Housing inventory shortage - what drives supply and demand?

6 Replies

I would like to put my theory out for a test and see if you guys can shoot some holes into it.

Here it is:

1.) Real Estate Prices are mostly a function of supply and demand. There are some other factors that play into it short term like interest rates, elections, pandemics, speculation - but it seems to me they have only superficial short term impact, like throwing a rock into a wave. There are lots of examples: when interest rates were around 15% in the early 1980's people were buying houses and prices went even up despite the rates. When someone decides to buy a new house, it is usualy because of a life situation, a birth, a death, a marriage etc - they may hold off for a few months, but in the end they will buy/sell regardless of the external circumstances, because the decision is based on life events. In the end demand (and supply) override all other circumstances.

2.) Demand is mostly driven by demographics. Migration is an obvious factor, if more people move to a country or a city demand for housing goes up. Or down, if they move away. But that is usually a low single digit percentage, like 2% or 5%. Now we have Millennials entering the demand side and they are about 25% of the US population. 40% of all deals currently involve a Millennial. The oldest Millennials are now 38. There are many more to come and gen Z is right behind them. This dwarfts any demand change based on employment opportunities or other reasons for migration. And so far we have seen only the oldest Millennials buy, so it seems like this is the beginning of a tidal wave.

3.) Supply has two main sources: people dying and new construction. Migration is a third one, and is becomming a factor in super expensive cities like San Franciscon and NY as working from home opportunities grow. But not a factor for most of the country, certainly not for Milwaukee. If people move within town it's a net zero exchange to inventory. People tend to live longer and they like to age in place, so housing is not being vacated as it used to be. This is limiting supply of affordable homes. New construction is very expensive; in the Milwaukee market it is more then 2 times the median home price, so unavailable for most. The only option I see are high rise condo's for a reasonable cost, but that will take 5-10 years before significant volume is available. 

My conclusion: the inventory shortage is chronic - a huge wave driven by demographic demand and no real relief on the supply side. With 3 to 5 buyers for every seller and existing inventory being less than half of new construction we will continue to see prices (in the midwest at least) go up for years to come.

There you have it - what does everyone think? Where am I wrong and what am I overlooking?

 

I don't think you're wrong, I would just caution not to minimize the external forces that have a strong effect on supply and demand.

High enough interest rates will effectively kill any demand, since few individuals have the ability to purchase a house for cash.

Lack of government supported mortgages will effectively kill any demand, since relatively few individuals have the ability to overcome the banking objections (and interest rates) that would accompany loans that weren't federally backed.

Extreme local changes in desirability will effectively kill demand, such as the oil bust in Texas/Oklahoma in the 80s, the Rust Belt state declines in the 90s, etc.


There are other factors but those are some examples. You can have a very low supply of properties and still have no demand. I managed a town that hardly ever has any properties for sale, but when it does it has virtually no buyers because the area is so economically depressed. In fact, the local knowledge that there are essentially no buyers means that few people even bother putting their properties up for sale and instead turn them into rentals for Section 8 or simply abandon them and eventually they get torn down or repossessed for tax liens.

Originally posted by @JD Martin :

I don't think you're wrong, I would just caution not to minimize the external forces that have a strong effect on supply and demand.

High enough interest rates will effectively kill any demand, since few individuals have the ability to purchase a house for cash.

Lack of government supported mortgages will effectively kill any demand, since relatively few individuals have the ability to overcome the banking objections (and interest rates) that would accompany loans that weren't federally backed.

Extreme local changes in desirability will effectively kill demand, such as the oil bust in Texas/Oklahoma in the 80s, the Rust Belt state declines in the 90s, etc.


There are other factors but those are some examples. You can have a very low supply of properties and still have no demand. I managed a town that hardly ever has any properties for sale, but when it does it has virtually no buyers because the area is so economically depressed. In fact, the local knowledge that there are essentially no buyers means that few people even bother putting their properties up for sale and instead turn them into rentals for Section 8 or simply abandon them and eventually they get torn down or repossessed for tax liens.

I agree with the last part.  

 

Great post @Marcus Auerbach ! You bring up many valid points I’ve pondered on myself as I think about where the market is heading not only here in WI, but in general. One thing I would add to the demographic side of the discussion:

Yes, millennials and gen Z represent a large buying power moving forward. However, they are not prone to buying a home if it doesn’t make financial sense in their budget at the time, or they believe they are overspending for something that will take too long to see a return on. In a previous light, I worked as a financial advisor for several years and millennials did their homework. They researched, analyzed, asked questions, and almost undoubtedly asked for advice from their parents. All different parts of an equation you would think leads to making a home purchase a good decision. If external factors impact the metrics of a home purchase though, they will rent, as they will:

1. Look at rent to mortgage costs and wait to build their down payment nest egg if renting is cheaper

  a. This could result from interest rates being too high, leading them to invest money in the market or other vehicles

b. Continued nest egg saving to void the lost leader in buying a home with high interest rates; less amortization time, less money spent on interest

2. Wait until the market corrects if home prices are too high

     a. Overspending on a home now to see that bar take 10+ years increase and yield little return won’t click for many, as they aren’t buying their forever home with their first purchase, and in some cases, even their second

Overall, millennials and gen Z have so much buying power real estate will see the tidal wave you mentioned for years to come. It just depends when that wave crests every now and then and has to regenerate. But such is anything!

@JD Martin you are basically talking about a dying town, that is sad. We have seen that phenomenon earlier this year when seller would not list, because they thought the market is bad because of covid. That corrected itself after a few months and still is to some extend.

@Matthew Meunier interesting points - high rents are definitley one of the factors that motivate millennials to buy. I have not seen such low supply on the rental side in the last ten years as we have right now. If we get a vacancy we have it filled after one open house and multiple strong applications left.

Waiting until the market corrects itself - I hear that a lot on BP and from clients that is a concept I am pondering. The big question is: will it correct?? 

In many ways real estate is cheap. Relative affordability (% of income) is better than most of the time in the last 20 years, except 2010/2011 years. Existing homes are cheap compared to new construction. Milwaukee is cheap compared to many other similar cities. People say it is expensive, but that is quite subjective. 

When you look at long term housing price developments you can see the real estate prices are much more linear than the stock market - with the exception of the mortgage crash - there were no major downturns.

Another factor to consider is inflation. As we keep printing money it is actually surprising that the inflation is still as low as it is today. Ray Dalio has been pretty vocal about this the last few months. As the dollar is loosing value, the price of hard assets goes up measured in dollars.

Part of me wished to see another 2008; I would be much more prepared now to take advanatage of it, but I think that was a once in a life time opportunity.

@Marcus Auerbach I think the other things that are driving demand are mom and pop out of state investors, internet-based companies like roofstock.com, and hudge funds like SFR3.com (which is on the smaller size). I think it is very foreseeable that these companies own or facilitate purchasing of a large percent of the US housing stock. 

What do you think about government-backed housing programs like after WWII to build cheap affordable housing?  

@Michael Henry yes that's additional demand from investors, but the houses are then at least available as rental units. 

I think you are right. It will take political support - municipal zoning is a big one. We don't need any more 5acre per lot luxury subdivisions. What we need is 1/10 of an acre with city water and city sewer 30k lots to build 250k structures and retail for low 300k - and we will need thousands of them, which will take political will and a decade to materialize. But the goc does not even have to build it, private investors will be happy to do, given the opportunity!