U.S. home prices roared higher following the onset of COVID-19, and although there has been a moderate pullback lately, the median selling price remains 30% higher than in January 2020. An asset boom inevitably raises the specter of an impending bust, especially with the memory of the real estate crash during the Great Recession of 2007 still in our collective memories.
But not so fast. While the sharp acceleration of post-COVID housing costs resembles the rapid runup leading into the financial crisis, the proximate causes of the two spikes appear to be materially different, suggesting that another traumatic decline is much less likely this time around.
Researchers Lara Lowenstein and Jason Meyer at the Federal Reserve Bank of Cleveland examined several key factors driving the residential real estate market and concluded the two housing booms this century trace their origin to distinctly different fundamental drivers. The economists found that the current surge is tied to fundamental factors including structural supply and demand imbalances, the state of the mortgage market and the behavior of rents. The 2000-2006 boom appears to have been driven primarily by expectations of future appreciation: in a word, speculation. Speculative bubbles burst, while fundamental imbalances adjust more slowly and (usually) more sustainably.
Let’s begin with the first housing boom of the millennium. Starting in 1997 and continuing through the peak in 2006, new home construction expanded rapidly to over 2 million units per year, a level not seen since the mid-1970s. Note that during this building bonanza, average 30-year mortgage rates hovered above 6%, not much lower than the current environment. New construction was dominated by single family homes; over 2/3 of all units under construction in 2006 were stand-alone houses.
Yet demand continued to outstrip the expanding supply, creating incentives to further boost the quantity of new dwellings coming onto the market. However, somewhat counterintuitively, rents did not rise much during this period. In fact, average rents remained relatively stable, growing by only 10% cumulatively between 2000 and 2006, far slower than home prices rose. Meanwhile, the vacancy rate for residential units increased markedly during the same time frame. Supply, it seems, eventually outran demand.