Why Home Prices Are Defying Expectations: A Closer Look at the Current Housing Market

As we progress through the second half of the year, many housing market watchers have been anticipating a slowdown in home prices. However, contrary to these expectations, prices have remained resilient, even as the supply of homes on the market has begun to rise. Understanding why this is happening requires a closer look at the unique economic forces at play.

A Market Like No Other

We are currently navigating a housing market shaped by a series of unprecedented economic events. From the foreclosure crisis and the Great Recession to the COVID-19 pandemic and the rapid fluctuations in mortgage rates, the market is unlike anything we've seen before.

During the housing boom of 2005, the supply of homes surged, only to be followed by a wave of foreclosures that flooded the market. This led to a significant slowdown in home construction, and by 2012, newly built homes accounted for just 6% of the total housing supply. The pandemic then further reduced overall supply as demand surged during its first two years. Now, although supply is gradually increasing, it's doing so in a somewhat unexpected way: primarily through newly built homes.

The Divergence in Supply

Today, the supply of newly built homes is almost three times that of existing homes. Typically, the supply of new and old homes tracks closely together, but the market dynamics have shifted. New construction now makes up 30% of total inventory, a figure that is notably high compared to historical trends.

The rapid changes in mortgage rates have played a significant role in this shift. Rates dropped to historic lows at the start of the pandemic, only to spike to 20-year highs just two years later. This volatility has caused many homeowners who might have considered moving up to stay put instead, further constraining the supply of existing homes. At the same time, buyers are increasingly seeking out more affordable options, leading to a higher demand for newly built homes in the lower price ranges.

Demand for Affordable Housing

The supply of homes in the $100,000 to $500,000 price range has seen the most significant increase. However, demand in this segment remains so strong that these homes are being quickly absorbed, which is why prices continue to rise despite the growing inventory.

Builders Adapting to Market Conditions

For home builders, the focus has shifted to meeting the demand for affordable, entry-level homes. Builders like DR Horton and KR Home, which offer more budget-friendly options, are experiencing strong sales. On the other hand, luxury builders like Toll Brothers are also seeing success, but this is largely due to their reliance on wealthier, less mortgage-dependent buyers.

Interestingly, the large supply of homes that appears in market data doesn't fully reflect completed homes. Builders have significant control over the supply chain, deciding when to start or complete construction based on market conditions. This means that while there may be a nine-month supply of homes on paper, only about 20% of these homes are actually completed, giving builders flexibility in managing inventory.

What If Mortgage Rates Fall?

One of the key factors holding back the market is the current high mortgage rates. Many potential sellers, particularly aging Baby Boomers, are hesitant to give up their low-interest mortgages to take on a new, higher rate. However, if rates were to drop back into the 6% range, we might see a surge in seller activity. Lower rates would make selling more attractive, potentially leading to an increase in existing home listings, which could, in turn, stabilize prices.

In conclusion, while the market is seeing a rise in supply, it's primarily driven by newly built homes, and demand remains robust, especially in the more affordable price ranges. This unique combination of factors is why home prices continue to climb, defying expectations. The future of the housing market will likely depend on how mortgage rates evolve and how builders manage their supply in response to ongoing demand.