I enjoy browsing through various social media platforms like Reddit and Twitter. It’s interesting to come across posts where people express their concerns about the high housing prices in the United States. Many of them believe that a housing market crash is on the horizon, hoping that it would enable them to enter the market at lower prices and become homeowners. Of course, they also anticipate their property value to increase over time. However, relying on timing the housing market is an unrealistic expectation. In fact, historical price trends indicate that real estate is a consistent and stable long-term investment. Moreover, there are several structural factors within the economy that currently exert upward pressure on housing prices. In this blog post, I’ll delve into these elements and explain why the idea of timing the housing market is essentially a futile endeavor.
Rent prices surge
In 2022, rent prices skyrocketed and continue to surge in many cities across the country, exerting a direct influence on home prices. One critical determinant of home prices is the capitalization rate, commonly referred to as the cap rate, of rental properties. The cap rate represents the ratio of net operating income to property value, serving as a measure of the return on investment for rental properties.
As rent prices climb, rental properties generate higher income, subsequently increasing their value. In order to maintain a consistent cap rate, property prices must also rise. Consequently, this dynamic applies upward pressure on home prices in the overall market, particularly for properties resembling rental units. Zillow data from the past year reveals an average rent increase of 4.1%, with only Austin and Las Vegas experiencing a decline in rents among major metropolitan areas.
Thus, rent hikes not only make homeownership more appealing to some renters but also elevate the value of rental properties, resulting in a surge in the market price for comparable homes.
Improving sentiment | Rising Prices, Increased Demand, and Favorable Outlook
The housing market is exhibiting signs of recovery in 2023, with prices on the rise throughout the country. Even areas that experienced declines in 2022, such as San Jose and San Francisco, are now witnessing a reversal of this trend, with prices steadily increasing. This can be observed in the Zillow Home Value Index visualization above. Although year-over-year values show mixed impacts on home prices, month-over-month data demonstrates consistent price appreciation across all measured metropolitan areas. This indicates a growing demand that surpasses the relatively limited housing supply, as homeowners hold onto their ultra-low rates from the pandemic. With a significant number of millennials entering their prime home-buying years, I anticipate a sustained demand in the housing market for the next decade, which will continue to exert pressure on prices unless there is a corresponding increase in new construction. Overall, the outlook for the housing market is positive, as more individuals are actively seeking to buy or sell their homes in the near future.
If you’re seeking a secure and dependable method to grow your wealth, real estate investment is worth considering. Unlike stocks or bonds, which can experience significant value fluctuations, housing prices have demonstrated remarkable stability over the long term. According to a study conducted by Yale economist Robert Shiller, there have been only two instances in the past century when national housing prices declined by double digits: during the Great Depression and the Great Financial Crisis. These were exceptional economic shocks that are unlikely to be repeated.
While securities like bonds have inflation risk, real estate is often regarded as a hedge against inflation. Real estate represents a tangible asset, and as price levels increase over time, homeowners can adjust their market rent to reflect changes in the cost of living. Furthermore, for homeowners with fixed-rate mortgages, the balance of their loans becomes relatively smaller compared to the new price levels, resulting in a financial gain. Let’s consider an example: Suppose a homeowner earns $250,000 annually, owns a $1 million property, and has made a 20% down payment. If inflation runs at a high rate of 10% in a year, the homeowner now possesses a property worth $1.1 million while the mortgage balance is below $800,000. Consequently, their home equity has increased from $200,000 to a value exceeding $300,000, and their $275,000 income is better equipped to handle mortgage payments.
However, there are concerns among economists and analysts that inflation may persistently remain at high levels, a phenomenon known as “sticky” inflation. Sticky inflation refers to a situation where inflation remains elevated for an extended period, even after the factors that initially caused it to rise have diminished. This could occur if inflation expectations become unanchored or if businesses and workers frequently adjust their prices and wages to keep up with inflation. Should we experience higher rates for an extended duration, existing homeowners with fixed-rate mortgages would benefit. Since the majority of US borrowers utilize 30-year fixed-rate mortgages rather than adjustable-rate mortgages (ARMs), sticky inflation is likely to work in favor of these homeowners.
In the past year, annual wages have witnessed growth, as indicated by sources like Demand Sage and other economic indicators. This rise in wages enables households to allocate more funds towards purchasing homes. As income increases, it exerts upward pressure on housing prices, especially in a market with limited supply due to homeowners holding onto low-interest-rate mortgages. The combination of increasing real wages and a restricted supply further intensifies the upward pressure on prices, surpassing the effects of inflation alone.
Furthermore, the current state of the US housing market reveals a severe shortage of supply, which will sustain high and ascending prices. The National Association of Realtors reports that in November 2022, there were only 1.25 million homes available for sale, marking the lowest level on record. Over the last 8 months since November, new listings have remained low limiting supply. Conversely, housing demand remains robust and continues to grow, driven by favorable demographics, and the increasing prevalence of remote work opportunities. This supply-demand imbalance ensures that housing will remain a valuable and resilient asset for years to come.
Housing prices are likely to appreciate for several reasons
- Timing the housing market is unrealistic: The idea of predicting and timing the housing market to take advantage of lower prices is debunked. Historical price trends indicate that real estate is a consistent and stable long-term investment.
- Rent prices influence home prices: The surge in rent prices directly affects the value of rental properties, creating upward pressure on home prices. Rent hikes not only make homeownership more appealing but also elevate the value of rental properties, driving up the market price for comparable homes.
- Positive outlook for the housing market: The housing market is showing signs of recovery, with prices rising throughout the country. Even areas that experienced declines in the past are witnessing a reversal of the trend. Growing demand, favorable demographics, and remote work opportunities contribute to the sustained demand in the housing market, keeping upward pressure on prices.
- Real estate as an inflation hedge: Real estate is often regarded as a hedge against inflation. As price levels increase over time, homeowners can adjust their market rent to reflect changes in the cost of living. Homeowners with fixed-rate mortgages also benefit as their loan balances become proportionally smaller compared to new price levels.
- Supply-demand imbalance: The US housing market faces a shortage of supply, with limited homes available for sale. This scarcity, coupled with robust housing demand, contributes to the sustainability and resilience of housing as a valuable asset.