If you are trying to buy a home now you are facing a very competitive market. Homes are receiving multiple offers, often in cash, and frequently for tens of thousands of dollars above the asking price. For example, a home in our neighborhood was listed for $500,000 and sold for $650,000, a $150,000 premium above the asking price. In broader terms the median price of a U.S. single family home has risen from $165,300 in 2000 to $347,500 in early 2021 according to the Federal Reserve Bank of St. Louis.
The pace at which homes are sold is measured by the available inventory. In normal conditions a balanced real estate market has a little more than six months of inventory of homes for sale. The average now is below 54 days and some markets have an inventory of less than 30 days. Below are five reasons why home prices are rising so quickly along with some strategies to help you navigate this challenging market.
1. Limited Supply of Homes and Skilled Labor
The origin story for today's high home prices starts back in 2007-08 when the Global Financial Crisis saw real estate prices crater and some homebuilders went bankrupt. The builders that survived weathered years of low prices as the market slowly absorbed the excess supply of homes built during the bubble. The builders that survived remained cautious for years and were unwilling to risk major investments in large scale housing developments. At the same time many smaller builders and trades people left the real estate sector permanently. Some of this labor came from immigrants who returned home during the last real estate crash and have not returned.
Now that the real estate sector is stronger, the skilled labor is not available to expand supply. In addition, the home builders who are taking on projects find they can build fewer high end homes with higher profits on each unit. For home builders this approach has reduced their exposure to a broader slowdown in real estate prices as they are working with fewer price sensitive buyers. This trend over the last decade has led to a tremendous shortage of affordable homes.
2. Limited Supply of Building Materials
Just as construction firms were building fewer homes, a similar trend occurred among producers of building materials. These producers did not want to have a glut of supply so they reduced their output. As demand for housing has increased we are seeing a shortages of lumber, steel, and electrical supplies. This lack of available supply has led to a rise in prices which builders pass on to consumers which, in turn, pushes home prices higher.
Some of the reduced supply is due to expectations that the pandemic would reduce demand for building materials. However, the opposite happened and demand increased, and producers were caught unprepared. The supply problem will not be corrected quickly, it will take time to increase production, and the sector still remains cautions that we could see a slowing in the overall economy. Like homebuilders, the construction material suppliers have not forgotten the painful lessons learned during the Global Financial Crisis and are hesitant to overextend themselves again.
3. Rising Demand for Homes
As the economy recovered from the Global Financial Crisis demand for housing increased, fueled by lower unemployment rates and lower interest rates for mortgages making housing more affordable. Mortgage interest rates continue to remain at historic lows which makes borrowing money cheaper for buyers. Mortgage rates are unlikely to rise dramatically in the near term which would cool demand slightly.
When the COVID-19 pandemic spread in 2020 it quickly led to a recession and higher unemployment. Most home builders expected this recession to reduce demand for housing but the opposite occurred, as self-isolating households looked for larger homes and yards with space to spread out during quarantines. Another factor that is driving demand is Millennials are now entering the real estate market in sizable numbers which is further increasing demand for homes. Demand for homes is unlikely to decline in the near term which means prices will remain relatively high for at least the coming year.
4. Remote Working Drove Buyers Into Cheaper Markets
The ability to work remotely also helped shift demand to secondary cities where the overall cost of living, including housing, is cheaper. As workers with well paying jobs sold homes in expensive markets like New York and California they could buy far nicer homes in Florida and Idaho for a fraction of the price. Many were also buying with cash with allowed them to present sellers with highly competitive offers. It is unclear if these regional moves will be permanent as employers are still navigating future remote working rules, but even a modest number of relocations to smaller cities has been enough to drive up home prices.
5. Institutional Investors Are Buying Homes
After the Global Financial Crisis, the private equity firm Blackstone spent nearly $10 billion purchasing tens of thousands of single family homes across the United States. Many smaller scale investors followed a similar path of acquiring single family homes to turn into rental properties. Even though real estate prices have risen significantly over the last decade, many investors are still buying which crowds out traditional homebuyers. John Burns Real Estate consulting estimates 20 percent of all U.S. homes are being bought by investors and in certain key cities like Phoenix the rates can be has high as 30 percent. When you factor in the limited supply of available homes, you can see why traditional buyers feel out maneuvered by seasoned investors who can pay cash for properties or increase their offer to secure a sale. Sellers may also be more inclined to take an offer from a well resourced investor because they want the sale to go through.
Strategies for Buying in this Market
Homebuyers looking for relief will not find it in the coming months. Expect the supply of homes to remain low over next year or so, especially for entry level homes. Builders and materials will not be able to fill the current demand and buyers will continue to face competition from investors. Trying to buy a home in a hot market is frustrating especially for buyers who have lost on multiple bids and expect bidding wars on properties to continue. But, now is also the time to pause, and think strategically about your next steps to avoid making an expensive housing mistake.
Below are a few options to change your buying strategy and increase your chances of success. If you can't get your desired 3 bed and 2 bath property you might want to refocus to a 2 bed and 1 bath that has adequate land for you to build an addition later. In a hot market it can be cheaper to renovate a property especially if you can wait until after the bubble deflates and their are more contactors and building materials available to complete the work.
You may also find less competition for duplexes or three-plex units than single family homes. A multifamily property provides an income stream from other tenants to help you cover your housing expenses. The same rule applies if you can find a home that can be split into a separate unit such as a house that has a full basement with a kitchen, a legal bedroom, and bathroom. With some basic modifications you could turn this into a separate unit and generate rents. You may also be able to remodel a stand alone garage into an accessory dwelling unit to be a rental property.
Most important is to avoid getting swept up in the irrational nature of this housing bubble. Be careful overbidding on a property that you can't afford. As home prices appreciate your property taxes may also climb significantly, adding to your monthly expenses. Remember you make your money in real estate when you buy, not when you sell, so buy at a price that makes sense for the long term. Also be cautious about waiving a home inspection in order to get a property, as this could lead to some very expensive repairs after you move in. For more details on this topic see When to Avoid Buying Real Estate.
Renting May Be The Wise Choice
Also look at rents in the neighborhoods where you want to buy. You may find it is much cheaper to rent now than to buy. If you can rent a great home for $2,500 per month that would cost $7,500 per month to own, renting is the wise choice. If you want to secure a good deal with a landlord, offer a little more than the asking price for rent, and ask to sign a three year lease. This provides you with fixed housing expenses for the next three years and the market may cool during this period. Also, you may find better returns on real estate in another market, so rent where you want to live and buy in another market. This could be a great time to buy your future retirement home and renting it out over the next two decades. That way you are still building real estate equity while you are renting. Above all, be patient and make sure you are buying a home that you can afford.
If you want to know how the current real estate market compares to the market just before the 2007-08 crash see Real Estate: Comparing Today's Market to the 2007-08 Crash. If you are looking for more advice to understand real estate bubbles, see Six Signs of an Asset or Real Estate Bubble and for more information on real estate investing, please see Ten Things to Know About Real Estate Investing.
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