Why Do Houses Cost So Much?

We often received questions about why housing costs are so high. This issue comes from people in different situations; first-time home buyers, people wanting to move up and people looking to sell and realizing it’s hard to find a new home. Let’s look at home prices and see if we can shed some light on this popular – and distressing – topic.  

Are Home Prices High?

First, are home prices high compared to other periods of time and adjusted for inflation? The short answer is “yes.” An NPR report states: “The average price of American homes, in real terms, is now the highest it’s ever been — even higher than the peak of the housing bubble in 2006 before it crashed 60% and bottomed out in 2012.”

What Is Causing Home Prices to Be High?

High Housing Costs Reason #1: Demand

Demand for new homes has been on an upward trend since 1991 and really took off starting in 2012.  The chart below shows monthly new home sales.

In the last year, new home sales spiked to a high in January 2021 and have now slowed. The U.S. Department of Housing and Urban Affairs (HUD) reports almost 1 million new homes were bought in January 2021 and only 708,000 were sold in July 2021. According to CNBC, inventory has come back from a low of 3.5 months last Fall to 6.3-month supply, near a normal housing inventory. However, some of the decrease in demand is due to high costs and low inventory. Many house hunters got discouraged and just gave up looking.

There are three factors causing the surge in demand.  

First, the COVID-19 pandemic caused a demand for more house space and many people discovered working remotely. Both factors caused many people to look for new homes, especially in the suburbs.

Second, there is a population shift occurring which affects the housing market.  According to Pew Research, as of July 1, 2019 millennials (ages 25 to 40 in 2021) are the largest living adult generation, surpassing Boomers as the largest populations group. The National Association of Realtors reports millennials make up the largest group of homebuyers (38%). As millennials age they move into the prime house buying stages of their lives (typically early to mid-30’s). This trend continues to put pressure on the housing market as millennials seek their first homes.

Third, low mortgage rates make home buying more affordable for new home buyers and people looking to move up. As you are probably aware, interest rates are at near record lows.

High Housing Costs Reason #2: Low Supply

Why is there a low supply of homes for sale?

First, home builders were hurt by the housing bubble in 2007—2009. As a result, they’ve been very cautious about building new homes ahead of demand Second, it takes time for houses to be built. Just when demand was increasing, the cost for land, labor and building materials skyrocketed due to the pandemic and supply chain issues. Finally, fewer existing homes are hitting the market. Some people are reluctant to sell because they fear they won’t be able to buy their next house. Also, government mortgage forbearance and foreclosure moratoriums may have disrupted the normal flow of existing homes coming into the market.

Summary and Looking Ahead

Home prices are high thanks to the twin forces of high demand and low supply. Basic economics dictate a commodity in short supply and in high demand is going to cost more compared to when supply and demand are more in balance.

What about future home prices? The increasing house inventory may provide some near-term relief to price increases and make it easier for buyers. Some sellers are now responding to lower buyer demand by reducing prices. For example, in Austin, Texas, one of the hot markets early in the year, housing values have dropped by 3% to 4% in the last month. According to an article on Forbes.com, other areas of the country are seeing a similar pattern, for example, Northern Virginia, Los Angeles, and Cape Cod.

However, longer term, it’s difficult to predict how housing supply and demand might change. A rise in interest rates to offset inflation will likely cause housing demand to lessen. However, the long-term housing supply issue has not been resolved.  Plus, the influx of new buyers is not going to end.  

According to Realtor Magazine, nine of the top ten average home prices in 10 years are expected to be in the West. Seven of the top ten most expensive cities to live in are also expected to be in the West. Cities like San Francisco, San Jose, Seattle, Los Angeles, and San Diego lead the way. Current high-cost cities in the East will also remain very expensive locations (Boston, New York, Washington, D.C.). Whereas midwestern and southern cities will remain relatively affordable. For example, in 10 years, the median home in Kansas City is expected to be $253,509 and the median price in Memphis is projected to be $148,368.

Our best guess is to expect home prices to remain relatively high due to continued demand and low inventory. Housing prices may not continue to grow at ridiculous recent rates, but a steady climb in house prices is a high probability. Keep in mind that while a primary residence adds to your net worth, you can’t eat a house. In other words, you will need to save for retirement and other goals to pay for living expenses like food, health care and recreation.