Why the Real Estate Market is So Hot
And Why Rising Interest Rates Won't Cause it to Crash
The real estate market is obviously very hot. In the last year, prices went up a full 14 percent and 45 percent of all listed houses were under contract within the first two weeks of being on the market. This is all but unheard of.
Between 2000 and 2020, home prices have more than doubled. And that’s with a massive real estate-driven financial crisis in the middle those two decades. As of March, 2022, the median price of a home is $408,100. Indeed, since the 2008 financial crisis, the big line has been going up at a pretty consistent pace.
In Jackson County, MO where I work (basically Kansas City), there was only 0.7 months of inventory on the market in February, 2022!
That means for every 10 houses sold in February, only seven were still available at the end of the month. For reference sake, a “balanced” market that favors neither buyers nor sellers is considered to be one with six months of inventory.
So, the market is hot. But why?
Why the Market is So Hot
There are several major reasons the market is hot. The first is simply inflation. As of March, 2022, the inflation rate was at 7.5 percent, the highest it has been since the early 80s.
This shouldn’t be surprising at all as the money printers have been going brrr like there’s no tomorrow. Here’s the Fed’s chart for the M3 Money Supply:
Since Covid came around at the beginning of 2020, something absurd, like 80 percent of all the money in circulation, has been printed. Quite obviously, this much additional money is going to lead to inflation.
So it makes perfect sense that housing would go up in price as with everything else. But it’s even more acute with housing as new money is typically created as debt. When the Fed engages in “quantitative easing” it is simply buying assets (usually bonds) with newly created money. And as it lowers interest rates or reserve requirements, banks will lend more. Each time a bank lends money it is engaged in fractional reserve banking (lending out more than its current cash reserves; usually at a ratio of about 10 to 1) and thereby pushing new money into the economy.
This creates something called a “Cantillon Effect.” Namely, those who get that money first buy at lower prices before the additional money has an inflationary effect. Because most new money is created through credit and most credit is used to buy assets (especially real estate) asset prices will go up before and more so than commodities and other such things.
Thus, the incredibly low interest rates of the last 15 years and endless quantitative easing has lit a fire under real estate prices since the Great Recession ended. Indeed, what we have seen should more accurately be called “housing inflation” than appreciation. But since housing prices are conveniently not a part of the consumer price index, they have had no effect on official inflation numbers.
In other words, people mistakenly thought that inflation was low until recently. It wasn’t. Inflation has been going on for a while now, but it has mostly been in assets and particularly in housing.
The Supply Crisis
Inflation and Cantillon Effects don’t explain it all, however. There’s also a major housing shortage in the United States that also traces itself back to the Great Recession of 2008.
Namely, they just didn’t build enough.
This chart that’s been making the rounds on social media should drive the point home.
After 2008, everyone was shell shocked. Banks didn’t want to lend on new construction because they took such big losses in that sector. The government wanted to regulate lending on new construction to death. Investors didn’t want to touch it. Many developers were bankrupt. Basically, no one wanted to build anything.
Between 2000 and 2007, there were over one million housing starts each year with over two million between 2005 and 2007. After the financial crisis, housing starts fell below 500,000. They didn’t get back to over a million until 2020 and then Covid hit and the lockdowns shut down and delayed construction for months on end.
All the while, the US population kept growing.
More people and less new housing equals a housing crisis.
Right now, Freddie Mac estimates there is a 3.8 million unit housing shortage, the largest ever recorded.
Economics 101: When demand exceeds supply, prices go up.
And then on top of that, when you throw in all the various supply shocks, particularly in lumber, and the labor shortage, it’s just going to make things all the worse as these added costs will get passed on to consumers.
What Does the Future Hold?
I can’t say for certain, of course. Economic predictions have an almost farcically poor track record. But rising interest rates and general affordability issues will likely cool the housing market.
That being said, it will take years to rectify this supply crisis and supply and demand remain undefeated. It’s almost impossible to see housing prices collapsing when demand outpaces supply as much as it does now.
Inflation is also likely to be with us for the foreseeable future, even with a few rate increases by the Fed. Housing should go up in price, at least nominally, for that reason alone. (Housing prices basically kept pace with inflation in the high-inflation decade of the 1970s.)
In addition, most of the NINJA loans and teaser rates from the 2000s that helped create the 2008 Financial Crisis are now, thankfully gone.
So while the real estate market might cool or even be pulled down with the rest of the economy if a general recession comes about, it’s highly unlikely the housing market will collapse. Indeed, it’s likely to continue rising, albeit at a slower pace.