As an investor, you should absolutely keep an eye on housing prices in your market. However, it's also important to consider how and why housing prices have changed over time.
Here's a guide to why houses are so expensive. You'll learn how housing prices have changed from a historical perspective, what's causing housing prices to rise, and the impact rising housing prices will have on you as you add more properties to your portfolio.
The price of housing, from a historical perspective
There's no denying the price of housing has shot up over time. According to data from the U.S. Census Bureau, the average price of a single-family home in 1940 was just $2,938. Even when adjusted for inflation, that figure only reaches $30,600.
Since then, the price of housing has risen dramatically. For example, the Federal Reserve Bank of St. Louis did a study on housing prices and found in 2000, the median price of a single-family home was $165,300. Twenty years later, that number has reached $324,900.
At the same time, housing prices have long outpaced wage growth. According to data by the Pew Research Center, wages now grow at an average rate of 2% to 3% per year. However, during the 1970s and 1980s, it wasn't uncommon for wages to rise at a rate of 8% or 9% per year. In today's economy, the highest wage growth also typically goes to the highest earners.
All this has led to concerns over housing affordability, especially for those at the bottom of the earning scale, for whom expensive housing is more of a stretch. According to the most recent State of the Nation's Housing report for 2019 from the Joint Center for Housing Studies at Harvard University, the ratio of median home price to median household income in the U.S. was 4.1, meaning the median price of housing is over four times greater than the median income. That said, this figure varies depending on the market.
What's causing rising housing prices?
Explains Rhea Thomas, senior economist at Wilmington Trust in Philadelphia: "It's a supply and demand issue. We're in a spot today where demand is very high and supply is very low, which drives prices even higher."
For context on how the supply and demand issue came to be, she points to five key factors that have affected housing costs in recent years.
An increase in local zoning laws
While local zoning regulations are often important for public safety, an unpleasant side effect of increasing regulation is increased housing prices in a given area. Whether it's restrictions on where housing can be built, which lowers housing density and overall supply of available homes, or specific permit requirements that drive up the cost of building and disincentivize new construction, Thomas says local zoning laws are often to blame for limited housing supply.
Thomas also points out this is a major driver behind the enormous growth of property prices in major cities like San Francisco and New York City, which often puts home ownership out of reach for many workers in those areas.
Higher construction costs
When discussing limited supply, another factor is higher construction costs. Aside from the permitting issues mentioned above, the political climate and particularly any existing tariffs on construction materials undoubtedly play a role in contributing to today's housing prices.
In large part, the fact tariffs on Chinese goods, including metals and finished materials like flooring and wall panels, were raised from 10% to 25% under the current administration is part of the reason we've seen such a limited supply of housing in recent years. However, before that, the Canadian tariff on lumber was a large contributor, Thomas says.
Lack of builder confidence
The last big influencing factor Thomas mentions regarding limited supply is a general lack of builder confidence as a result of the last recession. She explains that, in the wake of the 2007 housing crisis, many builders took huge losses on new construction communities that were built before the crash and subsequently couldn't be filled.
As a result, builder confidence has waned across the industry. According to data from Trading Economics, the rate of new housing sales declined sharply during the years of the financial crisis. Although they've been climbing back since then, the numbers have yet to reach what they were before the crash.
Lower interest rates
On the demand side, Thomas points to historically low mortgage rates as a major factor driving many people to buy. When interest rates are low, more people can afford to buy homes and start flooding the housing market. Although rates are at record lows right now, Thomas notes they have continuously been declining since their peak in the 1980s.
Changing demographics
Lastly, Thomas believes changing demographics are part of the reason we're seeing an increased demand. In particular, Thomas says the coming of age of the millennial generation is a major factor, and the data seems to agree. According to the most recent Home Buyers and Sellers Generational Trends Report by the National Association of Realtors (NAR), millennials currently make up the largest market share of homebuyers (38%).
How do rising housing prices impact investors?
So how do rising home prices impact investors? We've laid out some of the impacts below. Be sure to consider these factors when adding another property to your portfolio.
Higher demand requires a higher overall cost
First, when there's more demand for housing, you'll pay a higher price than in a down market. More buyers will be in the market for homes, which is likely to drive up prices.
Be prepared to pay higher prices with all that entails, including a higher mortgage payment if you're financing. However, as an investor, do the math to ensure you don't end up losing money.
Appreciation brings higher returns, but it's not guaranteed
Investors may also benefit from rising housing prices when it comes time to use an exit strategy. After all, an appreciating property value is bound to bring you higher returns.
But appreciation is not necessarily guaranteed. Before the 2007 housing crisis, many people thought the value of housing could only appreciate over time, but that's obviously not always the case. You'll also need to have an alternative exit strategy in mind if your property doesn't appreciate in the future.
The Millionacres bottom line
In today's economy, housing is very expensive and, if the current growth rate continues, it only stands to increase in price. As an investor, you must take that into account as you build your portfolio. With that in mind, use this information to help guide your investment decisions.
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November 04, 2020 at 09:00PM
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Why Are Houses So Expensive? An Investor's Guide to Housing Prices in the U.S. - Motley Fool
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