MONEY THOUGHT:

Home Prices & Snoop Dogg: Both Sky High… and Rational?

Let’s talk about what home prices and Snoop Dogg have in common: they’re both sky high but still, somehow, surprisingly rational. I know a lot of people see home prices and definitely don’t think “rational”. But it’s true. Today’s residential real estate costs actually make sense if you know where to look.

In order to find the root of the soaring home price problem, we must first travel back to the housing bubble of 2007.

Before that whole Jenga tower of bad mortgages came crashing down, the construction industry was going absolutely bananas trying to build houses. But once the dust settled and it became clear that building homes for people who couldn’t afford to pay the loans back was a terrible business plan, the number of companies registered to build homes fell 50%. 

Like most human reactions, this caused the pendulum to swing too far in the wrong direction and the US hasn’t been building enough new houses since.

In a perfect world, new home construction would roughly follow the pace of new household formation.

But that hasn’t been happening. The housing experts at Freddie Mac estimate the US is about 3.8 million housing units short for its household formation since 2007.

Not building enough houses also means there haven’t been enough jobs for skilled construction workers to enter into. The industry is facing a worker shortage that no amount of fancy-shmancy AI will ever solve. This slows down construction of new units. 

The shortage creates a classic Econ 101 supply-demand case study. When there is not enough supply to meet demand, the market raises prices until enough people drop out of the bottom.

A lot of what we’re seeing in home prices is a Hunger Games fight for shelter. 

While the supply stays low, demand continues to grow. Millennials are the largest generation to date in US history. The pop of the housing bubble rippled out through the economy and slowed Millennial adulthood by a few years, but now the generation is catching up to the traditional milestone of homeownership.

Rather than living with their parents or with roommates, Millennials are moving out and trying to move up. 

Typically, we would expect the aging generation (yes, I am looking at you, Boomers) to transition from a single-family home into a smaller unit. But Boomers are healthier and wealthier and see no reason to give up their space. It’s led to a trend of “aging in place” that further constrains home supply.

Then there’s rising interest rates. 

The Federal Reserve uses interest rates to control the US economy. They set the base rate for any kind of borrowing. When the rate is low, it’s easier to borrow money and, subsequently, easier to buy. Raising that rate makes borrowing money a bit harder, thus slowing down spending, and slowing down the economy.

Despite a lot of people feeling differently, the economy as a whole has been doing pretty great. This has caused the money nerds at the Federal Reserve to raise the base interest rate from the rock bottom depths it’s languished in for the past decade as a way to gently pump the brakes. Raising the base rate has caused the average mortgage interest rate to rise from its unheard of low to a more historically normal 7%-ish.

In addition to the unemployment mentioned above, the construction workforce also has an aging problem.

Older workers typically demand higher wages for their skill.

When there are a lot of job openings, a worker has even more leverage to make bank.

These higher wages flow directly into the home’s price tag.

In a normal market, rising rates would push prices down. It’s a reaction to the higher monthly cost a borrower needs to cover the higher interest. But the supply problem is overriding that. So we’re seeing more expensive houses with higher monthly payments.

Homeowners who may have moved into a differently sized home feel caged in by a low mortgage rate. They can’t make a move without hurting their financial picture. So the market grinds to a further halt.

As a result of this perfect storm, the median price for a house sold in the last three months of 2023 was $417,000. Almost $100k higher than it was in the beginning of 2020. In order to finance that jump at today’s higher mortgage rates, a household needs to earn 80% more than they did in 2020.

I don’t know anyone who’s gotten an 80% raise in the past 3 years. The average income raise has been 23% (honestly, even that number feels high). 

There are no quick fixes to this housing problem.

Owning a home has traditionally been one of the best ways to build wealth. We’re awful at saving for ourselves, but paying a mortgage is saving masquerading as a bill. Each month a little bit more money is put towards your principle and raises your net worth. And that doesn’t even consider that the property’s value is likely to go up. 

So if we can’t magically fix the supply, what can we do to control house prices?

We could take an ax to the costs around buying a house. Which is exactly what a verdict late last October against the National Association of Realtors did. The case questioned the very questionable standard practice of having a home seller pay the commission for boththeir selling agent and the buyer’s agent.

Why should the seller have to pay for the buyer’s agent?

Especially when that amount is 5-6% of the selling price and can encourage agents to steer their buyers towards more expensive homes for a higher commission. The hope is that we-the-people will be better able to negotiate with real estate agents, which will both bring down the transaction part of buying a home and pull the price down. It’s a tiny change, but at least it’s an improvement.

Any improvement is necessary as more Millennials age into wanting a home. It’s important that Americans have access to buying a home. Even though building enough cash for a downpayment is hard, once that purchase is completed, a homeowner knows their monthly payment is pretty much locked-in for as long as they’ll live there. Renting will always face the risk of rising costs. But a homeowner gets a sense of security. The benefit of that surety is just as impactful as the wealth building. 

Buying a home isn’t the answer for everyone. But it needs to be an option. Until the housing supply chain gets unraveled, expect to see eye-popping price tags.

Home prices aren’t in a bubble, but it’s still not great.

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Wisconsin CERTIFIED FINANCIAL PLANNER™ professional and educator Sarah Paulson

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CERTIFIED FINANCIAL PLANNER

Although I’m a born-and-raised Wisconsinite – living in Appleton, Wisconsin –

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True story: once when going through international customs in Amsterdam, the officers asked why they couldn’t find a Dutch residency permit in my American passport.

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