Home Price Gains Are Greater Than The 2005/2006 Housing Bubble Peak
In the past year, U.S. home prices have surged due to a mix of factors such as historically low interest rates, a limited housing supply, and a strong economy fueled by pandemic-related government support. The Case-Shiller Home Price Index climbed 17% year-over-year in May 2021, breaking the previous peak of 15% recorded in September 2005. Today, national home prices are 38% higher than the previous high.
Many are calling this a new housing bubble, but the current situation is different from the 2005/2006 period. Back then, the boom was driven by reckless lending and risky financial products from banks. These practices were well-documented and widely reported. This time around, while lending has become more aggressive, it’s not nearly as speculative. There aren’t five TV shows about people quitting their jobs to flip houses for quick profits anymore.
Instead, today's surge is largely due to supply and demand dynamics. The pandemic caused a sudden economic shift—businesses paused, workers were laid off, and spending dropped. Governments responded with massive fiscal stimulus, which helped revive the economy. However, this led to a temporary slowdown in production and a surge in consumer demand. With less supply and more money in consumers' pockets, inflation began to rise across multiple sectors.
Source: Federal Reserve and Case-Shiller
Takeaway: Home prices are now 38% above the prior peak, and the growth rate of +17% in May 2021 surpassed the previous cycle's peak of +15%.
Long-term home price trends depend on affordability, which is determined by wages and interest rates. When wages rise and interest rates fall, people can afford to pay more for homes. Conversely, if wages stagnate or interest rates increase, home prices tend to decline. In 2020, average wages only rose by about 5%, far below the 17% increase in home prices. This gap is not sustainable over the long term. Either wages will need to grow significantly, or home prices will have to slow down until they align with income levels.
Home Price Increases This Cycle Are Not As Speculative - It's More About Supply And Demand
Earlier this year, Emily Badger and Quoctrung Bui of the New York Times published an article titled "Where Have All the Houses Gone?" that highlighted a sharp drop in available housing inventory. According to Altos Research, the number of homes for sale hit a historic low. Inventory had been around 1.0 to 1.2 million in 2015–2016, but it steadily declined through 2019. The pandemic caused a major slowdown in construction, as builders delayed projects due to uncertainty. Today, inventory is about 50% below normal levels, creating a significant housing shortage.
Source: Altos Research
Takeaway: US inventory of homes for sale is ~50% below normal levels as of August 2021
According to Altos Research’s August update, the tight supply is beginning to ease slightly. "We're seeing real estate inventory continue to climb and demand pull back a bit," wrote Mike Simonsen. "Some things to note about our rising inventory levels: 2.5% in and of itself is not an alarming change. It’s pretty common. Inventory is still 50% below normal." A local appraiser compared the situation to a car slowing down after hitting 100 mph—it’s still moving fast, even though it's decelerating.
Meanwhile, demand remains strong as the economy continues to benefit from the fiscal stimulus provided during the pandemic. Rich Barton, Zillow’s co-founder and CEO, noted on the company’s second-quarter earnings call that the pandemic has changed how people work. "The pandemic has jolted and dramatically unbundled work from location," he said. This shift allows people to choose where they live based on personal preferences rather than job locations, leading to a “great reshuffling†of population and housing demand.
Building Materials & Labor Costs Are Rising
Prices for building materials and labor are soaring, and inflation is back. If you’ve shopped at a hardware store recently, you know this well. According to NAHBNow, residential construction costs have risen 19% over the past year. Between 2015 and 2020, the annual increase was typically under 2%. But in 2021, the increase jumped to over 12% year-to-date.
Source: NAHBNow and Bureau of Labor Statistics
Companies are also feeling the pressure. Bank of America found that the word "inflation" was mentioned 1,100% more often in second-quarter 2021 earnings calls compared to the same period in 2020.
Source: Bank of America Research
Takeaway: Mentions of the word "inflation" during company earnings calls rose 1,100% year-over-year
Construction companies are facing higher material costs and delays. From December 2019 to August 2021, several key materials saw significant price increases:
- Copper +56%
- Steel +44%
- Drywall +26%
- Lumber +17%
- Insulation +13%
- Asphalt +7%
- Labor +6%
Construction costs make up about 60% of the cost of a new home. When these costs rise, they eventually get passed on to buyers, often after a delay due to long-term contracts. This means that recent home price gains may be partially driven by rising construction costs.
Source: NAHB Cost of New Home Construction Survey
Source: NAHB Cost Of New Home Construction Survey
Takeaway: Construction costs are the largest component of a new home cost at ~60% of the purchase price. Builder profit margins are typically between 8-10%.
At Equipment Radar, we developed a tool to help model how changes in construction costs impact home prices. You can check it out here.
Residential Construction Stands To Benefit
With the current housing shortage, construction companies and equipment dealers stand to gain. More machines and tools will be needed to meet demand. Additionally, construction firms are likely to invest in automation and technology to offset labor shortages and boost productivity.
Conclusion
The current rise in home prices may last longer than the 2005/2006 bubble, partly due to higher construction costs and limited inventory. While prices might stabilize or even dip slightly, a sharp crash like the one in 2008 is unlikely. Furthermore, the post-pandemic world has changed—governments are more willing to use fiscal stimulus to support the economy, which could keep home prices elevated for some time.
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