By Dr. Uric Dufrene, Sanders Chair in Business and Professor of Finance, Indiana University Southeast
If you have been a recent buyer or seller for residential real estate, you were either very satisfied as a seller, or faced repeated disappointment as a buyer. Homes are frequently sold as soon as listed, and in some cases with competing multiple offers. Buyers may have to offer above the asking price just to be competitive, and still may find themselves with an unaccepted offer. Booming prices are the result of a classic supply and demand problem. Demand for housing is high, but the supply is perhaps at the lowest. There are early signs that conditions have begun to normalize but the emphasis is on “begun”. Before we get into the data, let me admit that I do not closely follow real estate. The article below is in the spirit of sharing information that may be of interest to you. Any errors are exclusively my own.
Nationally, the nation is facing a housing shortage due to underbuilding that started around 2000. According to a study published by the National Association of Realtors, the U.S. is facing a shortage of 5.5. million homes. Annual home starts have been running about 275,000 lower than the level that existed from 1968 to 2000, as also reported by the Wall Street Journal (U.S. Housing Market Needs 5.5 Million More Units, Says New Report, Nicole Friedman, June 16, 2021). The pandemic exacerbated this shortage with the plummeting of housing starts early in the pandemic. Construction shutdowns, rising commodity costs, and supply chain issues have all contributed to challenges in building. Moving past the pandemic, starts have rebounded since last year, and are now at levels higher than existed pre-pandemic. Even with higher starts, it takes time to build a home, especially with supply chain constraints facing contractors.
Strong demand and limited supply have produced record breaking changes in home prices. The median home price in the U.S. climbed to $350,000 in May 2021. This compares to a median home price of $310,700 in February 2020. The limited supply of homes, and record prices are beginning to have an impact on sales. The latest data show that existing home sales have been declining since December 2020, and new home sales since January 2021. Slowing sales will help build up inventories, and level the playing field between sellers and buyers. Nationally, inventory levels have been increasing since January, but remain about 320,000 homes under May 2020.
Locally, we are observing similar conditions. Inventories are down, but demand is up. This combination is producing higher prices. Harrison and Scott Counties are observing the highest year over year increases in median home prices, climbing 35.2% and 25.9% respectively, year over year from May 2020 to May 2021. The highest median home prices are in Clark and Harrison Counties, $229,950 and $229,900, respectively.
Some counties in Indiana are observing price increases significantly higher than the region. Franklin County, just south of Indianapolis, saw median home prices increase by 127% in May, year over year. Posey County, just west of Evansville, saw home prices increase by 117%. And in Blackford County, just north of Muncie, median prices increased by a whopping 171%!
Data from the Indiana Association of Realtors show that May inventories have been declining for three consecutive years, and inventories are down 48.2% from same time last year. Like the national data, home inventories have been gradually increasing since the beginning of the year but are still at extremely low levels.
On the supply side across the five counties of Southern Indiana, the data are fascinating. Total building permits are just under the level that existed in 2004, the boom in building that helped fuel the last housing crisis. However, unlike that time, multi-family permits are now driving the increase. In fact, it is almost a reversal from the period leading up to the Great Recession. In 2004, there were 1,549 total single- family permits; in 2020, the region generated 1,144 permits. In 2004, the region had a level of only 158 multi-family permits; in 2020, the number of multi-family permits stood at 576. The number of multi-family permits since 2018 exceeds all multi-family permits from 2004 to 2017!
To help demonstrate the supply issues, we can compare building permits from around 2004 to the most recent period. Three years prior to the Great Recession, the region generated a sum of 4,465 single family permits. Fast forward to three years around the pandemic recession, the region generated a total of 2,882 single family permits. This limited supply of homes, and excessive demand result in the higher prices we have been observing.
Will conditions ever return to normal? Yes, but it will take some time. Existing homeowners will list homes when there is confidence that an adequate pool of homes will be available for purchase, and the nation has moved past supply chain issues. This will support a higher inventory of homes available for sale. Higher prices have had an impact on existing inventories expanding, although at nominal incremental levels. As interest rates increase, this will also place headwinds to price increases, and soften demand. At some point, the Fed will begin to taper purchases of mortgage bonds, and this will help lift mortgage rates and remove oxygen out of rising home prices. On the commodity front, prices are beginning to fall, with lumber prices declining drastically. As supply chain issues normalize, new construction will also increase the supply of homes on the market.
While there are challenges to buyers and contractors, higher home prices help fuel consumer spending, the driver of the nation’s economy. Higher home values are building stronger household balance sheets, and household debt as a percentage of income has declined. Stronger household net worth, linked to home values and equity markets, along with elevated savings rates, will help sustain the strong recovery through the rest of 2021.
Data sources: Indiana Association of Realtors, FactSet, STATS Indiana