Monday, October 2, 2017

there's a mismatch between the houses DC area buyers want, and what's on the market

Ten years after the Great Recession, home prices in many parts of the Washington region have reached or even topped their pre-recession peaks. But will this trend continue? A look at a wide sampling of real estate websites says yes – but the mismatch between what buyers can afford and what kinds of homes are available could change that.

New townhomes in Rockville. Photo by the author.

The conventional wisdom appears to say we’re not heading into another recession anytime soon. However, while Millennials are finally settling down and ready to buy homes, they will struggle to afford homes in places like DC due to high costs. In the coming years, climbing home prices will stagnate because buyers' income levels increases aren’t keeping pace with costs.

These three things suggest a recession isn’t coming soon

Real estate downturns tend to happen pretty regularly, notes real estate entrepreneur and Harvard Extension School lecturer Ted Nicolais. Going all the way back to the 19th century, real estate downturns take place about once every 16 to 18 years. Since the last recession occurred between 2006 and 2008, he predicts we can expect another one between 2022 and 2024.

Nicolais says there are three indicators of a recession: an increase in unsold inventory, increasing vacancy rates, and an increase in interest rates, all of which would discourage people from building houses or buying them. While the Federal Reserve may increase interest rates later this year, rates are still quite low. Even as the region built over 25,000 new homes last year, vacancy rates are still low because there's still high demand from people who want to rent them.

How many active home listings there are in the Mid-Atlantic from 2007 to 2017. Graphs from MRIS.

On top of that, the supply of homes for sale is less than half what it was 10 years ago. MRIS, the listing service for real estate agents in DC, Maryland, Northern Virginia, and small parts of West Virginia and Pennsylvania, found there were 37,000 homes for sale in the region in August 2017 compared to 82,000 in September 2007.

The housing market is working, but not for everyone

As a result, the housing market is pretty tight, especially for people who are looking for more affordable starter homes. Many of my fellow Millennials are finally getting settled into stable employment, and more of them are ready to buy homes. But area home builders are primarily constructing high-end homes due to high land costs, high labor costs, and high regulatory costs that make it too expensive to build smaller, cheaper homes. In Silver Spring, one local builder says that the legal costs alone for a new townhouse development added $50,000 to the price of each home.

How median home sale prices have changed compared to one year earlier. Less-expensive homes have increased in value faster than more expensive ones.

Because there aren’t enough smaller, cheaper homes being built, there’s more competition for them, which drives up prices faster. This graph shows how DC-area homes in the $200,000 range have increased in value at higher rates than homes in the $800,000 range. You can swap these out for other price ranges and get a similar result.

Meanwhile, local incomes are staying flat, even as house prices rise. After a certain point prices won’t be able to keep increasing, because buyers won’t be able to afford them. But that doesn’t mean home prices will crater. With so few homes for sale relative to demand, the housing market will remain really competitive, which will create upward pressure on house prices. It’ll just happen more slowly than it has over the past few years.

What does this mean?

For now, things may stay the same. Faced with rising house prices, those who buy may be forced to compromise on the size or features of their new home, or the location. That might mean moving to a DC neighborhood on the cusp of gentrification, or moving into a more distant suburban community further from jobs and services.

Meanwhile, other people may simply choose to keep renting because they can't find homes that meet their needs at prices they can afford. That alone might cause a slowdown in the housing market. In some areas that could spark a buyer's market because so many buyers give up that those who remain suddenly have a lot more houses to choose from.

None of those scenarios are ideal. There's a big mismatch in the housing market as buyers seek lower-cost homes where only high-end homes are available. One of the best ways to fix that is to allow more housing and reduce financial and regulatory barriers to building more affordably-priced homes.

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