The escalating cost of housing has become a pressing concern for many Americans. As housing prices increase significantly, the concept of homeownership seems increasingly unattainable for a significant portion of the population. Understanding why houses are so expensive requires a comprehensive examination of various factors, including supply and demand variations, economic conditions, government policies, and historical trends.

The purchase of a home is often the only real estate ownership that individuals experience directly. At Georgetown University McDonough School Business, students pursuing a Master of Science in Global Real Assets must have a clear understanding of the drivers of this asset class. This article draws from the program’s Housing Markets and Social Infrastructure course.

So, what’s driving up home prices?

Supply and Demand Dynamics

At the heart of the surge in housing prices lies the fundamental economic principle of supply and demand. When the demand outpaces the available supply of houses, prices naturally rise. Several factors contribute to this imbalance:

1. Limited Housing Supply: The National Association of Home Builders reports that the United States is currently facing a shortage of approximately 1.5 million housing units, a gap that is contributing to rising home prices and rents.
2. Population Growth and Urbanization: Cities attract people seeking employment and better amenities, increasing demand in urban areas. The U.S. Census Bureau reported that the nation’s total population grew by 7.4% from 2010 to 2020, with significant growth in urban areas.
3. Regulatory Constraints: Zoning and land-use regulations can limit the development of new housing. Restrictions on building heights, densities, and land usage limit the number of homes that can be built in high-demand areas.

Low Interest Rates

Over time, lower interest rates have reduced the cost of borrowing, making it easier for more people to buy homes. To boost the economy, especially in times of recession, the Federal Reserve often cuts interest rates. Although this lowers mortgage rates, it can also lead to higher demand, which, when supply is constrained, can push housing prices upward.

Population Growth

The U.S. population continues to grow, adding pressure to the housing market. Immigration and higher birth rates contribute to an increasing number of households needing accommodation. The Pew Research Center projects that immigrants and their descendants will account for 88% of the U.S. population growth through 2065.

Challenges of Homeownership in the Current Market

Rising Down Payment Requirements

As housing prices rise, so do the amounts required for down payments. Traditional mortgages often require a 20% down payment to avoid private mortgage insurance. For a median-priced home of $350,000, this equates to $70,000—a substantial sum for many Americans

First-time buyers face unique hurdles:

• Limited Savings: Younger buyers may not have had enough time to accumulate significant savings, especially with student loan debts averaging $30,000 per borrower.
• Competitive Market: With high demand, sellers may prefer cash offers or bids above the asking price, putting first-time buyers at a disadvantage.
• Lack of Affordable Starter Homes: Builders focus on luxury homes for higher profit margins, leading to a scarcity of entry-level homes.

Increasing Property Taxes

Homeowners in rapidly appreciating markets may experience significant tax hikes. For instance, property taxes in the Washington, D.C. metro area have increased by 25.4% between 2019 and 2023, with median property taxes rising from $2,036 to $2,554 during this period.

Historical Trends in Home Values

Appreciation Rates Over Time

Real estate has generally been a sound investment due to property appreciation. On average, home values in the United States have increased by about 5% annually since 1968. However, this growth is not uniform and can be influenced by local economic conditions.

Previous Housing Bubbles

The early 2000s saw a housing bubble fueled by easy credit and speculative buying. In 2008, home prices collapsed, leading to foreclosures and a financial crisis. Lessons from this period highlight the risks of unsustainable price growth.

Impact of Inflation on Home Prices

Inflation erodes purchasing power, but real assets like homes often retain or increase their value during inflationary periods. As construction costs rise due to more expensive materials and labor, these costs are passed on to buyers.

The Role of Government Policies in Housing Affordability

Zoning and Land-Use Regulations

Local governments use zoning laws to control land development. While these regulations can preserve community character and environmental quality, they can also limit housing supply. For example, single-family zoning restricts land to one house per lot, reducing density and exacerbating supply shortages.

Affordable Housing Initiatives

Governments often implement programs to address affordability, such as:

• Housing Choice voucher programs provide rental assistance to low-income families.
• Low-income housing tax credits are used to incentivize developers to build affordable housing.

While beneficial, these types of programs often face funding limitations and may not meet the overall demand.

Tax Incentives for Homeowners

Tax policies can encourage homeownership, for example the Internal Revenue Service allows for:

• Home Mortgage Interest Deduction  
• State and Local Real Property Tax Deduction

While these incentives can make owning a home more affordable, they may also inflate demand and, consequently, prices.

How Economic Factors Affect the Housing Market

Job Market and Income Levels

A robust economy enhances employment and wages, bolstering individuals’ capacity to purchase homes. However, if housing prices escalate more rapidly than incomes, affordability diminishes. From 2012 to 2023, the median sales price of homes increased by approximately 87%, while the median household income rose by about 18%.

Foreign Investments

Investors from abroad often view U.S. real estate as a safe investment, which drives up demand, especially in major cities. International buyers purchased $42 billion worth of U.S. existing homes between April 2023 and March 2024, marking a 21.2% decline from the previous year.

Economic Recessions

Economic downturns can depress housing prices due to decreased demand. However, low interest rates used to stimulate the economy can counteract this effect by making borrowing cheaper, sometimes leading to a quicker rebound in housing prices.

Predictions for the Future of Housing Prices

Economists and real estate experts have varying views. Some predict that housing shortages will persist, keeping prices high. Others foresee a stabilization or slight decline in prices as supply catches up with demand. 

The COVID-19 pandemic reshaped housing demand and its impact is still being felt:

• Remote Work: Increased flexibility has led people to relocate from expensive urban centers to more affordable areas.
• Supply Chain Disruptions: Delays in construction materials have slowed new housing developments.

Any Federal Reserve adjustment to interest rates can affect mortgage rates:

• Rising Rates: Higher rates can reduce affordability, potentially cooling demand.
• Variable Impact: The extent depends on how quickly and significantly rates increase.

The high cost of housing is influenced by many elements, from the imbalance of supply and demand to economic conditions, government policies, and historical trends. Limited housing supply amid growing demand, interest rates, and regulatory constraints have all contributed to escalating prices.

While challenges persist, especially for first-time buyers, understanding these influences can help prospective home buyers navigate the complex housing market. Future trends remain uncertain, but staying informed and considering expert insights can aid in making sound real estate decisions.