I was talking to some clients the other day who have been actively looking for a home for the past few months. They let me know they were going to put their home-buying plans on hold for the rest of the year until home prices came back down. I completely understood where they were coming from and know working through a market of multiple offers and bidding wars is both frustrating and intimidating, but couldn’t help but wonder why they thought home prices would be lower in a year. The last question I asked them was what they planned to do a year from now if prices hadn’t come down, but were higher than they were today?

I didn’t ask them this question to suggest they should move forward with their plans to buy now, everyone needs to make their own decision on what’s best for them and their families, but simply because I’m not sure everyone understands the reasons prices are rising why they are currently. I break it down in this blog post and point out some of the major differences between now and 2008. Watch the following video or continue reading below to learn more.

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When reports of homes selling for $30k, $50k, and even $100k or more over list price circulate it is completely normal for people to become uneasy, nervous, and just shake their heads at the insanity of it all. After all, the last time the market saw a rapid run-up in home prices during the mid-2000s it was followed by a crash. Just last week, Google announced that searches around the topic of a real estate crash had soared:

I’m not suggesting we all bury our heads in the sand and pretend current market conditions are the new normal, but are we really heading for a crash? Truth is nobody knows for sure what the future holds. Even all of the so-called “experts” can’t agree! My goal here isn’t to try and convince you one way or another, but simply to share the information I have so that you can come to your own conclusion.

What I do know for sure is housing market conditions now, and for the past several years, are very different than they were in the years leading up to 2008.

So Why Are Home Prices Rising So Fast?

One main difference now compared to the real estate market in 2005 - 2007 is that prices then were rising rapidly even though there were plenty of homes for sale. There was a tremendous fear of missing out. New homes were targeted by speculators who would buy only to flip the house upon completion. Investor activity was high, mortgage standards were low, and virtually everyone was maxed out on credit.

The rise in prices we are seeing currently is largely attributed to an imbalance between supply and demand. This imbalance didn’t happen overnight though. It has actually been 13 years in the making because that is how many years in a row we have been underbuilt in terms of new single-family homes across the country. Here’s a look at single-family home construction dating back to 1970:

2021 is the first year since 2006 that we will exceed 1 million new single-family homes built. The current estimate is that approximately 1.6 million homes will be built. That will definitely help, but consider just last week the Wall Street Journal reported that we need nearly 4 million new homes to come on the market to bring the real estate market back into balance.

When the pandemic hit last year a “perfect storm” was created in the real estate market that dramatically impacted the supply side of the equation. New home construction slowed, lumber mills and material suppliers closed creating a shortage and severe backlog, and resale homes never appeared. Visit a new home builder now and you will find that lot releases are being restricted and delayed. The majority of builders simply cannot get the materials or labor needed to ramp up construction further. Not to mention raw material prices have soared due to demand. Lumber prices are up nearly 200% year-over-year.

Here is a look at how the number of homes for sale has changed in Frisco and Prosper over the past 3 years.

When supply is low and demand is high what happens to prices? They go up. The rapid rise in home prices locally didn’t start until after the 1st quarter of 2020 as inventory levels started to fall. The lower inventory levels went the faster prices have risen. From January 2018 until the beginning of 2020 home price appreciation was following a fairly standard trend line as shown on the following chart:

What About Demand?

In order for the price of any product or service to increase faster than normal, the decrease in supply has to be matched by an increase in demand. So where is the demand coming from?

Unlike the high levels of speculation in the housing market in the mid-2000s, the vast majority of demand today is coming from end-users - people that intend to live in the house they are buying. There has been a natural increase in demand as homeownership rates in the US have been steadily rising since 2015. Part of this is due to the fact that millennials, the largest generation, have been reaching prime home-buying age. Another factor is rents have been rising steadily for several years now as well. According to the 2021 Rent Affordability Report in 63% of the 915 counties analyzed, it is cheaper to own a median-priced 3-bedroom home than to rent one.

Another thing we know is the pandemic changed the definition of “home” for many of us. Home became work, school, the gym, entertainment etc. This caused a number of people to realize their current address no longer suited their needs as well as it once did.

As the economy started to reopen after the initial pandemic lockdown mortgage rates started to fall as well. These historically low mortgage rates brought more buyers into the market and helped keep affordability in check in the face of rising home prices. Notice on the following chart how falling mortgage rates matched the falling inventory levels shown above:

Now that mortgage rates have started to rise we have started to see a decrease in the number of new mortgage applications. Experts are predicting that mortgage rates will most likely be between 3.5% and 3.75% by the end of 2021. although still an amazingly low rate, that increase is likely to cause buyer demand to soften slightly.

Bottom Line

There is no denying the current real estate market is a crazy ride and home prices certainly cannot continue rising at the pace they have been. While it’s natural for the rise in prices to make people nervous, it doesn’t mean a crash is imminent. Does that mean there won’t be a correction at some point? No, but a correction doesn’t have to be a crash.

The fundamentals of the current real estate market are strong, but I realize that could change. We are starting to see a slight uptick in the number of new home listings, which is typical this time of year, and I do expect inventory to increase as we move further into the year. This, coupled with a slight softening of buyer demand due to rising mortgage rates and buyers “taking a break” should cause home price appreciation to moderate.

Hopefully, this information has helped explain how we arrived at the current situation and I will be sure to post updates as soon as additional information becomes available.

If you would like to join my email list where I provide insights and updates each week please send an email to Andrew@TheAndrewSmithTeam.com and I would be happy to add you.