Why home prices will continue to rise even as inventory recovers

Anyone out shopping for a house today will know that there are still very few homes for sale.

The housing market is just starting to emerge from some of the most depressed years in history. Inventory of both new and existing homes is finally increasing, but there’s suddenly something strange in the numbers: There seems to be too much new home supply.

But that figure is misleading due to unprecedented trends in today’s housing market — trends that can be traced back two decades to another unprecedented period in the housing market: the subprime mortgage boom.

All of this is why home prices, which tend to stabilize when supply is high, continue to rise.

According to the National Association of Home Builders (NAHB), there is currently a 4.4 month supply of homes for sale, including new and existing homes. Months of supply is a calculation commonly used in the market to measure how long it would take to sell all homes for sale at the current sales pace. A six month supply is considered a balanced market between buyers and sellers.

Supply was already low at the start of the decade, but the increased demand caused by the pandemic has pushed it to a record low of just two months’ supply at the start of 2021. The lack of homes for sale, combined with strong demand, has caused home prices to rise by more than 40% from pre-pandemic levels.

Now, supply is finally starting to recover, but the increase has been primarily in the new home market, not the existing home market. In fact, there is currently a nine-month supply of new homes available, nearly three times the supply of existing homes. New and existing home supplies typically are fairly close together. According to the NAHB, new homes now make up 30 percent of the total inventory, nearly double its historical share.

“June 2022 recorded the largest ever gap in months of new home supply (9.9) over months of existing single-family home supply (2.9),” NAHB chief economist Robert Dietz wrote. “This decoupling makes it clear that an assessment of current market inventory cannot be made by simply looking at either existing or new home inventory in isolation.”

This unusual trend was driven by both recent fluctuations in mortgage rates and the unprecedented disaster in the housing market that began two decades ago.

This housing market is different from other markets because of economic forces that are different from any other market. First, in 2005, the explosion of subprime mortgages and the trading frenzy of new financial products backed by those mortgages led to huge increases in home sales, home construction, and home prices.

Then that all came tumbling down, ushering in the worst foreclosure crisis since the Great Depression and the Great Recession that followed. Single-family housing starts plummeted from a peak of 1.7 million in 2005 to just 430,000 by 2011. By 2012, new homes made up just 6% of the total supply of homes for sale, and even in 2020, housing starts remained at just 990,000, down from the historical average of about 1.1 million.

Then the COVID-19 pandemic hit, during which consumer demand soared and mortgage rates hit record lows more than a dozen times, and homebuilders responded. Housing starts soared to 1.1 million in 2021. The Federal Reserve bailed out the economy, making home purchases significantly cheaper, and a new work-from-home culture had Americans on the move like never before. Suddenly, supply was sucked into a tornado of demand.

The current bizarre disparity between new and existing home supply is also due to the rollercoaster swings in mortgage rates, which plummeted to historic lows when the pandemic began, then soared to 20-year highs just two years later. Millions of borrowers are now uninspired to move because they had to refinance at rock bottom rates to get their 3% or 4% mortgage rates down to current rates of around 7%. This lock-in effect has caused new listings to dry up.

And homebuilders led the way. Homebuilders had already ramped up production in the first few years of the pandemic, and single-family home construction surged to more than 1.1 million in 2021, according to the U.S. Census, but then fell again when mortgage rates soared. Homebuilders have been able to keep sales high by lowering mortgage rates, but as of May of this year they were building at an annual pace of 992,000 homes.

Existing home listings improved slightly this spring as mortgage rates fell slightly, and through June, active listings were up 16.5% from a year ago, according to Redfin, but some of this increased supply was due to listings remaining on the market longer.

“The percentage of homes on the market for at least a month has increased year-over-year since March, when new listings accelerated, but demand from buyers has remained sluggish since 2022 as mortgage rates began to rise,” according to the Redfin report.

The existing home market has the smallest supply of homes in the $100,000 to $500,000 price range, according to the National Association of Realtors. That’s where most of today’s buyers are. Rising mortgage rates have buyers seeking cheaper homes.

But what’s interesting is that while supply is increasing at all price points, it’s increasing the most at the same low price points — meaning there isn’t enough supply. Homes are going into contracts as fast as they’re coming on the market.

For example, there is just a 2.7 month supply of homes between $100,000 and $250,000, but supply is up 19% year over year. Meanwhile, there is a 4.2 month supply of homes over $1 million, but supply is up just 5% year over year.

That explains why home prices have remained stubbornly high even as supply is improving: Prices in May, the most recent data available, were 4.9% higher than they will be in May 2023, according to CoreLogic. Price gains are starting to taper off slightly, but not in all regions.

“Markets where inventory remains well below pre-pandemic levels, such as the Northeast, have seen home price gains continue this spring,” said Thelma Hepp, chief economist at CoreLogic.

“Additionally, more affordable markets, such as the Midwest, have seen healthy price increases this spring.”

Hepp noted that in Florida and Texas, states that have seen larger increases in the supply of homes for sale, home prices are lower now than they were a year ago.

Analysts expect home prices to stabilize and mortgage rates to fall later this year, but it remains to be seen whether rates will actually fall and whether the imbalance in supply and demand will lead to lower home prices. Lower mortgage rates would certainly lead to a surge in demand, putting further pressure on supply and keeping home prices high.

“Certainly, inventory is rising and will continue to rise, especially as the lock-in effect of mortgage rates diminishes over the coming quarters. But current inventory levels continue to support new home construction and price appreciation across the country,” Dietz added.