Two years into the pandemic, the housing market remains on fire and shows few signs of receding. What was initially fueled by buyers’ need for more space and a low interest rate environment has proven to have staying power.
The factors driving the hot housing market go beyond low rates and include a thriving economy, favorable demographics and a limited supply.
Now, with inflation hitting 7.9%, a 40-year high, in February, the Federal Reserve recently announced a quarter percentage point increase in its policy rate, the first of what it said would be seven rate hikes this year.
The increases have raised concerns over housing affordability and have left home buyers wondering whether these increases will put an end to the housing market frenzy. Chances are they will not.
While low interest rates have contributed to the increased demand for housing, the factors driving the market go beyond low rates and include a thriving economy, favorable demographics and a limited supply.
This is not to say that rising interest rates will not have an impact. In fact, higher interest rates are certain to challenge already stretched affordability.
Based on fourth-quarter readings, the National Association of Realtors’ housing affordability composite index was 148.1, suggesting a market that is still affordable but off the recent peak of a year ago.
At the same time, the first-time home buyer index was 97.5, according to the association. A value of 100 means that a family with a median income has exactly enough income to qualify for a mortgage on a median-priced home.
As rates increase, some buyers are likely to pull out of the competitive market, easing bidding wars and ultimately leading to increased inventory as builders catch up with demand. But the need for housing is not going away.
A chronic shortage
The current shortage of home inventory in the United States is not only a result of homeowners not listing their properties or builders not producing more homes during the pandemic. This shortage, which realtor.com estimates to be more than 5 million units, is chronic, and can be also traced to the significant underbuilding following the financial crisis.
Couple the shortage with the high demand during the pandemic as families looked for more space and millennials entered the market, and demand significantly outpaced supply.
What’s more, as Americans have taken advantage of the low interest rates over the past decade, even those looking to upsize have felt no need to sell their existing homes. Many have become landlords, further contributing to the housing shortage.
According to data from the Census Bureau’s 2018 Rental Housing Finance Survey, its most recent, 72.5% of single-unit rental properties in the U.S. were owned by individuals. The strong rental market with increases in rent in the double digits and vacancies at record lows is likely to grow this trend.
The supply side
Then there is the supply side of the equation. Builders have faced a tight labor force and supply chain disruptions, limiting their production. Lennar’s executive chairman, Stuart Miller, indicated in a March 17 earnings call that the company’s ability to deliver homes has been “slowed by the supply chain that is all but broken by the workforce that is short in supply and the intense competition for scarce entitled land assets.”
But the market, given enough time, will find an equilibrium. Higher interest rates will make homes less affordable in the short term, but over time they will help put more inventory into the market, as less market competition from buyers will allow builders to catch up to more normalized levels of inventory.
The housing market will remain strong for the foreseeable future, and as supply chains ease, home builders and multi-family developers will be able to capitalize on new opportunities in the housing sector.