No, We’re Not in a Bubble

Making sense of what’s going on in the red-hot housing market

Photo: Bob Sacha / Getty Images

Real estate. It’s on everyone’s minds. At least it certainly feels that way. Everywhere you turn, there’s an article about home prices soaring to record highs, a tweet about someone getting outbid on a home they offered 10% above ask, or a video trying to make sense of the market right now and if one should get involved. Anecdotes have prevailed in these uncertain times. It’s a bubble! Home prices have increased 25% in our market, and it’s going to pop like 2008. We’ve all heard or uttered these words in the past several months.

Theres talk of bubbles and crashes. There’s confusion. Dismay about whether younger folks will ever be able to afford a home. What’s going on?!

First, the housing market isn’t broken. It’s operating exactly in the way one would expect based on how it’s been structured. The system may be fundamentally broken, but the market is not. This gives me some level of confidence in saying that I don’t believe we’re in a housing bubble. Technical indicators don’t point to one, either. (Here’s to this paragraph aging like sour milk if we are in a bubble or going unnoticed if we’re not.)

So, if we’re not in a housing bubble, what exactly is happening? There are three prevailing themes, as I see them, that explain the state of the market.

Let’s break them down.

The macroeconomic view

Two factors are driving the housing market right now from a macroeconomic perspective: low interest rates and higher net worths (via savings and equities). Unprecedented liquidity from the federal government is also helping, but not to the extent that it can be pointed to as a key driver for prospective homebuyers, as the stimulus packages have been targeted toward basic infrastructure and assistance programs for lower-income groups.

At the beginning of the pandemic, the fed cut interest rates to help stimulate the economy and stabilize it from the systems shock of the coronavirus. It has maintained this stance in the year since and anticipates keeping rates low until 2023. With the fed introducing and standing by this aggressive policy, mortgage rates have been driven down to record lows, continuing a 30-year downward trend from the record-high rate of 18.61% in 1981.

Thirty-year fixed mortgage rates. Source: Freddy Mac & St. Louis Fed

Mortgage rates bottomed out around 2.65% in the beginning of January and rebounded slightly to 3.04% by mid-April. These are the lowest rates ever. What this means in real terms is that it’s almost free to borrow money for a home. For people who might have bought their first house in the early 1980s, they’re entering retirement with an opportunity to lock in a fixed rate 80% lower than what they got on their first homes. This can mean potentially hundreds of thousands of dollars saved in interest payments over the life of a mortgage. There may never be another time as good as this past year to lock in a low rate.

But low interest rates alone aren’t enough to incentivize people to take out mortgages. They also need more principal money as a down payment and reserve for future payments.

Enter savings and increased stock portfolios: Personal savings rates have spiked in the past year, ranging from 13% to 20% outside of the first months of lockdown. This has been double and, in some cases, triple the 7% to 8% saved since around 2011. What’s more, the S&P 500 increased by 18.4% in 2020 and is up another 11% so far in 2021. With more money being saved and investments yielding higher returns, the more there is to spend on homes.

Home improvements, space, and peer pressure: The social perspective

If this past year taught us anything about our homes, it’s that we looked to them in collective dissatisfaction. In the Before Times—when we weren’t spending 100% of our time at home—the tattered rug, peeling paint, or faulty air conditioning didn’t bother us as much. After a long day at the office, we were (mostly) happy plopping down on a couch whose springs had long since broken and to move from our work screens only to stare at our “good screens.”

But with the switch to remote work during the pandemic, that same tattered carpet looked dreadful as we peered over our bad screens, and the air-conditioning system’s malfunctions were unbearable in the summer months. With every member of the family camping out in different sections of the house or apartment, plotting offensive campaigns for the best places to work and lounge, the endless war for space needed to be rectified by treaty.

Could a new home solve the issues we’d all long since put off and offer the family a fresh start — specifically one with more space? We took to the internet to find out. Now Instagram, now YouTube! Now TikTok and Zillow! We turned our eyes with envy to see what gifts of housing others were receiving. We ogled at property in ways we never have before. Zillow saw 9.6 billion searches in 2020, an increase of 20% over 2019. Yes, maybe a new home could solve these issues that have been heightened by the pandemic.

Home sales skyrocketed in 2020 to levels not seen since before the Great Recession. Indeed, since the beginning of last summer, there have been more home sales than in any other time period since 1970 except for 2005–2008. Not only does this makes sense because of the increased desire for more space and improved housing, but it also tracks with how Americans view investing. While having more cash on hand from savings and proceeds from the growth of public equities is all well and good, a whopping 90% of Americans prefer their primary residence as an investment over the stock market. People are likely to move funds from savings and the stock market into their homes, because they believe this to be the best strategy.

Millennials, that oft-derided demographic who came of age in the wake of the Great Recession, have driven much of the demand for housing in this low rate, higher savings environment, as they were the group most affected by the 2008 financial calamity. Sensing that this may be their best chance at homeownership, they’ve poured into the market, adding millions to a demand curve that was already quite robust.

The housing market’s inherent supply-demand imbalance

But this demand has run up against a brick wall. As more people have entered the housing market, they’ve discovered what makes the U.S. system fundamentally broken: our supply-demand imbalance. We’re 4 million homes short of our demand. This will only increase as consumers’ savings accrue, interest rates remain low, and we build less.

The U.S. housing market is artificially suppressed through local zoning laws—specifically, single-family zoning. In a normal market, when demand for a parcel of land is high, price increases accompanying that demand can be offset by building more densely. For example, $5 million may be a prohibitively high for one family to spend on a home, but if a real estate developer is planning to build 100 units, those costs are spread far more easily across 100 families. But that’s not happening in the United States.

Row homes in D.C.’s Bloomingdale neighborhood. Source: Curbed DC

The land parcels that are the most desirable in cities—perhaps because they’re closest to jobs, transportation hubs, and parks and within walking distance to downtowns or a favorite mixed-use neighborhood—are locked in as the sole domain for homeowners. Regardless of whether or not those who move to cities prefer to live in a duplex, apartment building, or condominium tower, they’re restricted from doing so because these types of homes cannot legally be built. And so that $5 million cannot be put toward more intensive, affordable uses. This isn’t just happening in the suburbs, which historically has been associated with single-family zoning. Even major cities like Seattle, Charlotte, and San Jose dedicate 81%, 84%, and 94% of their land, respectively, to single-family zoning (SFZ).

This shortage would be difficult enough to overcome with zoning constraints alone. Unfortunately, construction has become almost prohibitively expensive due to rising materials costs and labor shortages. This means that in a historic housing shortage, we’re building at a slower rate than ever before. This isn’t just because of the pandemic: Construction costs were already untenable in 2019 — they’ve just become unsustainable now.

The cost of lumber has risen exponentially in the past year due to supply chain disruptions. Source: St. Louis Fed

Between the artificial suppression of homes through zoning and the difficulty to build new homes thanks to rising construction and labor costs, there is an alarmingly limited supply of housing. There are 40% fewer homes on the market this year than last year, leading to a record-low inventory level.

Record-low housing inventory, with fewer than 500,000 homes on the market. Source: St Louis Fed

With fewer homes on the market, there’s more competition. Effectively, a funnel has been created where only the wealthiest are able to filter through. As they elbow each other out for a diminishing supply of homes, they push prices up higher and higher. One example: escalating bidding wars, where wealthy prospective buyers are swooping in with all-cash offers above the asking price and waiving inspection altogether, making it nearly impossible for those hoping to buy with more conventional down payments and loans to even compete. The pace of these housing price increases can be jarring. Nationally, U.S. home prices rose at the highest levels in 15 years, the period just before the housing bubble popped in 2008.

Case-Shiller index shows that U.S. home prices have risen to historic levels. Source: St. Louis Fed

Those who can’t afford to compete in one neighborhood bounce out to the next, which forces people in that neighborhood who can’t afford to buy a home to bounce out to the next, and so on and so forth. When zoning codes are paired with lot-size minimums—regulations that restrict how small lots can be—those half-acres of land can stretch to be even larger once you bounce out to the inner suburbs. Eventually, people are forced to drive farther away from urban cores until they qualify for housing they can afford, which can be several hours of daily commuting time from downtown and other amenities. Supercommuters don’t drive three-plus hours to work because they really love cars—they’re victims of a broken system.

While the market looks a lot like 2005–2008 on the surface, the underlying fundamentals today are very different from back then. We are in a record-low interest rate environment, we’ve experienced unprecedented support via fiscal stimulus, and mortgage underwriting standards are far stronger than in the early 2000s, which has led to less leverage and reduced the likelihood that a pile of cards built on risky mortgages will collapse the economy.

The increase in home values is due to record-low housing inventory, record-high savings rates, record-low interest rates, and historically high demand, which has been augmented by an increased awareness (read: dissatisfaction) of our home life during the pandemic. This is no bubble. Sky-high home prices reflect the predictable outcome of a market that refuses to fix its supply-demand imbalance.

So, what should we do? Throw our hands up and tell younger people, “Tough luck. You’re priced out of your market. Uproot your entire life so you can afford a home”? Of course not. That’s absurd. We need to loosen zoning regulations to allow more homes to be built where more people want to live.

This is no bubble. Sky-high home prices reflect the predictable outcome of a market that refuses to fix its supply-demand imbalance.

This is the only way to fix a historically faulty housing market that has refused to believe increased home prices are a problem. Who can blame those who hold the levers to this system? In the past year alone, homeowners have collectively increased their equity by $1.5 trillion. We have to take decisions out of the hands of those who have a vested interest in prices increasing at the expense of all other segments of society.

Parabolic increase in value of owners’ equity in real estate. Source: St. Louis Fed

But there may be hope around the corner. President Biden’s American Jobs Plan Proposal would make meaningful strides. Jamelle Bouie, an opinion columnist for the New York Times, explains:

Biden wants $213 billion to “build, preserve and retrofit more than two million homes and commercial buildings,” according to the White House fact sheet on the plan. He would pair this with incentives and regulations to “eliminate state and local exclusionary zoning laws,” which raise the price of housing through strict limits on the amount of housing that can be built in the first place and the form homes take when they do get built.

This is a start. But only a start. We need to move away from a housing market that is structured such that when it operates correctly, the entire country interprets it as a bubble.

Homeownership and private property rights are among the most sacred values Americans hold. They are the bedrock of the dream that has been drilled into our heads since children. I don’t believe the fulfillment of an American dream should mean everyone being forced to buy a home, since that’s how we’ve arrived at a country ruled by single-family homes, but that’s for a different time. For now, we must make this dream as attainable as possible.

Break the restrictions to homeownership in the United States, and let the people live.

Passionate about cities and the potential to create better places at the intersection of Real Estate Development & Urban Planning. Twitter: @cobylefko

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