Why is the Housing Market Skyrocketing?

The pandemic has changed the world. It is not an exaggeration to claim that it has changed the world forever. This change has affected many aspects of the economy including the housing market. The housing market value has been dramatically increasing lately. Indeed, it is currently at an all-time high. This is clearly not a surprise. The main question is to understand why the housing market is currently overvalued. What are the reasons that lead to an overvaluation of the housing market?

Reason 1: Apartments Convertibility

The first reason that justifies the rise of prices of the housing market is the shift from corporate housing to residential housing. Indeed the number of office buildings converting to residential housing skyrocketed due to the pandemic. As remote work became the new way of professional life, companies that rented office spaces saw no longer the need to be paying rent for a space they will not have to use if the staff is able to maintain the same level of productivity it had before the pandemic. This incentivized the housing market to shift gears. Owners who shifted their office space to apartments logically increased the price. As a result, a record number of more than 20,100 apartment conversions are to be finalized in 2021, a total of 32,000 in the first two years of the decade. 41% of apartments are in former office buildings, accelerating a trend that began in the 2010s. The following data show the trend of the conversion of office spaces into apartments.

Figure 1. Source: Yardi Matrix

Reason 2: Low-Interest Rates

Second, the housing market is right because of low-interest rates. Low-interest rates increase demand. As we know, excessive demand leads to a shortage if supply cannot follow. We currently live in an era where access to wealth and capital is much easier than it was half a century ago. Those who were a decade ago in the lower brackets of the income distribution have now moved up to the higher brackets. Low-income households moved to middle-class households, and middle-class households moved to upper-income households. Hence, they have a higher buying power.

Middle-class Household Expansion

Figure 2. Source: Euromonitor International from National Statistics

More importantly, most of the middle-class now are millennials. Millennials have wider access to capital than the previous generation. Thus, as their buying power increased with lowered interest rates, more millennials who are prospective homeowners decided to buy property. As a result, this increase in demand for housing leads to an increase in pricing. Furthermore, low-interest rates lead to higher inflation. Since the 1990s, the house price index has outpaced inflation because the demand for housing has become excessive over time.

House Price Index and Consumer Price Index

Figure 3. Source: Federal Housing Finance Agency

Reason 3: Demographics

The third reason is demographics. As a matter of fact, demographics play a tremendous role in the evolution of the real estate market. The non-White population is growing while the White population is in decline. The following data in figure 4 show that the population since 2016 has been in constant decline while non-White populations, especially the Hispanic population, are on the rise. For example, the Hispanic population of the Southside of Oklahoma City has increased over the last twenty years, and the southwest part of the city has been an area to buy rental properties at an affordable price.

Again, millennials represent a substantial portion of the new demographic change. Millennials are the biggest demographic driver affecting the real estate market in urban markets, office workspaces, and elsewhere. But baby boomers are still wielding influence over the industry in senior housing and medical facilities. Properties are being repurposed to accommodate the rising demand for one-day distribution. Lifestyles and demographic cohorts are influencing urban and suburban real estate markets alike.

Figure 4. Source: William H. Frey Analysis of the U.S. Census Bureau

Reason 4: Government Policy

Lastly, government policies increase the price of the real estate market. Through tax credits, deductions, and subsidies, government policy leads to an increase in the price of the housing market. For example, in 2009, the U.S. government implemented the first-time homebuyer’s tax credit to owners in an attempt to increase home sales. According to the National Association of Realtors, this tax incentive alone led to 900,000 homebuyers to buy home. Thus, this tax incentive subsequently inflated the house price index.

I cannot really determine for how long the housing market “bubble” will last. The Federal Reserve, in late January 2022 announced a modest rise of interest rates to tame inflation (FEDs want to increase rates to 2% while inflation is currently at more than 7%). But how much impact this rise of interest rates will have on an economy that is in a walking-inflation stage? More importantly, how this rise will impact the housing market? We know that raising interest rates lowers demand and pricing for real estate. Can the next economic recession come, once again, from a burst of the housing market? Only time will tell, but I will not be surprised if, indeed, a recession was caused by a burst from this economic sector.