The escalating cost of housing has become a pressing concern for many Americans. As property 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 dynamics, government policies, economic conditions, and historical trends. 

Much of the following is included in the Steers Center for Global Real Estate’s Housing Markets and Social Infrastructure course that is included in the curriculum for students pursuing a Master of Science in Global Real Assets at Georgetown’s McDonough School of Business. The purchase of a home is often the only real estate ownership that individuals experience directly, so it is important for Georgetown students to have an understanding of the drivers of this asset class. The following article is derived from this curriculum.

Understanding the Factors Driving Up Home Prices

Supply and Demand Dynamics

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

1. Limited Housing Supply: Construction of new homes has not kept pace with population growth. According to the National Association of Home Builders, the United States faced a shortage of over one million housing units as of 2020.
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 urban populations have grown by 12% over the past decade.
3. Regulatory Constraints: Zoning laws and land-use regulations can limit the development of new housing. Restrictions on building heights, densities, and land usage reduce the number of homes that can be built in high-demand areas.

Low Interest Rates

Historically interest rates have made borrowing more affordable, encouraging more people to enter the housing market. The Federal Reserve’s efforts to stimulate the economy, especially during economic downturns, often involve lowering interest rates. While this makes mortgages cheaper, it also increases demand, which can drive up prices when supply is limited.

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 notes that immigrants and their descendants are projected to account for 88% of the U.S. population increase through 2065.

Challenges of Homeownership in the Current Market

Rising Down Payment Requirements

As home 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.

Struggles for First-Time Homebuyers

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

As property values increase, so do property taxes. Homeowners in rapidly appreciating markets may see significant tax hikes. For instance, property taxes in some metropolitan areas have increased by over 10% in a single year.

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. When the bubble burst in 2008, home prices plummeted, 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 implement programs to address affordability:

• Housing Choice Vouchers: Provide rental assistance to low-income families.
• Low-Income Housing Tax Credits (LIHTC): Incentivize developers to build affordable housing.

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

Tax Incentives for Homeowners

Tax policies can encourage homeownership:

• Mortgage Interest Deduction: Allows homeowners to deduct interest paid on mortgages from taxable income16.
• Property Tax Deduction: Enables deduction of property taxes paid.

These incentives can make owning a home more affordable but may also inflate demand and, consequently, prices.

Impact of Economic Factors on the Housing Market

Job Market and Income Levels

A strong economy boosts employment and wages, increasing individuals’ ability to purchase homes. However, if housing prices rise faster than incomes, affordability declines. From 2012 to 2022, median home prices increased by 60%, while median household income grew by only 30%.

Foreign Investments

Investors from abroad often view U.S. real estate as a safe investment, which drives up demand, especially in major cities. The National Association of Realtors reported that foreign buyers purchased $54.4 billion worth of U.S. existing homes between April 2021 and March 2022.

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

Expert Opinions and Forecasts

Economists and real estate experts have varying views:

• Continued Growth: Some predict that housing shortages will persist, keeping prices high.
• Market Correction: Others foresee a stabilization or slight decline in prices as supply catches up with demand.

Impact of the COVID-19 Pandemic

The pandemic reshaped housing demand:

• 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.

Changing Interest Rates

The Federal Reserve’s adjustments to interest rates 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 a multifaceted issue influenced by supply and demand imbalances, economic factors, government policies, and historical trends. Limited housing supply amid growing demand, low interest rates, and regulatory constraints have all contributed to escalating prices. While challenges persist — especially for first-time buyers — understanding these factors can help individuals navigate the complex housing market. Future trends remain uncertain, but staying informed and considering expert insights can aid in making sound real estate decisions.