by Joe Herrle, CFA
Vice President, Alternative Assets
Last week while my wife was engaging in one of the favorite millennial pastimes of perusing Zillow.com, she blurted out, “Joe, come take a look at this!” At first, I didn’t believe what she was showing me. Our home, which we had purchased only a little more than a year ago, had appreciated a surprising amount according to the estimate. When I realized this wasn’t a mistake, I felt validated as a savvy investor. And, as investing is my profession, I would like to think I know a good deal when I see one. But, as it turns out, lucky timing and broad housing market strength probably had more to do with it … and I am reminded of the Wall Street adage to “not confuse brains with a bull market.”
Sure enough, the data is clear: home prices across the U.S. have seen large increases in the last 18 months. And, for those of us in the Pacific Northwest, home price appreciation is running well above the long-term average. Over the last 12 months, prices in Portland have increased on average 20% and Seattle increased 23%, but Boise wins first place with an increase of 46%.1 In fact, the Boise market leads the nation for fastest home price appreciation.
So, what is behind the current price acceleration? The first part of the equation is demand, and there are several drivers at play. The lockdowns associated with COVID-19 caused many to work from home which increased the desire for more space in suburban areas. Also, it has accelerated household formation as the millennial generation enters prime first-time home-buying age. Supportive monetary policy from the Fed has helped decrease borrowing rates, making mortgages cheaper and therefore increasing demand. On the other end of the equation is supply. While labor shortages and supply chain bottlenecks have temporarily slowed the pace of homebuilding, housing starts are still running above long-term demand. As homebuilders race to fill demand, the cost to build has increased significantly. The major culprit of increased housing prices on the supply side is input costs. Both labor and material costs have increased. According to the Bureau of Labor Statistics Producer Price Index, the price of housing materials has risen 13.2% year-to-date, more than triple the rate of core inflation over the same period.2
While the hyperbolic run up in prices may cool in the coming months, there are significant catalysts that point to a strong housing market beyond the short-term. The most straightforward and clear evidence of this is the gap between housing supply and housing demand that has deepened every year since 2009. Due to underinvestment over the last decade, the U.S. housing industry is currently underbuilt by approximately 4.5 million units on a cumulative basis with monthly supply of homes close to a three-decade low. 3,4 Closing the gap at current building rates will take several years. As such, housing remains perhaps our highest-conviction, investable theme within equity portfolios. To that end, not only have we allocated directly to real estate through alternative investments, but also to public equities that directly serve the housing industry or operate in adjacent sectors that directly benefit from household formation.
Sources: Zillow, Federal Reserve
Takeaways for the Week
Housing price appreciation may cool off in the near term as supply issues abate, but the underlying drivers of demand will remain and should make this a durable bull market in housing
The U.S. housing market is a major indicator of the strength of the economy, and the current evidence supports our belief that we are closer to the start of an economic expansion than the end
Sources: (1) Zillow Group Inc.; (2) BLS, October 2021; (3) Forest Economic Advisors, June 2021; (4) Federal Reserve Economic Data, June 2021