Supply and Demand: Housing Recovery Threatens Home Affordability

By Stevie Duffin Updated on 1/23/2013

By Daniel Duffield

Following the wake of the housing market bubble burst at the turn of the last decade, the housing market struggled for years to regain its former strength. However, in a surprising reverse, the housing market has made such progress that the U.S. housing inventory has grown scarce, which could make home purchase more difficult in the near future. According to statistics from the National Association of Realtors (NAR), existing home sales rose 12.8% in December from the measurements a year before. Considering data for the entire year of 2012, sales rose 9.2% from 2011 to 4.65 million. Despite these figures, analysts had expected a slightly higher rate. According to Lawrence Yun, chief economist at NAR, “Record low mortgage rates clearly are helping many homebuyers, but tight inventory and restrictive mortgage underwriting standards are limiting sales.” Primarily, the supply of houses has declined and slowed the housing recovery.

In addition, December measurements revealed that housing inventory would only last for 4.4 months at the current rate of sale, reaching the lowest level of supply since May 2005 in which there was only a 4.3 month supply of homes on the housing market. In terms of new homes, November 2012 statistics revealed a total of 149,000 new homes with a 4.7 month supply, declining greatly from the 155,000 homes for sale in November 2011 at a 5.7 month supply.

While such strong data would typically be a good thing, since excess inventory is both a sign and cause of a weakened housing market, this scarce inventory will result in a high increase in home prices, making future home purchases increasingly expensive. With a greater amount of inventory, sellers are pressured to reduce their price to provide additional incentive for potential buyers. However, under the current circumstances which would be classified as a seller’s market, these home sellers will be able to maintain high prices due to the lack of available competition.

Although this market scenario may apply pressure on borrowers to purchase for fear of losing out to other buyer competition, it may also have the opposite effect, discouraging borrowers due to the prices and fears of settling for a less-than-profitable purchase. This becomes even more realized in housing purchases for higher value homes, in which borrowers must commit large sums of money for down payments and therefore cannot afford to make regrettable decisions. With an appropriately valued, attractive house for sale, a bidding war becomes increasingly likely in a low-inventory housing market. As a result, housing prices increased 11.5% in December 2012 from the same month in 2011. Furthermore, while homes averaged 99 days on the market in 2011, 2012 statistics saw this figure decline to a mere 73 days, with NAR reporting that, “Thirty-one percent of all homes sold in December were on the market for less than a month.”

These problems arise from the basic principles of supply and demand. While demand has steadily risen for several years, the supply has been unable to keep pace. Unlike other markets, housing market supply takes a much longer period of time to grow due to the time required for home construction. With many assertive builders and lenders going out of business as a result of the housing boom, many have been reluctant to attempt to fill in the missing supply gap due to the risk of another downturn. Consequently, housing affordability will be affected this year and in the coming years if supply fails to catch up, both as a result of the strong housing recovery and presenting an obstacle to it.