The US housing market as of August 2021 is exhibiting all the signs of a seller’s market: low inventory, fewer days on market, and rising prices. These developments are causing many investors to wonder if the market is peaking and ask the question will housing prices drop in the last 5 months of 2021 and into 2022.
An examination of the current economic and political landscape indicates that the current rise in housing prices is only just beginning, and shows no signs of slowing down. In other words, housing prices will not be dropping anytime soon and in this article I’ll explain why.
3 Reasons Housing Prices Will Not Drop in the Near Future
There are a variety of reasons that I don’t believe housing prices will drop in the coming months, including high demand, low supply and the government adding fuel to fire.
#1 - Demand is High
The first economic factor to consider when determining if housing prices will drop is demand for housing. Currently, demand is very high.
Millennials are in the prime household formation years – ages 21 to 38 – and are starting to enter the housing market. At 82 million, this demographic cohort is the largest in the United States, and as they enter the housing market they will drive higher demand for housing and higher prices.
If that weren’t enough, there’s also pent-up demand from the Covid pandemic: All the people that would have bought houses in the last year and a half and have been sitting on the sidelines are now entering the housing market in force and are buying houses now.
Additionally institutional investors like Blackrock, Invitation Homes and other private equity firms are investing in real estate – both commercial and single-family homes. With the 10 year Treasury yielding only 1.5%, these firms need to find other investments where they can gain a higher return. Real estate offers cash flow, appreciation, principal pay-down and tax write-offs, which makes it an attractive alternative for capital that would normally go into bonds.
Low Interest Rates
Finally, interest rates are low and are expected to remain low for the foreseeable future. As noted in Barron’s magazine recently (Barron’s, July 19th 2021, page 23), the US currently has $28.5 trillion worth of accumulated debt: If interest rates rise by one percentage point, that adds $285 billion of interest expense to the budget deficit each year. The government has painted itself into a corner and has to keep rates low.
All these factors add up to strong demand for residential real estate in the foreseeable future.
#2 - Supply is Low
At the same time that demand is high, the supply of single-family housing is at an all-time low, which is another indication that housing prices will not drop.
According to the National Association of Realtors, the US single-family housing stock is too low by as much as six-million houses. This is due to the combination of stricter permitting requirements by local governments, scarcity of building materials and skilled workers, and the delay of new housing starts during the Covid pandemic.
#3 - The Government is Adding Fuel to the Fire
High demand and low supply is a formula for increasing housing prices, but if that weren’t enough the government is exacerbating these trends in two ways.
The federal government is currently planning to spend $1 trillion or more on an infrastructure bill for improving bridges, highways, airports and other key infrastructure. This means that there will be increased demand for building materials like lumber, concrete, copper as well as skilled labor.
Homebuilders today are finding it difficult to find sufficient building materials and are paying more for the materials they get, but by this time next year those builders will be competing with the federal government for those resources and for workers – and the federal government has deep pockets. We can expect the cost of building to go up – and new home prices with them.
Additionally, the federal government’s printing of trillions of dollars in the last year is expected to result in inflation. Inflation is good for real estate investors because it causes rents and property values to go up while fixed mortgages can be paid off in inflated dollars. But inflation also results in higher housing purchase costs.
Caveats - 3 Reasons Why Housing Prices Could Drop
As prudent investors, we always have to ask “what could mess up this thesis?” What factors out there might cause housing prices to drop? Here are the ones I could think of.
#1 - The End of Loan Forbearance
One possibility is the expiration of mortgage loan forbearance programs on September 30. That could potentially result in a spike in foreclosures. Personally, I don’t see that as very likely because no one – the federal government, the banks, consumers – wants a repeat of 2008. If the end of forbearance programs shows any spike in foreclosures, the banks or the government will extend the program to soften the impact.
#2 - Fed Purchases of Mortgage-Backed Securities (MBS)
Another wildcard is if the Fed stops buying mortgage-backed securities. The Fed currently buys $40 billion of mortgage-backed securities per-month to provide capital for Fannie Mae and Freddie Mac. Economists think that that subsidy is no longer necessary, and that the Fed can stop its bond purchases. Theoretically, that might lead to a shortage of capital available to finance home buying, however most economists believe that there is so much private money out there looking for yield that there’s ample capital out there to replace the Fed’s buying.
#3 - All Real Estate is Local
Finally, it’s worth repeating that all real estate is local. Though housing prices are likely to increase on a national level, anything can happen at a local level. Local supply and demand dynamics could make housing prices go down in any specific local market. Rising home prices nationally doesn’t necessarily mean rising home prices in your neighborhood.
Given the current economic and political landscape, the chance of housing prices dropping is pretty unlikely – in almost all markets, housing prices are likely to keep rising. The combination of high demand, low supply and the actions of the federal government are creating a “perfect storm” for rising housing prices.
Investors sitting on the sidelines waiting for a correction are likely to miss out on much appreciation. As the old adage says “don’t wait to buy real estate, buy real estate and wait!”