Can't Build Them? Join them: Rising Home Prices & Lack of Construction

There’s a tug of war brewing between housing costs and consumer budgets in the US. Single-family home prices have risen 6% a year or more since 20111, and supply/demand forces point to further increases. But consumer budgets have limits. Some buyers are now spending around half of their income on housing.

Over time, rising home prices and interest rates should put pressure on either home price appreciation, consumer consumption or both. But near term, I think home prices can still go higher.

Here’s a look at the factors driving home prices and how higher housing costs are affecting consumers.

Housing Shortage, Higher Prices in Single-Family Homes

The US is short 7.3 million single-family homes according to some estimates,2 a major factor boosting prices. New construction remains far below pre-crisis levels, held back by land, labor and funding constraints. Demand for single-family homes is highest in a handful of densely populated cities, which have very little land to develop. Environmental and zoning regulations continue to tighten, making it more difficult to develop the land that is available. The nation’s pool of construction workers has shrunk since the housing bust, when years of inactivity drove many workers to abandon the construction industry. And construction is financed mostly through local banks, which cut back their construction lending after suffering large losses during the crisis. As a result, loans are harder to get, and interest rates are much higher. Meanwhile, population growth continues, exacerbating the shortage.

Higher labor and materials costs are also a factor. New construction supplies the market with additional homes when there is a shortage, so home prices are likely to grow at least at the rate of new construction inflation. Costs for construction materials rose significantly in 2017-2018.

Housing Costs Are A Heavy Burden for Many Consumers

Home buyers still need a place to live in this tight supply market, but many are at uncomfortable debt-to-income levels. House prices are increasing faster than incomes. And thanks to rising mortgage rates, borrower payment burdens are growing even faster than prices. With the recent rise in rates, roughly 10-20% of GSE borrowers3 have debt-to-income levels of 40% or more4, which is considered very stretched. When taxes are factored in to the calculation, these consumers are spending more than 50%5 of their post-tax income just to pay for housing (mortgage, taxes, insurance), which is likely unsustainable.