If you’re in the market for a new home, you’ve undoubtedly experienced the frustration of what realestate professionals call a “seller’s market.” By May, Zillow predicts homes will be worth 21.6% more on average than they were a year ago. Talk about feeling late to the party!
Given the recent explosion in prices, many would-be buyers feel anxious. Some feel that if they don’t buy now, they’ll miss even more appreciation. Others feel that they’re buying at prices they’ll regret in a few years.
Is this a bubble? Would it be smarter to wait until the housing market crashes and homes are cheap again?
Many homebuyers remember the housing crash of 2007-2012. Home prices rose so fast in the early 2000s that consumers came to depend on tapping a seemingly never-ending supply of home equity for anything they desired — from college tuition to home improvements.
The banking industry didn’t help matters. They allowed borrowers to access more equity than their home could possibly sell for and took the borrower’s word for it when they said they were good for the payments.
Greedy Wall Street investment bankers happily packaged up these loans and securitized them so pension funds and mutual fund investors could supply virtually unlimited demand for bad debt. Also attending the blame party was the federal government, which lazily stamped AAA ratings on these securities.
But as Tommy Boy taught us, marking something AAA doesn’t really matter if all you’re buying is a guaranteed piece of — well, you know. Everyone, from pension fund investors to Main Street investors, was left holding the bag when the “boxes marked guaranteed” hit the fan in 2008. Today’s homebuyers are understandably nervous watching home prices soar once again.
Is This Different?
At some point, housing prices will indeed drop, but to what degree and for how long is anybody’s guess.
Homebuyers should note that substantial and sustained drops in home prices are actually very rare. As shown in the chart below, the housing crisis in 2007-2012 was an anomaly, not a cyclical or routine occurrence.
This chart displays the growth rate of homes, not their prices. As you can see, the red line would have to get below the 0% return line for prices to actually drop in value. What’s more likely, in the short term, is for the rate of increase to drop, not the actual prices. And while this “crazy housing market” can’t last forever, it may very well be years or even decades before we see prices substantially drop across the board.
Why Are Prices Increasing?
The recent rise in home values makes perfect sense. The most fundamental law of economics has been conspicuously on display in the real estate market. There is simply too much demand compared to the available supply of homes.
As illustrated below, the pace at which homebuilders were building homes slowed significantly during the financial crisis. It didn’t ramp back up until around 2013. Even then, the pace building was nowhere near what it was during the early 2000s.
Home prices have steadily increased since 2013, and as displayed in the chart, the pandemic all but stopped homebuilders once again in early 2020. Meanwhile, the pandemic gave Americans time to sit in their homes and think about all the ways their living room no longer fit their new work-from-home lifestyle or any number of new family dynamics brought on by the stay-at-home revolution. When shopping for homes, buyers found very little inventory.
Buy Low, Sell High. Right?
We’ve all been told that buying when prices are high and selling when they’re low is the opposite of what we’re supposed to do. But when it comes to your home, it’s not just an investment. It’s your shelter, and it determines your family’s lifestyle.
If you are a home-flipper or real estate developer and want to wait for the next crash to make opportunistic bets, that’s probably a good strategy. But trying to time your next family home purchase is like waiting to have a baby until you think the best kindergarten teachers are moving to your town. It’s just not a feasible strategy.
Don’t confuse your stock market entry points with family and lifestyle changes that may necessitate a new home purchase. You shouldn’t be buying a home you don’t expect to live in for a minimum of five years anyway. The transaction costs of buying and selling just don’t support short-term moves. And over the long-term, you’re likely to recover any potential short-term price hiccups and still come out with your head well above water.
It’s also worth mentioning that if you’re selling a home to buy a new one, you’ll also be able to participate in the seller’s market, at least on the front end. To be fair, only those downsizing to a cheaper home will truly be able to capitalize on what’s going on here from a buy/sell pricing perspective. Good for them, but when it comes to the place you lay your head at night, the investment component tends to be a matter of luck and timing more often than a strategic win. And that’s okay!