U.S. Home Prices Surge Past 2005/2006 Housing Bubble Peaks
Over the past year, U.S. home prices have skyrocketed due to multiple factors such as record-low interest rates, a lack of available housing stock, and a robust economy bolstered by pandemic-related fiscal stimulus. The Case-Shiller Home Price Index recorded a 17% year-over-year increase in May 2021, surpassing the previous housing market peak of 15% in September 2005. Nationwide home prices are now 38% above their prior peak.
Many experts have expressed concerns that we’re witnessing a second housing bubble. While possible, the dynamics driving this cycle differ significantly from the 2005/2006 housing market surge. Back then, reckless lending practices and innovative financial products fueled the boom. In contrast, today’s lending environment remains aggressive but isn’t overly speculative. I haven't noticed a rash of reality TV shows about flipping houses and making quick fortunes like we did last time.
This current housing boom is rooted in basic supply-and-demand economics rather than speculative gambling. Supply is severely constrained, and demand remains high. The pandemic wreaked havoc on the economy—initially, uncertainty lingered, businesses paused expansion plans, workers were laid off, and spending slowed. Governments worldwide responded with generous fiscal stimulus packages to revive growth. Although successful, this intervention created a six-month period of subdued activity and output. Consequently, consumers are flush with cash while goods remain scarce, causing shortages across numerous sectors.
Source: Federal Reserve and Case-Shiller
Key Point: Home prices are 38% above the prior peak, with May 2021’s growth rate (+17%) exceeding the previous cycle’s peak growth rate (+15%).
Long-term home prices hinge on affordability—basically how much an average worker can afford monthly. Affordability depends on wages and interest rates (the cost of borrowing). Higher wages and lower interest rates boost what buyers can spend on mortgages (raising home prices), whereas lower wages and higher interest rates reduce that amount (lowering home prices).
Average wages increased by approximately +5% year-over-year in 2020, which falls short of the current home price gain of +17%. This disparity is unsustainable long-term—home prices cannot rise indefinitely without becoming unaffordable for marginal buyers. Either wages must grow faster, or home prices need to stabilize while wages catch up.
This Housing Boom Isn’t As Speculative—It’s Driven By Supply And Demand
Earlier this year, Emily Badger and Quoctrung Bui of the New York Times highlighted data from Altos Research showing a dramatic drop in available homes for sale. The inventory of condos, townhouses, and single-family homes hit its lowest point since Altos began tracking. In 2015/2016, inventory hovered around 1.0-1.2 million units, gradually declining until the pandemic struck. With economic uncertainty looming, builders paused projects and adopted a cautious “wait-and-see†approach. Today, inventory stands at 50% below normal levels—a significant housing shortage compared to historical norms.
Source: Altos Research
Key Insight: U.S. inventory of homes for sale is ~50% below normal levels as of August 2021.
Altos Research’s August update noted that tight supply trends are starting to ease. "This week we're seeing real estate inventory continue to climb and demand pulling back slightly, with more homes taking price reductions and fewer immediate sales," wrote Mike Simonsen. "Some things to note about our rising inventory levels: 2.5% in and of itself is not an alarming change. It’s pretty common. Inventory is still 50% below normal. My friend Ryan Lundquist, an appraiser in Sacramento, put it this way: ‘A car going 100 mph down the highway and you take your foot off the gas, is rapidly decelerating and it’s still going really really fast. Both things can be true at the same time.’ That’s really the right way to look at it."
Demand remains robust as the economy continues to absorb fiscal stimulus distributed during the pandemic’s peak. Rich Barton, Zillow Co-founder and CEO, stated on the company's second-quarter earnings call, "We believe there is strong durable support for the housing market. Historically, work and location have been inextricably linked. The pandemic has dramatically untied work from location for many, creating new flexibility by enabling people to optimize for work and location separately and simultaneously. Moving to big cities is no longer a requirement for many job seekers, and this shift will inevitably disperse talent and economic opportunities. This untethering of location from work holds deep implications for the future of work, life, and housing, what we’ve been calling the great reshuffling."
Rising Construction Material & Labor Costs
Input costs are surging, and inflation has returned—this is no secret if you frequent grocery stores or hardware shops. NAHBNow recently published an insightful piece on rising residential construction costs, noting that overall building costs have climbed 19% over the past 12 months. The year-to-date change in residential construction costs averaged below 2% between 2015 and 2020; however, in 2021, the year-to-date construction cost increased over 12% (19% year-over-year).
Source: NAHBNow and Bureau of Labor Statistics
Companies are witnessing their input prices soar, and for many, the increases are substantial. Bank of America compiled the chart below illustrating how frequently the word "inflation" appeared in company earnings calls. Second-quarter 2021 earnings saw a 1,100% year-over-year increase in mentions of "inflation."
Source: Bank of America Research
Key Point: Mentions of the word "inflation" during company earnings calls rose 1,100% year-over-year.
Homebuilders face rising input costs for building materials, along with shortages and shipping delays. Below is the percentage change between December 2019 and August 2021 for several key home construction inputs:
- Copper +56%
- Steel +44%
- Drywall +26%
- Lumber +17%
- Insulation +13%
- Asphalt +7%
- Labor +6%
Construction costs typically account for about 60% of a new home's price. When building material costs increase, this expense is passed along from builders to homebuyers (it can take 6-12 months for the full cost to be reflected due to contract pricing and delays).
The National Association of Home Builders released its 2020 New Home Construction Survey last year, categorizing various cost components involved in building a home. Construction costs represent about 60% of a new home's price—meaning shifts in construction costs have a meaningful impact on home prices over the medium and long term.
Source: NAHB Cost of New Home Construction Survey
Source: NAHB Cost Of New Home Construction Survey
Key Insight: Construction costs constitute the largest portion of a new home's price at ~60% of the purchase price. Builder profit margins typically range between 8-10%.
Our team at Equipment Radar developed a useful tool for modeling and forecasting how changes in construction costs can affect the price of a new home. Check out our Airtable Interactive Spreadsheet here.
Higher input costs will eventually push up the cost of new homes. It’s reasonable to assume a significant part of recent home price gains can be attributed to rising building material costs and replacement value. Home prices might stay elevated if construction costs remain high.
Residential Construction Stands To Gain
Construction firms and equipment dealers stand to benefit from the low national supply of homes available for sale. We’ll need more machinery and tools to address the inventory issue. Additionally, construction companies will seek to boost productivity through automation and technology investments amid labor shortages.
Conclusion
The robust price gains in home values may prove more persistent than those seen in the 2005/2006 cycle due to higher building costs and the scarcity of homes for sale. Home prices could plateau for some time—unlike the sharp decline witnessed in 2005/06, a similar downturn seems less probable. Lastly, the post-pandemic landscape has shifted—generous fiscal stimulus (government checks) will likely re-emerge at the first sign of a major slowdown.
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#construction #housing #transportation #inflation #real estate
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