a national scale. Though these price levels are unprecedented, the phenomenon of residents leaving the cities is not. Following World War II, American industry was booming, and population patterns changed in two significant ways: shifts from older metros in the Midwest toward newer urban centers in the South; and from the inner cities to newly developing suburbs. Despite those disturbances, this post-World War II period was the last occurrence of price stability in American housing. Examining the reasons for this price stability is crucial to understanding the disfunction in the present-day market.
The Industrial Revolution and Rise of Suburbia
In the 1950s, housing wasn't considered as daunting of an expense as it's known today. The average home cost only about $7,400, and considering the median annual household income was $2,900, a single breadwinner could expect to pay off a property within a matter of years. Meanwhile, a new car cost an average of $2,000, and it was not uncommon for a family to hold more value in their driveway than in their house. It was, in part, the introduction of these cars and other key developments such as the interstate highway that would accelerate the rise of the suburbs post-World War II. A few decades prior, getting in and out of a city to commute to work involved catching a train or a horse-drawn carriage. The widespread adoption of the car made travel across greater distances feasible. With the ability to commute, city dwellers began expanding out and developing more spacious residential areas. Those leaving the inner cities were predominantly white and middle-class, and this period is also known as one of the first occurrences of 'white flight.' The inner cities had become racially and economically diverse in a time of deep-rooted prejudice and segregation. Meanwhile, white veterans had exclusively benefited from provisions in the GI bill that helped them buy houses in the more segregated suburbs. However misguided, the 1950's rise of suburbia helped maintain housing affordability for the following couple of decades. By 1970, the average housing cost ($17,000) had kept pace with the rate of inflation. In the same amount of time, the median annual salary had almost tripled to $8,700.
Why The Stable Prices?
Price stability in the aforementioned 20-year period can be explained by simple supply and demand economics. Urban sprawl and newly developed residential land (housing supply) had easily kept pace with the growing American population (housing demand). However, there was one more fundamental difference with this housing market that contributed to price stability; a lack of real estate investment. The concept of investing, particularly in real estate, had yet to hit the mainstream. Housing was a high value but traditional commodity, which kept prices dependent on supply and demand forces. Even for investors with an abundance of capital and the ability to take out several mortgages, there was no perceived benefit in doing so. It would've been difficult for anyone to predict the extent to which American home values would rise come the 1980s.
A Market Transformation
In the 1980s, Americans began moving back to the proximity of booming city centers, which had become prosperous and prestigious locations in popular culture. Additionally, the recession of 1981 posed a historic opportunity as defaulted real estate in the city was sold-off in mass, tempting people to buy up fire-sale properties as their first speculative investment into real estate. This buying frenzy was accelerated by the introduction of the Louis Ranieri mortgage bond. Housing began functioning less like a supply-demand commodity and more like an investment vehicle. Naturally, prices began to inflate at a pace almost entirely divorced from variables like wage growth. Only three decades later, this excessive financialization and speculation triggered a subprime mortgage crisis and another recession in 2008. Despite this, market dynamics remained relatively unchanged and, in 2010, recovering housing prices were now more than four times the average annual salary. Larger homes near public amenities and metropolitan areas had become more desirable, and Americans could now obtain them with the widespread availability of 30-year mortgages, low-interest rates, and a financial industry incentivized to write more loans. The availability of these new financing methods may seem advantageous to buyers. However, the more consumers were able to pay through new debt instruments, the higher the prices demanded by the market; this is because housing qualifies as a relatively inelastic good. In basic economics, an inelastic good refers to a good with a demand unaffected by factors such as price and income level. In simpler terms, a comfortable and sufficient in size shelter in a suitable location is a basic human necessity; thus, it is assumed that the average consumer will pay as much as possible to keep a roof over their head. If taking on debt allows buyers to spend more on a home than otherwise, sellers are incentivized to charge them the difference. No matter how unreasonable prices and mortgage terms seem, there will always be demand for housing. Naturally, it is financially well-off households that can secure the most advantageous loans and mortgages, avoiding unserviceable debt risk. On the other hand, skyrocketing prices and insurmountable debt requirements threaten to push the basic necessity of housing outside the reach of ordinary people.
COVID-19 Introduces New Challenges
Like with most structural problems in the US, the pandemic has only seemed to make matters worse for housing affordability. A market that sustains high prices with excessive levels of debt is analogous to a house of cards. In times of turbulence, this metaphorical house is in danger of collapse. Last year, many homeowners lost their sources of income and couldn't afford rent or make mortgage payments. Generally, a drop in consumers' ability to spend may reduce demand for higher prices and decrease them to more affordable levels. However, the current real estate market is oversaturated with speculators and professionally managed private equity funds that view volatile times as investment opportunities. This speculative investment has helped maintain purchases and market profitability at high prices. Not only have prices been retained, but they’ve increased in most major city centers in America since the start of the COVID-19 pandemic. The virus has pushed many residents away from the cities, but unlike in the 1980s, there has been no correlated price stabilization. Several factors are contributing to this current dilemma.
In the 1980s, homebuyers were less reliant on loans to buy houses, and interest rates went as high as 8% at certain points. Interest rates are generally lower in modern America, and they have been kept particularly low during COVID. Lower interest rates have been used to help stimulate the economy and make borrowing money easier. However, this gives speculative investors more monetary firepower in property sale negotiations, where they compete with ordinary people. Homebuyers that are less secure and confident in borrowing are disadvantaged and can be squeezed out of markets.
The Rich Get Richer
Since the worst of the pandemic, the American government has undergone some of the most extensive stimulus measures in US history. Stimulus checks and increased unemployment benefits have undoubtedly helped the country's most in need. However, those workers and employers at the top income brackets received a disproportionate amount of this government spending. Many Americans that received non-targeted stimulus while retaining their jobs or working for companies granted large PPP loans have seen an unprecedented increase in their savings. The savings are also a result of higher-income households sharply reducing spending on services that require in-person interactions. Money once spent on holidays, going out, or personal care has instead been accumulating in bank accounts. This trend conversely affected middle to lower-class Americans as service businesses offset revenue declines by laying off employees. In fact, according to a recent Harvard Opportunity Insights study, nearly 50% of low-wage workers in the highest-rent ZIP codes lost their jobs during the pandemic. One of the biggest hurdles to purchasing a property is saving the money needed for a down payment. This hurdle is becoming increasingly insurmountable for lower-income Americans while diminishing for those with the capital to make down payments and investments in real estate. Additionally, this is a time when residents with money to spare are genuinely looking to spend on housing. After a year of encouragement to stay indoors, residents are keen on some extra square footage of living space. Renters with one bedroom may desire more room for a home office, and those living in townhouses may seek a single-family home to host more guests or get freedom from the rest of the family. When large numbers of buyers are trading up, it puts more stress on the entire property ladder and its prices.
Not For Sale
As mentioned earlier, in the 1950s, housing migration mainly consisted of renters in the inner cities leaving to buy homes in the suburbs. Those movers with homes in the cities primarily sold; why wouldn't they? Conventional economic wisdom dictates that as the price of a good rises higher, more market participants will be willing to sell and satiate demand at that higher price. However, in the 20th century, real estate blurs the line between an essential commodity and an investment vehicle. Both of these classifications tend to skew results of ideal supply and demand market outcomes. Everyone needs a place to live, so higher house prices don't always compel homeowners to sell when they know they'll immediately need to buy back into that same market. When few are selling, those who do, run the risk of not finding a suitable home quickly enough in a rapidly appreciating market. This process is exacerbated when you consider the expenses involved in transacting a home: real estate agent commissions, capital gains taxes, sales taxes, legal fees, and property evaluation fees. Moving is an expensive affair and isn’t desirable unless there is a substantial benefit to doing so. Those that own investment properties also tend to ignore typical market forces. With real-estate values rising, investors may feel motivated to continue holding on to or even doubling down on their portfolios. Just examine meme cryptocurrencies like dogecoin for an example of counter-intuitive market expectation in action.
Damaged Supply Chains
The last factor pushing up housing prices has only just started to take effect, and that is a severe shortage of building supplies. The slowdown of international supply chains and the closure of various industrial centers across the world have caused goods such as lumber to temporarily more than double in price. Some builders are turning down jobs simply because they can't afford or find the supplies to fit their budgets. Developers that expect these prices to eventually drop may hold off on projects if possible. For prospective home buyers, damaged supply chains and expensive materials also incentivize buying an already established residence off the market rather than constructing a new one. All these factors threaten to constrain the supply of new housing units further.
Rising Prices or Appreciation?
As an affordable housing company seeking to build homes for lower-income residents, rising prices may seem like the antithesis of Nesthub's mission. However, high costs and the lack of affordable housing are, in many ways, the symptoms of deeper systematic issues, and it's important to acknowledge why this system has been sustained. For a satisfied homeowner not looking to move, it stands to reason that inflating prices are a benefit; from their perspective, this is just an appreciation of their asset value. Homeowners experiencing appreciation can access this equity to fund new construction, investment, or luxuries. If a buyer takes out a loan for a property that appreciates and doubles in value, at the same time they've substantially paid that loan down, they've likely increased their net worth multiple times over. Potential for massive gains is expected for most leveraged investments, yet buying stocks with the same five to one leverage standard for a mortgage will typically attract higher interest rates and riskier contract terms, making them unsuitable for regular Americans; not to mention, they can’t live in a stock portfolio. Therefore, homeownership is a powerful tool for the average person to save for retirement. Simply paying off a 30-year mortgage builds equity in a tangible asset that will continue appreciating. Later in life, a home can be sold in exchange for a smaller dwelling, leaving the seller with the price difference. Properties can also be rented out and provide steady cash flow. This kind of self-funded retirement is increasingly needed as aging populations put a considerable burden on state-funded retirement systems. Homeownership is also an effective hedge against inflation risk: a story for another blog. Considering all this, in a democracy where most of the voting population are already homeowners, it's not surprising the government has neglected policy actions that would stifle price growth.
The Ideal Market Outcome?
Homeowners don't want prices to crash, resulting in them underwater on loans. However, no nation wants housing to become unaffordable to all but the wealthiest, and at the current rate, that's where America's heading. Market fundamentalism suggests that market forces automatically correct prices in the competitive marketplace. This theory holds up better for commodities such as grain, which, like housing, accommodates an essential need as a source of food. Types of grain can also be speculated on, and indeed they are, in the commodities market. However, a key difference is that grain is not purchased and held onto for years in the hopes that it will triple in value. If the cost did rise to that extent, it would cause food to become excessively priced and would be considered by most as a market failure or dangerous inflation. Outside of a financial context, there is little reason that housing appreciation should be understood differently from the price appreciation of other commodities. Though housing appreciation profits speculators and satisfied homeowners, stable prices would have their own set of benefits for the broader public. For starters, people trying to break into the property market would no longer need to save more money in anticipation of a rising price target. Homeowners could still build wealth by paying off their mortgages or get cashflow by investing in rental properties. Stable prices also risk less depreciation during economic downturns. There would be less anxiety about the right time to buy or sell and fewer capital gains taxes paid on those transactions. Residents would be more willing to move between homes as their families grow and shrink over their life. This ease of movement would create some market flexibility. It may seem that all of these advantages come at the expense of landlords and developers; however, this would be a slanted interpretation. Investors and developers that do nothing but sit on properties and wait for them to appreciate would undoubtedly lose out, but that money would instead flow to where active value was being provided to the market. Like with regular commodities, producers, or in this case developers, would be incentivized to provide the market with as many adequate and affordable goods as possible to increase their profit margin. This dynamic would efficiently allocate capital to serve consumers rather than greedy suppliers. Instead of maintaining an underutilized lot with an older house on it, there would be more value in reconstructing a new community of units. This hypothetical market is not far from the reality in Japan, where housing prices have barely moved over the past decade, including during the pandemic. It might be hard to convince the home-owning majority that this is ideal, but the only alternative may be a future where people choose between crippling debt or being left out in the cold.
Can Stable Prices Be Achieved?
As alluded to in this piece, many complex factors influence housing prices. Potential remedies have been and will continue to be a focus of the Nesthubs blog in more detail. However, there are some simple solutions related to this post. One of the main reasons that Japan's housing prices have remained so stable is the country's ability to keep the housing supply in line with housing needs. In 2014, the city of Tokyo was issued permits for 142,417 new units. In contrast, the entire state of California, which has three times the population of Tokyo, issued permits for only 83,657 new units. Japan is able to keep its pace because it sets housing regulations at the national level and prioritizes keeping up with population growth and migration. Meanwhile, the US is relying on more decentralized and localized zoning and permitting administration. This localized hierarchy gives community leaders more of a voice in their city and neighborhood planning; however, it sometimes allows policy decisions to be constrained by a 'not in my back yard' or 'NIMBY' culture rather than material housing needs. The 1950 housing supply was expanded outwards into untapped land and rural areas. In 2021, with a larger population and so much of America already zoned and developed, an inward expansion is needed. This inward expansion would require a mass replacement of older homes and underutilized lots in favor of more efficiently built and designed multifamily units. Despite supply needs, neighborhoods and metros experiencing population increases are justified in their desire to maintain community culture and city planning. These concerns are why Nesthubs believes modular home developments are the path forward to increase housing supply in these areas. Nesthubs' properties are community-centered and designed to look like quality suburban homes in the aesthetic theme of the surrounding area. However, to allow space for innovative housing developers like Nesthubs, grassroots action and awareness concerning zoning policy is needed. To learn more about zoning and Nesthubs' middle housing initiatives, read America's Zoning Problem: Implications, Legacy, and a Path Forward on the Nesthubs blog.
Dylan Butts is the Director of Business Development at Nesthubs where he leads initiatives centered on developing the organization's relationships and outreach, producing research and written pieces, and improving services. He has a background in Economics and Renewable Energy and is passionate about leveraging innovative economic thinking to maximize social advancement.