Why Do Home Prices Go Up and Down?

The housing market has its ups and downs, a fact that can work out to your advantage whether you’re a potential homebuyer or home seller or, conversely, lead to disappointment and frustration.

There’s no way to guarantee that home prices will always be doing what you would like them to do, but you can at least understand the underlying reasons why they fluctuate as they do.

Home Prices and the Law of Supply and Demand

You’ve probably heard of the law of supply and demand. It’s one of the most basic principles in economics and says that the interaction of these two market forces determines the prices of items, for our purposes, house prices. Low supply tends to increase home value and thus home prices. Low demand depresses them. Similarly, high supply depresses real estate prices and low supply raises the average house price.

Home Prices and the Cost to Build a House

But the law of supply and demand applied simplistically isn’t the only thing hat affects home prices. The cost to build a home does, too. It varies according to such factors as the price of materials and the cost of labor (themselves in large measure determined by the law of supply and demand.) If the cost to build a home is relatively high, then real estate prices have to be fairly high as well. Otherwise builders would be selling new homes at a loss, which is obviously not the way to stay in business.

Home Prices, the Prospective Homeowner’s Income, and the Economy

A person who’s earning a good living and feels optimistic about the future may opt to buy a home even when real estate prices are relatively high. There are more such people around when the economy is booming, and accordingly, demand increases.

Home Prices and Recession

Extrapolating from the ideas above, you might infer that just as home prices are likely to rise in economic good time, real estate prices are likely to take a hard hit during times of recession, and some prognosticators anticipate that happening in the fairly near future. After all, no period of economic growth like the one the US is currently enjoying lasts forever, and they see warning signs that the current strong housing market may be coming to an end:

New home sales declined by 12% at the end of 2018.

Inventory has begun to rise.

Growth in the S&P CoreLogic Case-Schiller Home Index has declined for seven months straight.

The current economic expansion is just half a year shy of being the longest ever, which leads to the expectation that the end is in sight.

Yet despite these housing market indicators, there’s an argument to be made that whenever the next recession arrives (as it inevitably will), home prices will remain relatively strong. The argument rests on three considerations.

Major declines in housing prices are actually rare in recessions. In the past five recessions, home prices generally fared pretty well. Home prices grew 6.1% during the 1980 recession, 3.5% during the 1981 recession, and 6.6% during the dot.com recession of 2001. In contrast, only two of the last five recessions produced declines in home prices, and in the 1991 recession, it was just 1.9%. It was only in the Great Recession that house prices showed a serious decline of 19.7%.

Moreover, currently, inventory is having trouble meeting demand, and as you’ll recall from the law of supply and demand, this should make prices relatively high. The inventory of single-family homes, which includes both new and used houses, is currently 15.7 homes per 1,000 households. This is low. In fact, it’s almost as low as the record low of 14.9 per 1,000 from December 2017. This points up one difference between today and the days immediately before the Great Recession when the inventory was massive.

Also, the current demographics of the US are expected to support prime household growth for the next 20 years. About 46% of Americans are under 35 years of age. That means their peak marital and childbearing years are before them, and they’ll want to own or rent houses as they enter that phase of their lives. In fact, it’s been estimated that Millennial households will grow by 32 million between now and 2039. In other words, the demand for houses will increase, and home prices should increase with it.

Taking all the above into consideration, the housing market should remain fairly strong even in the face of the next recession.