Home Price Gains Are Greater Than The 2005/2006 Housing Bubble Peak
U.S. home prices have surged over the past year, driven by a mix of factors such as low interest rates, limited housing supply, and a strong economy recovering from pandemic-related stimulus. The Case-Shiller Home Price Index climbed 17% year-over-year in May 2021, surpassing the peak of the 2005/2006 housing bubble, which had reached 15% in September 2005. Today, national home prices are 38% above the previous peak.
Many analysts have raised concerns that we're witnessing a new housing bubble. While it's possible, the dynamics behind this cycle are quite different from those of 2005/2006. Back then, the market was fueled by speculative lending and risky financial practices. This time, while lending is more aggressive, it’s not as reckless. There aren’t five back-to-back TV shows about people quitting jobs to flip homes for quick profits anymore.
Instead, the current boom is primarily driven by supply and demand. Supply has tightened significantly, while demand remains robust. 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 but left a six-month gap in production and activity. As a result, consumers now have more cash on hand, while supply chains struggle to keep up, creating shortages across industries.
Source: Federal Reserve and Case-Shiller
Takeaway: Home prices are 38% above the prior peak, and the growth rate of +17% in May 2021 surpassed the prior cycle peak growth rate of +15%.
Long-term home price trends are largely determined by affordability. Affordability depends on wages and interest rates—the cost of borrowing money. When wages rise and interest rates fall, buyers can afford higher home prices. Conversely, when wages stagnate or interest rates increase, affordability declines, and home prices tend to drop.
Average wages increased by about 5% year-over-year in 2020, which is far below the current home price gains of 17%. In the long run, this gap isn't sustainable. Prices can only rise so much before they become unaffordable for many buyers. Either wages will need to grow significantly, or home prices will have to stabilize while wages catch up.
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?" which highlighted data from Altos Research showing a sharp decline in available housing inventory. The number of condos, townhouses, and single-family homes on the market hit its lowest level since Altos started tracking the data. Inventory hovered around 1.0–1.2 million in 2015–2016, then gradually declined through 2019. The drop accelerated during the pandemic as builders delayed projects due to uncertainty. Today, inventory is 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 situation is starting to ease slightly. “This week we're seeing real estate inventory continue to climb and demand pull back a bit,†wrote Mike Simonsen. “More homes are taking price reductions, and fewer are selling immediately.†He added, “A car going 100 mph down the highway and you take your foot off the gas, is rapidly decelerating and it’s still going really fast. Both things can be true at the same time.â€
Meanwhile, demand remains strong as the economy continues to absorb the effects of pandemic-era stimulus. 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 and live. “The pandemic has jolted and dramatically unbundled work from location for many, creating a new flexibility,†he said. “Moving to the big city is no longer a requirement for many job seekers, and that shift will inevitably disperse talent and economic opportunities.â€
Building Materials & Labor Costs Are Rising
Input costs are rising, and inflation is back—this is clear if you’ve shopped at a grocery or hardware store lately. NAHBNow reported that overall construction costs have risen 19% over the past 12 months. Between 2015 and 2020, the average annual change in residential construction costs was below 2%, but in 2021, the year-to-date increase exceeded 12% (19% year-over-year).
Source: NAHBNow and Bureau of Labor Statistics
Companies are also reporting rising input prices, and for many, the increases are even steeper. Bank of America found that mentions of the word "inflation" in company earnings calls rose by 1,100% year-over-year in Q2 2021.
Source: Bank of America Research
Takeaway: Mentions of the word "inflation" during company earnings calls rose 1,100% year-over-year.
Homebuilders are facing higher material costs and supply chain delays. From December 2019 to August 2021, several key construction materials saw significant price hikes:
- Copper: +56%
- Steel: +44%
- Drywall: +26%
- Lumber: +17%
- Insulation: +13%
- Asphalt: +7%
- Labor: +6%
Construction costs typically make up about 60% of a new home’s total cost. As these costs rise, they are eventually passed along to buyers, often after a delay of 6–12 months due to contract pricing.
The National Association of Home Builders’ 2020 survey showed that construction costs account for about 60% of a new home’s price. This means that any changes in building costs can significantly impact home prices over time.
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 can affect home prices. You can check it out here: [Airtable Interactive Spreadsheet](link).
With input costs rising, it’s reasonable to expect that home prices will stay elevated for some time. If construction costs remain high, the upward trend in home prices may persist.
Residential Construction Stands To Benefit
Construction companies and equipment dealers stand to benefit from the current low inventory of homes for sale. We’ll need more machines and tools to address the housing shortage. Additionally, construction firms are likely to invest in automation and technology to boost productivity amid labor shortages.
Conclusion
The strong price gains in home prices may be more durable than in the 2005/2006 cycle, thanks to higher construction costs and limited housing supply. While prices might slow down or flatten for a while, a sharp correction like in 2005/2006 seems less likely. Furthermore, the post-pandemic world has changed—governments are more willing to use fiscal stimulus again if needed.
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