[An earlier version of this post appeared on Forbes.com.]
The entire housing industry seems to have coalesced around one major explanation for today’s high home prices—home prices are high because new home builders haven’t built enough new homes since the Great Recession. The argument continues that homebuilders haven’t built enough new homes because local governments and residents won’t let the builders build more new homes due to zoning that is too restrictive and NIMBYism.
It’s almost as if the entire housing industry is saying, “High home prices aren’t our fault and there’s nothing we can do about them.”
This argument conveniently deflects attention away from the entire demand side of the equation. They don’t blame the mortgage industry and their policies, the Fed and its banking and interest rate policies, or the federal government and its mortgage and tax policies.
But let’s go with it. Let’s assume here that the cause of high home prices is that new home builders are not building enough single-family (detached) homes.
It doesn’t fit the narrative but it’s hard not to notice on the graph above from the website of the St. Louis Fed that home prices were highest when new home construction was also highest. Building twice as many homes as today didn’t slow down the enormous home price increase in 2005.
Despite that, the not-building-enough-new-homes argument is one that most people in the real estate industry get behind. Even the homebuilders themselves buy into the argument but they turn it to their advantage and blame their low levels of new home construction not on their decision to build fewer, larger, more profitable homes, but on local governments, zoning and building regs.
Yes, more new home construction tends to put downward pressure on home prices but the Great Real Estate Bubble shows graphically that the downward pressure on prices coming from increases in supply can easily be overwhelmed by the upward pressure put on prices coming from increases in the amount of money chasing homes.
In housing, increases in demand often completely offset increases in supply. Bankers can always increase the supply of mortgage credit faster than builders can build homes. The usual cause of high home prices is demand, not supply.
Demand Side Of The Equation
The demand for homes comes from potential homeowners but also from landlords. (When I say “homeowners” here, I mean owners who live in the homes they own as opposed to landlords.) Both homeowners and landlords are influenced by a lot of factors, especially lending standards but also tax policies.
From 2008 to 2012, nearly 750,000 new single-family homes were sold (increased supply), but landlords bought over 1,000,000 additional single-family homes (increased demand). The increase in demand from landlords was greater than the entire increase in supply from sales of new single-family homes over those five years.
In the early 2000s, landlords owned about 13% of the single-family homes. By 2013 it was 17%. That may not sound like a lot but in a market where only around 6% of homes are sold in a year, it’s huge, it’s like adding over a half year’s extra demand over those years.
It all started when home prices fell off a cliff from 2008 to 2012 and investors swooped in with cash to pick up bargains.
Those bargain prices were created by the earlier real estate bubble which was caused in no small part by a different set of real estate investors. In particular, the cascade of foreclosures that tanked home prices in 2008 was started by no-money-down real estate investors who bought at the top of the bubble and walked away as soon as prices stopped increasing.
All those distressed home sales from the real estate boom investors helped create the opportunity for all the later all-cash real estate bust investors from 2008 to 2012, and the additional one million single-family homes landlords bought.
Equals Two-Thirds Of New Homes Built 2008-2017
If we look over the last 10 years, we see the number of single-family homes that shifted from family-owned to landlord-owned was equivalent to two-thirds of all new single-family homes sold from 2008 to 2017. In a way, that increase in demand from landlords offset two-thirds of the increase in the supply from builders over the last 10 years.
Despite large home price increases since 2012, the percentage of single-family homes owned by landlords hasn’t fallen much. Landlords owned 17% of all single-family homes from 2013 through 2016 and it only fell to 16% in 2017 as landlords finally started to sell more homes than they bought.
The housing industry as a whole doesn’t seem to complain about the increase in landlord-owned homes because a home sale is a home sale to the industry whether to a landlord or to a family. The job of industry organizations is to represent their members, including their many members who sell homes, mortgages and other services to landlords and other investors.
Easy But Impossible
Nevertheless, if we wanted more stable home prices, both on the way up and on the way down in the real estate cycle, it would be easy to do economically, although it may be impossible to do politically.
The first step would be to admit that we now have a problem with unstable home prices and wild real estate cycles. The second step would be to realize that we can make prices more stable and sustainable if we want to.
One of many ways to help stabilize home prices on both the upside and downside of cycles is to stop subsidizing single-family landlords with tax breaks homeowners don’t get. Landlords get real tax deductions for imaginary depreciation and they can defer paying some taxes forever. Wouldn’t it be nice to defer some of your income taxes indefinitely, or to get a tax deduction when you paint your house or buy a new refrigerator like landlords do? No wonder landlords can bid up home prices for everyone!
Instead of addressing the problem, the tax bill last year made the problem worse. It reduced some tax breaks for homeowners (mortgage interest, and state and local tax deductions) but kept all those same deductions for landlords. It also created a new 20% tax deduction for landlords who are set up as “pass-through” businesses.
Oh, and by the way, the federal tax code doesn’t allow you to rent your house to yourself. The government won’t let homeowners reduce their income taxes the way landlords do.
The largest problem here is that all those landlord tax breaks encourage landlords to jump into hot markets when prices are rising which artificially increases demand and the cost of homes for everyone. And in the down part of the cycle, landlords are a lot quicker to walk away (if they’re underwater) or sell (if they have equity) which increases supply at the worst possible time and drives down prices more than otherwise. It’s a lot easier to walk away from an underwater investment property than the underwater house you live in. You’re trapped. They aren’t.
Next time you hear someone say home prices are high because home builders aren’t building enough homes remember that when it comes to homes, demand can easily outrun supply and often does. Also remember that a big part of that demand is set by government tax and mortgage policies.
The amount of money chasing homes can increase much faster than the number of homes.