The economy is down, yet home prices are rising so fast. What’s going on? Will the housing market crash? Are we in a bubble? Or will home prices continue to rise and be out of reach for first-time buyers?
If you want to understand why home values are insanely fast, there are four shockingly simple reasons why. Find out:
- The correlation between the stimulus (AKA printed money), inflation, and home prices rising
- How low interest rates increased home prices (big time!)
- Why there’s a bidding frenzy and home buyers are putting in offers above asking price
- The impact of insanely high lumber prices (and why lumber rose by 250% this year)
1. The Correlation Between the Stimulus (AKA Printed Money), Inflation, and Home Prices Rising
First off, the stimulus checks aren’t from government savings, or money set aside for a crisis. The stimulus checks came from printed money. Think of printed money, like money growing on a tree.
Who doesn’t love money from the government hitting their bank account, from the Covid stimulus package, right? It’s free money! However, we all know nothing is free. There are costs of printing money.
Printed money leads to inflation and is one reason why home prices are rising so fast. Investopedia outlines a basic example of how this works. If you have a money supply of $10 and five houses worth $2 (with no other products or services in the economy) and the money supply increases to $20, then the home values rise to $4.
2. How low interest rates increased home prices (big time!)
When the pandemic hit, the second measure the government took to boost the economy is lowering interest rates. How does this work? The U.S. Central Bank manages the monetary systems by determining the Fed’s interest rate and currently the rate is near zero.
The low Fed rate led to lower interest rates for all banks. It initially seems confusing how low interest rates raise home prices, but it makes perfect sense.
Low interest rates encourage more people to borrow and buy a home.
This logically increases the demand for housing; more people to want buy now to lock down low interest rates. This increases the demand for homes, and when demand increases, the price increases too.
In addition to an increase in demand, low interest rates raise prices because you can borrow more. For example, a 30-year home loan of $330,000 with 4.5% interest the payment is $1,955. The mortgage payment of a 30-year loan of $400,000 with 2.75% interest is $1,961 (almost exactly the same).
Why not buy a bigger home in a better neighborhood for the same amount? The low cost of debt drives up home prices.
3. Home buyers are competing with investors (and causing a bidding frenzy)
The Wall Street Journal wrote an article titled, If You Sell a House These Days, the Buyer Might Be a Pension Fund. Investors are saturating the single-home market and beating individuals out in the bidding wars.
The article explained how real estate is becoming institutionalized. D.R. Horton, a home builder, recently built a 124 new home community and then sold the properties to Fundrise LLC, an online real-estate investing platform.
Then there’s another fuel to the flame coming with this trend of investors buying single-home properties.
Biden recently announced a proposal to change the 1031 Exchange. It’s a tax law that allows real estate investors to defer paying capital gains tax. Currently investors don’t pay taxes on gains from real estate sales if the gains immediately go into another property. The proposal will allow capital gains to be deferred only for gains $500,000 or less.
This would encourage large financial institutions to avoid investing in multi-million-dollar properties (where gains over $500,000 would be likely). Instead, investors would target even more single-family homes.
4. Insanely high lumber prices (and why lumber rose by 250% this year)
The last reason why home prices are rising so fast is the price of lumber. Recently, I went to buy wood for a RV DIY project (I currently live full-time in an RV and am renovating it!). I was shocked by outrageously high lumber prices!
Business Insider reported lumber prices increased by 250% in the last year. This increase raised the cost of a new single-home property by $24,000. The result is home builders are delaying new construction. The housing supply is low, and demand is high (with low interest rates), further pushing housing costs up.
Why did the price of lumber skyrocket?
The low interest rates and stay-at-home order caused a surge in people wanting to buy a new home in the suburbs. This increased the demand for lumber simultaneously when the supply of lumber decreased. Many lumber mills production factories were closed with the stay-at-home order and production halted.
If you were wondering why housing prices are rising so fast, hope these four shockingly simple reasons explain the current real estate market.