The U.S. Housing Market: High Demand, Low Supply, Rising Prices

Signs of a hot U.S. housing market are everywhere. The trend that started last summer has only accelerated in 2021: Americans are on the move. City dwellers with employers that suddenly allowed them to work from anywhere due to COVID-19 lockdowns are escaping to the suburbs or more exotic locations (with wi-fi). Other homeowners discovered that with the entire family confined in the house, they needed more space or closer proximity to family as they juggled work and homeschooling/childcare. This surge in demand is driving up the prices of existing homes as well as construction materials for new homes as demand far outstrips supply.

Home Sales Are Being Constrained by Lack of Inventory

In the last nine months, sales of both new and existing homes surged to levels not seen since the bursting of the housing bubble in 2006. The year-over-year comparison can be a bit misleading because we’re exactly one year out from the pandemic bottom. Yet April new home sales were up 11.5% from their pre-pandemic peak in January 2020, while April existing home sales were up 2.6% compared to their February 2020 pre-pandemic peak. Note that existing home sales peaked in October of last year and have fallen in the last three months due to bad winter weather in some parts of the country and the lack of supply.

The lack of available supply of homes for sale is one of the main factors driving the dynamics of today’s housing market. According to the National Association of Realtors (NAR), the inventory of existing homes for sale nationwide was 1.16 million in April, above the all-time low of 1.03 in January and February but still inadequate considering the current demand. In the NAR’s latest existing home sales release, the organization’s chief economist stated, "First-time buyers, in particular, are having trouble securing that first home for a multitude of reasons, including not enough affordable properties, competition with cash buyers, and properties leaving the market at such a rapid pace.”

The result is that competition for homes is keeping buyers from closing deals while at the same time driving up prices. According to a survey by the National Association of Home Builders (NAHB), in the first quarter of 2021, 45% of active home buyers cited being outbid when they make an offer on a house. Thirty-two percent of respondents couldn’t find a home at a price they could afford.

The surge in home prices has been staggering. According to NAR data, the median sales price of existing homes was $341,600 in April, up 19.1% compared to a year ago. The Northeast leads the rest of the country with 22.0% year-over-year growth, but we’re also seeing high house price inflation in the West (up 19.9%), South (up 15.8%), and Midwest (up 13.5%). The jump in home prices is occurring at a time when mortgage rates are coming off historic lows; the average interest rate on a 30-year mortgage is now just 3.0%, up from 2.65% in early January. Normally, low rates would boost housing affordability, but the rapid increase in prices is weakening buyers’ purchasing power.

Challenges for Home Builders

With a lack of available inventory, you would expect to see home builders respond by stepping up residential construction activity. While we are seeing a strong upward trend in housing starts, the numbers have been erratic in recent months, with starts slipping in April. Still, April’s annual rate of 1.57 million starts is well ahead of 2020’s 1.4 million starts. But supply is nowhere close to satisfying demand. A recent analysis by Freddie Mac estimates that as of the fourth quarter of 2020, the U.S. had a housing supply deficit of 3.8 million units. With housing starts running at an annual rate of 1.6 million units in the first quarter, it will take years to bridge the deficit. However, home builders face two key obstacles to ramping up production to meet demand: a lack of skilled employees and rising input prices.

As the country emerges from the worst days of the pandemic, employment in construction remains well below pre-pandemic levels. While 917,000 construction jobs have been added since April 2020’s dip, employment gains stalled in April this year and industry employment remains 2.6% below the February 2020 expansion peak. Not surprisingly, construction wages are rising. According to the latest data from the U.S. Bureau of Labor Statistics (BLS), average hourly earnings in the construction industry jumped 3.8% year over year in April. According to a recent study published by the Associated Builders and Contractors of America, the U.S. construction industry will need to add 430,000 new workers in 2021 to keep up with expected demand.

At the same time, home builders face soaring product input prices. The BLS reports a producer price index (PPI) that measures the price of goods inputs to all construction; this index jumped 2.0% in April compared to March and 19.1% compared to a year ago. The futures market provides a real-time glimpse of what is happening to the prices of individual construction inputs. Copper futures prices have more than doubled since the end of March 2020; at the same time, steel futures prices are up by over 200% and lumber prices are up nearly 400%.

The NAHB estimates that the 12-month increase in lumber prices has added nearly $36,000 to the price of a new single-family home. This doesn’t appear to be hurting the large home builders. Three of the biggest national home builders, PulteGroup, Toll Brothers, and D.R. Horton, all reported strong revenue growth in their latest earnings reports. PulteGroup reported 17.1% year-over-year growth in home sale revenues for the March 2021 quarter while D.R. Horton saw sales soar by 43.3% for the comparable quarter. Just this week, Toll Brothers reported that home sale revenues for the April 2021 quarter jumped by 21.1%.

However, anecdotal evidence suggests that smaller builders are feeling the pinch of higher prices. Many builders with limited pricing power are being forced to absorb the higher input prices while many are including price escalation clauses in their contracts.

Conclusion

As anyone participating in the U.S. housing market right now can attest, it is a seller’s market. Houses are being snapped as fast as they are listed, often well above the asking price, leading to a surge in prices. At the same time, new home construction faces surging input prices that are dampening home building activity. As the law of supply and demand takes hold of the housing market, it could be some time before we see a return to equilibrium.