In 2022, the expectation amongst all economist was that as the Federal Reserve increased the federal fund rate 500 basis points in just over 12 months. The resulting increase in mortgage rates (the 30-year increased from below 3.0% to almost 8.0%) would have a significant, negative impact on home sales making them too expensive for potential buyers to afford.

They were correct on the first part; home sales have declined. However, not for lack of buyers but instead because of substantially low inventory levels that are below consumer demand. Whether it is existing homes or new home construction (shown in the graph below), the supply simply does not meet the demand.

Reasons Driving the Stable Prices and Low Supply

As with most supply and demand equilibrium issues, there are many factors driving this dislocation.  Below are the primary drivers:

• Builders Weary of 2008 Over Supply – So many buildiers were negatively impacted by the 2008 housing crash that many are reluctant to get extended too far with the amount of land or housing inventory that they have on their balance sheet.

• Bank Tight Lending Standards – Another bi-product of the 2008 crash is that banks, because of regulators and new laws, have much tighter lending standards with buyers and with home builders.   

• The Building Costs are Greater than the Selling Price – The material and labor costs to build new homes as increased so much that it keeps pushing the market price of new homes higher, even to the point where they are unaffordable to most buyers.  This in turn limits how many new homes a builder is willing and able to build because they may not be profitable to build and sell.

• Historically Low Interest Rates – Many existing home owners might be interested in moving or buying a larger home but they currently have a 30 year mortage rate that is below 3.0% and if even they bought an equivalently priced home it would be much more expensive to own because of the higher rate they would have to pay.  This equations pushes them to stay put and not move, meaning one less house is for sale.  

Where do We Go from Here

The two ways to get out of this predicament. The first is for home builders to start building more homes. This option would drive a great deal of economic growth and would be a net positive.  This is the more likely option and is one of the reasons to be optimistic about the current economy. 

The other option is for the demand of new homes to be reduced and that would only occur if the economy was hit hard by a recession and many individuals lost their job.  This is the less likely option and for everyone’s sake we hopefully won’t go down this path.