My Head And My Gut Are At Odds On This Housing Market

I have been selling homes in Tallahassee for the past 31 years, and I have never seen market conditions as they exist today, so I am going to share my internal conflict with the hope that you will be enlightened to make a better, measured decision when it comes to buying and selling a home.

In fact, I will make you a promise right now. You read this post through to the end so that you get both what I’m thinking as well as what I’m feeling, and you will understand the housing market better than most people on this planet. You won’t have all the answers, but none of us do. You’ll have the facts, my interpretation of those facts, and some conflicting feelings that I’m working through too.

This post is different than my past housing market reports. In the past, I have shared charts, graphs, and my analysis of what is going on in housing, and in return, I’ve received good feedback.

Readers looking for sensationalism will be disappointed by my well-supported arguments backed by facts. For those looking to read that the housing market is in great shape, you too will be disappointed. But I promise you this: Follow me to the end, and nobody will have a better grasp of where this market is headed than you!

I think the signs in the housing market are loud and clear, yet most real estate reports I read or view are missing the most critical factor in housing today. In fact, so many “real estate experts” are ignoring the strongest misalignment in housing in the past 80 years that it has me second-guessing myself. 

This caused me to produce this article to share my internal conflict with you, as I think it will give you a more complete perspective of today’s troubled housing market. On the one hand, home prices have soared at unsustainable, double-digit appreciation rates for more than two years, so everybody is claiming home prices must fall … What goes up, must come down? On the other hand, we are facing a historic low for the number of available homes to purchase or rent, meaning we should expect prices and rents to rise!

So this is my conundrum with the housing market conditions right now. My "gut" tells me we have to see home prices return towards a more affordable level, but my "mind" gets stuck on the metrics that all but guarantee further house price appreciation for the foreseeable future.

Follow along as I share key statistics and data, as well as my conflicting feelings so that you gain the best advice available for making a decision in the housing market today.

My Gut Feelings About Home Prices

I will confess that my gut feeling is that home prices should come down solely because they have exploded higher in a market fueled by historically low mortgage interest rates, and those rates are now gone. Today's mortgage interest rates are well below the fifty-year average, but they are about double what they were just one year ago, resulting in sticker shock for buyers.

On top of high mortgage interest rates is the fact that home prices have moved 44% higher in just the past two and one-half years. Historically, it would have taken eight years for home prices to move that high, meaning the prices we are seeing today are the prices we would have expected in the year 2030 had the market followed its normal value progression.

So naturally, my gut is telling me that the market is overpriced; who wants to pay 2030 prices today?

Nonetheless, I know that my gut feelings are fueled by my (still) raw memories of 2006, when home prices started coming down after rising rapidly for several years. Unfortunately, today feels a lot like 2006. Were it not for all the research I do, I would be standing on a soap box right now, screaming that we are ready to see the new housing bubble burst.

But this is where my gut feelings end, and my research and experience kick in.

Recency Bias Influences "The Gut"

First, I blame much of my professional "gut feelings" on recency bias. In case you have never heard of this term, "Recency bias" is a natural habit of favoring or valuing recent events over historical ones. In simple terms, we often give greater importance to the most recent events in our lives.

Recency bias explains why my memory of 2006 could convince me that today's market is just like 2006, allowing me to ignore more than 100 previous years of housing market statistics solely because I was in the market when it all went wrong 15 years ago.

So how do I form a professional opinion on future home prices while ignoring the attraction of recency bias? Well, when I keep emotion out of the process, I simply study the supply and demand for homes. The process is the same whether I'm doing it locally or at the national level, and today's report uses data from the US housing market.

Supply And Demand For US Housing

So let's take a look at the current supply and demand dynamic for homes in the US. 

The results could be very different in a small number of local markets. But I regularly interact with agents across the US, and the majority of them continue to report near historic low levels of housing inventory, rising home prices, and rising rents.

The blue bars in this graph measure the supply of homes for sale each month in the US, while the red line calculates the months of supply of homes. The dashed-gray line measures the one-year trend of the months of supply, and right now the supply of homes has slightly moved above the all-time low.

Here is what you must understand about the supply and demand for homes today. Number one, the number of homes on the market remains near an all-time low, and number 2, the year-over-year supply of homes for sale actually rose in June.

That's right, and this is big news, the month of June was the first month that the year-over-year supply of homes rose higher since May of 2019, ending more than three straight years of declining inventory. In the past, I have always told readers I would announce market changes, and for the housing market to become oversupplied, we first had to see supply start to rise. It finally has. But this is just possibly the first very small step.

To put today’s supply of homes into perspective, let’s compare June’s supply with the supply of homes recorded during the months of June in past years:

• 1 Year Ago - Up 2.4%
• 2 Years Ago - Down 18.2%
• 3 Years Ago - Down 34.4%
• 4 Years Ago - Down 34.7%
• 5 Years Ago - Down 35.1%
• 6 Years Ago - Down 40.3%

These comparisons show just how low today’s supply of homes for sale is compared with what we’ve seen in the past. In fact, the number of homes on the market in the US today is just barely more than the fewest recorded in the past 30+ years.

Today’s historically low supply is toxic, as our population has grown more than 35% since 1990, so one would expect that the number of people moving around today’s larger population would be higher than the number moving around in the past when the population was much smaller.

So while my gut is feeling that home prices should drop, my mind is taking in the data and seeing such a large supply imbalance that I'm wondering how prices can fall. Even if demand is cut in half, the supply of homes would not be large enough to oversaturate the market. What can we do to reconcile the mind and the gut?

I have reached out to several PhDs specializing in urban planning and the housing market. I've been following their Twitter feeds, asking and receiving information regarding their thoughts, and I find that they differ in their conclusions. It's as if one of them is my mind, while the other is my gut!

While my gut is forecasting falling home prices, my mind needs somebody to answer this question: "how do we get falling home prices from historically-low inventory?"

Fortunately, it is simple to forecast home prices. First of all, you need to understand what causes home prices to fall. You don't need to be a math major to understand this, and you do not need to track the supply and demand for homes either. You only need to understand that home prices fall when too many people want to sell their homes at once. 

You might wonder, how many is "too many?" To a homeowner, “too many” is the number that makes their home undesirable at its current asking price. Mathematically, it is when the months of supply of homes for sale pushes above 6 months of supply.

132 Years Of US Home Prices

Historically, we have seen about six times the number of sellers in the market as buyers at any given time. That supply and demand dynamic measures at 6 months of supply of homes, and historically, we've seen homes appreciate more than 5% each year since World War II (more than 80 years).

There have been surprisingly few times that home prices have fallen, and extended price declines only occur after a big event. For example, in the past 100 years, home prices fell during the great depression, at the beginning of World War II, and during the great recession. There were two other singular years when home prices dropped, 1959 and 1991. In 1959, home prices fell 1/10th of a percent, while in 1991, home prices fell 1.3%. Otherwise, home prices rose.

Statistically, we should bet on home prices rising over time since we've seen declines in just 17% of the years since 1922. But looking at this graph, the recent surge in prices generates the gut feeling that something big is happening, and recency bias makes one expect home prices to plunge.

But look closely at the graph. Home prices soared in the 1940s, but rather than decline, home prices rose conservatively in the 1950s, with just 1959 posting a drop of one-tenth of one percent! Home prices soared in the 1970s and then rose conservatively in the 1980s and the 1990s (with the one-year exception of a 1.3% decline in 1991). So basically, we saw 1942 through 2006 (65 years) post home price gains with just two years posting losses (again, for .1% and 1.3%).

Simply put, home prices over those 63 years fell twice (that's 3.2% of the time), and each time it was a very minimal decline compared to the overall 5.2% average annual increase during the entire 81 years going back to 1941.

Imagine if in 1950, after the huge run-up in home prices, all the talking heads on YouTube (yeah, imagine there was a YouTube back in 1950) said that home prices were about to plunge. Instead, home prices continued to rise for 55 more years! And what if you followed that advice?

Would you have waited 60 years to buy a home? Would you have shouted out “I told you so” to all the dead YouTubers when home prices dropped in 2007? Avoiding any bias is why we have to pay attention to more than our gut when it comes to the housing market. Recency bias makes us want to forget the lessons that history teaches us.

History has provided a clear message: if I'm going to have an emotional gut opinion on home prices, I'll be right far more often than not if I expect prices to rise. But, of course, we don't have to rely on gut feelings; instead, we monitor the supply and demand for homes and look for the trigger that will cause supply to outpace demand. Let me repeat that. We need to look for the trigger that will cause supply to outpace demand.

Some viewers will say "rising mortgage interest rates," and my response will be ... yeah, that was my hunch too. But then I dug deeper. I found that more than 1/2 of the buyers in the market have a home to sell, so if we see buyers leave the market due to mortgage interest rates, then we'll see the supply of homes for sale drop too.

Currently, the supply of homes for sale and rent is near all-time lows, so I do not believe that the decline in buyers due to rising mortgage interest rates will move the needle enough to bring down home prices. Instead, we'll see buyers return to the market in another six to nine months after the "sticker shock" has worn off and new buyers are conditioned to the higher mortgage interest rates. Remember, high as they are, today’s rates are still well below the 50-year average.

I believe higher rates will impact the market with fewer bidding wars and a lowered appreciation rate. Home sellers will have to reduce their unrealistic expectations and price their homes correctly, but home values are not yet poised to fall. The median home price may decrease as the upper end cools much faster than the middle and lower housing market segments. As a result, the high-end skew will be greatly diminished.

Will Homebuilders Oversupply The Market?

So, if not falling demand due to rising mortgage interest rates, some might say it may be the homebuilders who finally gear up production and produce a bunch of homes to add to the supply side of the housing market. Heightened builder activity could cause the supply of homes for sale to outpace demand. 

My first thought is, I don't think so.

Normally, builders would step up production when demand moved higher than supply. For example, home builders were building feverishly from 2002 through 2008, and they didn’t lower production in time as a response to the decline. We all know what happened.

Since the bubble burst, homebuilders have been operating cautiously, producing at lower levels to avoid another bubble. In fact, builders have been so cautious that a huge hole in the supply side of the housing market has developed to where the US is short about 2.5 million homes.

This graph plots the number of new housing units completed each month with a blue dot. The blue line shows the 12-month average while the red line shows the ten-year average. Follow the red line; look how far it has dropped!

The US population has grown roughly 70% since 1968, yet we’re building fewer homes than we were back then? Does that make any sense to you? Is it any surprise there's nowhere to live for tenants and homebuyers today? Recently, our population growth percentage has slowed, but there is still growth. And each year, several hundred thousand homes are demolished, so builders need to bring enough homes for the additional people as well as the replacement for demolished homes. That just has not happened.

Homebuilders have struggled to bring homes to the market in recent years due to rising material costs, increases in wages, and the COVID supply chain disruption. With inflation rising, we know that builders will never again be able to produce homes at pre-COVID prices, meaning the bulk of homes needed cannot be produced by homebuilders today.

I keep a close eye on building permits, housing starts, and new housing completed, and I’ll be sure to let you know when I feel a major corner has been turned by builders. I’m just not buying into the hype on this yet. Right now, this year ranks at #16 out of the past 64 years for the number of new housing starts, so I’m not going to get too excited about an oversupply of new construction any time soon.

There are concerns that the large institutional investors of single-family homes will be shedding inventory because they fear falling home prices, but these concerns are being voiced by people who are not paying attention to the large investors involved in buying homes. Sure, Zillow stopped buying homes, but they held very few properties compared to other i-buyers and the overall market. Zillow holdings can only help the market when sold. We need them in the supply side.

The institutional investors are buying homes with the purpose of renting them (not flipping). Currently, institutional investors only own about 0.2 percent of all single-family homes, and just one percent of rental homes, according to recent data presented to the U.S. Senate by The Heritage Foundation. The Heritage Foundation also pointed out that in no state, do institutional investors own more than 1 in 100 of all available housing. 

But that does not mean institutional investors are irrelevant! Most Institutional home-buying investors seek long-term holdings because they know that rents are soaring and will continue to soar so long as homebuilder production is stalled. 

I would argue that Institutional Investors are more of a problem keeping us undersupplied than a threat to oversupplying the market. Rather than releasing the homes they have (which are needed), they are actually continuing to buy (which is increasing competition among buyers and forcing up prices). Who can compete with a hedge fund when haggling for a home?

Soaring US Rental Rates

One final hugely important point, the for-rent market is also grossly undersupplied.

This graph shows that the median rental rate in the US is out of control. The red line reveals that year-over-year rents have shown double-digit increases for the past twelve months. This is a clear sign that tenants are competing over too low inventory and they can expect no relief from an oversupplied for-sale market.

Think about how this affects current tenants and their monthly budgets. This is why you see institutional investors hot for the housing market, as they know inflation is here, building costs are moving higher, so homes are going to appreciate, but so too are rents. 

Historically, there has been a give-and-take relationship between the for-sale and for-rent markets. When one got over-supplied, homes were shifted to the other. This just won't be a solution any time soon. Both home prices and rental rates are soaring, and the only solution that I can see is more housing units being built to quell the need for homes, but they will be delivered at prices far higher than today's median home price.

You should know that the homelessness rate is rising too, and I've seen reports that in some US cities, there is a growth in people with jobs becoming homeless. I believe this rising homelessness rate is more evidence that homes are harder to obtain today, whether somebody is renting or buying.

So here's where my conflict rests. My gut feels that prices need to drop, but my market analysis is looking for the mechanism that swings the supply and demand dynamic towards an oversupplied market. The market can become oversupplied by increasing the number of homes, decreasing the number of buyers, or a combination of both. I have yet to find this mechanism of change.

So now it's your turn. I have shared my thoughts and what I'm feeling, so I'll turn it over to you. Don't be the knucklehead that says home prices have to drop (just because that's what you've heard or that's how you feel). Rather, share the mechanism that will cause home prices to fall. I've addressed homebuilders and institutional investors on the supply side, and mortgage interest rates and institutional investors on the demand side. What would you add to the equation?

Until I hear or find a logical way out of this, my conclusion remains the same. I do not fear home prices falling, instead, I fear them rising to levels where only the wealthy and institutional investors will be able to afford them. This could very well mean a huge decline in home ownership, soaring rents, and a large increase in the typical American's budget for housing.