Series: Understanding the Housing Crisis | Part 1
How We Got Here (Hint: Supply/Demand Issues)
Sean Roberts, CEO of Villa
January 2024
It’s easy to get caught up in the “doom and gloom” headlines of the housing market that we saw in 2023. Media headlines too often focus on soundbites of what’s happening right now, but we at Villa prefer to look ahead with a longer-term perspective on where US housing needs to go this decade and beyond.
This is the first in a series of articles that breaks down how America reached this point in the housing economy and—most importantly—what a path out of this housing crisis could look like, at least in part.
How bad is it?
Home price appreciation, rapidly rising mortgage rates, and overall inflation has made housing affordability a critical challenge for many Americans. From 1990 to 2019, homeownership costs averaged 28% of median household income. As of 2023, American households are now seeing 41%+ of their household income going into homeownership costs.1 That’s a massive jump for most American households who are concurrently struggling to cover childcare, education costs, food, and other necessities.
The bad news is that housing availability and affordability is not likely to get better anytime soon. The last 15 years of housing underproduction coupled with high interest rates and inflation in 2022-23 has put us in a tough spot — it’s simple math.
The good news is that innovative solutions to create more attainable housing are out there, and there are many companies and organizations making real progress. At Villa, we are optimistic about the future for US housing, but it requires some rethinking of how we approach (at least some parts of) homebuilding in our country. We’ll get to that soon…
1Methodology: We calculate homeownership costs as % of median household income by taking 125% of the median household income dividing by homeownership costs based on a purchase of a home equal to the median home price at an 80% LTV mortgage at the then-prevailing 30-year mortgage interest rate + 1% of purchase price for property taxes + 1% of purchase price for homeowners’ insurance.
No easy way out
Unfortunately, there isn’t a quick fix to the current housing situation. Based on our analysis, in order for housing affordability to return to more normal and sustainable levels at say 30% of household income, you would need to believe in one of the following three things happening (assuming the other factors remain constant):
- Household incomes would have to increase by ~35%+. This will take a long time as wage growth is currently ~5% (which is elevated above 2010-2021 averages of only ~2-3%).
- Home prices would have to drop by 25%+. This seems unlikely given the massive supply/demand imbalance in the housing market (housing has been underproduced) and rate “lock-in” effect constraining resale inventory supply which is buoying home prices. Of course, a major recession (including significant job losses) could drive us towards this drop, but we’re not seeing signs of this risk being particularly elevated in recent economic data. The only time home prices fell even close to this much was in the aftermath of the Great Recession (where existing home prices fell by some ~23% peak-to-trough over multiple years), but that was in an environment of housing oversupply (not undersupply as we have today), massive amounts of resale inventory suddenly added through foreclosures resulting from the undisciplined subprime lending boom (not the much more disciplined lending we have now following Dodd-Frank and other regulations), and a massive global recession that drove significant unemployment. Those are prior conditions which seem unlikely to repeat themselves at that magnitude or speed anytime soon.
- Mortgage rates would have to drop by ~40%+ from ~7% today to ~4% or so. As much as we would all love to see lower interest rates, closing this gap entirely seems unlikely given current interest rate expectations and the market-implied forward curve for long-term rates. The 10Y UST has come down from its October 2023 recent peak of ~5% and is now hovering around ~4% right now – that’s some relief. However, the spread between mortgage rates and the 10Y UST has remained stubbornly high (effectively at ~2x historical norms) for several months – though we are starting to see that spread compress in recent weeks, there is still a long way to go to get back to “cheap” mortgage rates.
A supply/demand conundrum
The housing market is fundamentally about supply and demand, and we have a scarcity of supply. America built an average of nearly ~17 million total homes per decade in each of the 1980s, 1990s, and 2000s. However, new home construction fell to less than 11 million new homes between 2010-2020. Naturally, during this time population growth and new household formation continued, and supply couldn’t keep up with demand. We simply haven’t built enough homes since the Great Recession.
As a country, American housing production is not on track to meet housing demand this decade. Based on very thoughtful demographic research in a paper published in early 2023, John Burns Research & Consulting forecasts a need of 17.1 million new housing units from 2020 to 2030.2 So far, through 2023, we’ll have built something around 4.2 million new homes (roughly ~1.4 million per year), leaving another ~13 million or so to go. Current total housing completions are running around ~1.3-1.4 million annually, meaning we’re pacing to build maybe ~14 million of the 17.1 million homes needed by the end of the decade, leaving a likely gap of more than 3 million homes by 2030.
2“America’s Needed Housing Construction”, January 2023, John Burns Research & Consulting.
The challenge of single-family zoning
While there are several drivers of the supply problem, one of the biggest is single-family zoning. Throughout much of the 20th century, suburban zoning codes implemented measures that required minimum lot sizes (reducing density) and blocking forms of housing that deviated from single-family homes. Moreover, many jurisdictions started to impose other anti-growth measures including complicated and costly requirements for project approvals, overly strict construction and site requirements, onerous design reviews, stringent environmental restrictions (often motivated more by blocking building than actually helping the environment), and of course lots and lots of fees. This makes it harder and more expensive to build new housing than it needs to be, especially when a builder is trying to build smaller new homes at attainable price points through traditional site-built construction.
We’ve been building the ‘wrong’ homes for many would-be buyers
Unfortunately, as a result of both decades of policy decisions and the economics of traditional homebuilding, most of the suburban single-family homes we build are too big and too expensive for today’s would-be buyers. Only 23% of new homes built today are less than 1,800 square feet – the size for a typical “entry-level” home – and this is down from 37% in 1999.3 As of late 2023, there were ~55% fewer listings of small homes available in the resale market today than there were only a few years prior.4 People need entry-level starter homes at attainable price points and there aren’t enough of these being built.
In order to afford today’s median-priced new home at $428,000 (as of August 2023), a typical family would need to earn more than $107,000 of annual household income at an 8% 30-year fixed rate mortgage (at 80% LTV), which is where we were in October 2023. However, median household income nationally is closer to $75,0005 meaning that the median household is earning ~30% less than what is required to afford the median-priced home today.
To look at this math from a different perspective, a typical household earning $100,000 per year could afford to buy a ~3,700 square foot new home in 2019 (at a 4% mortgage rate when new homes were selling for roughly ~$150 PSF nationally). Today, that same household can only afford an ~1,800 square foot home (at an 8% mortgage rate and when new homes are selling for ~$205 PSF nationally). That’s an effective 50% reduction in the “amount of house” that exact same family can afford today vs five years ago.
There is clear and strong demand for smaller, entry-level homes today, and this demand will only get stronger given demographic inevitabilities. Between 2020 and 2030, we will have more than 21 million new people aging into their prime entry-level homebuying years (aged 30-39) and prime downsizing years (aged 65-84) during which time many older people will seek smaller, single-story homes at lower ownership costs. Smaller footprint houses with smart floor plans and functional, aesthetically-pleasing designs in appealing locations make for fantastic housing. However, we’re simply not building enough of these smaller, entry-level homes for these rapidly growing segments of buyers to actually afford.
3 Census Bureau 4 Realtor.com 5 Census Bureau
The American dream, powered by homeownership
The societal consequences of housing underproduction are profound. It leads to diminished economic dynamism for the entire country. There is lost wealth creation for households as an ever-greater share of their income goes to satisfying housing costs. Rising homeownership costs drive more would-be owners to renting, thereby forgoing the opportunity to build long-term wealth through building equity via homeownership. Rising housing costs directly fuel inflation. Housing’s contribution to inflation has increased from 47% in Dec 2019 to 68% of total inflation as of Aug 2023.6 High housing costs and the “lock-in” effect of homeowners who have low fixed-rate mortgages limit housing mobility: homeowners with a 3% mortgage are no longer incentivized to take out an 8% mortgage and move. Moreover, expensive housing is harming educational outcomes because teachers increasingly cannot afford to live within commuting distance of where they work. In Los Angeles, for example, a teacher in their first year earns ~$49,000 but the average apartment rental ranges from ~$2.2 to $3.8k per month, meaning that they would have to pay at least half their salary in rent.7 This is not sustainable.
The de facto economic segregation of neighborhoods and schools drives many working-class and lower-wage-earning Americans out of neighborhoods with good schools. The racial gap between black homeownership (44%) and white homeownership (73%) is at its widest levels in years.8 Clearly, these are not the outcomes we want. Housing costs matter tremendously.
How big “production” homebuilding has created problems
A majority of new housing production consists of new single-family homes in “master planned” subdivisions which typically focus on larger, more expensive homes where the big “production” home builders make their profit margins. The average new single-family home is more than 2,400 square feet today.9 Of course, these can be great places to live and these homes are fantastic products for the buyers who can afford them. However, these large-tract developments come at the cost of consuming many acres of raw undeveloped land (often previously used for agriculture) as these big “production” home builders that use traditional, site-built construction methods need to build lots of homes together at the same time (usually at least 100-150+ homes per development site) in order to achieve the economies of scale they require. Not only can this type of “suburban sprawl” development be damaging to the environment (by consuming large tracts of raw or agricultural land), it’s also arguably economically unsustainable for these builders over the longer term given the inevitable cost pressures from the increasingly acute construction labor shortage.
Construction labor is a major cost input for this type of site-built construction. This labor is becoming increasingly scarce and more expensive. In 2022, ~85% of builders reported labor costs and availability as a challenge, up from only 30% just ten years earlier.10 Our construction workforce is “aging out” as the percentage of construction workers aged 55+ has increased from ~11.5% in 2003 to nearly 23% in 2020 – and it’s only getting worse.11
Construction job openings have been trending at elevated levels for several years now with insufficient new workers to fill them. For those construction laborers who remain in the workforce, they will increasingly gravitate towards larger commercial projects where the money is – thereby leaving small scale residential construction labor even more scarcely supplied. All of this means that the costs for traditional site-built construction are going to continue to go up—if builders can find the labor they need at all. These construction labor challenges will only get worse and will persist for years to come.
6 Bureau of Labor Statistics 7 The Guardian, “US teachers grapple with a growing housing crisis: ‘We can’t afford rent’” (March 2023) 8 National Association of Realtors 9 St. Louis Federal Reserve 10 NAHB 11 Bureau of Labor Statistics
Forging a better path forward for housing supply
After reading all that, it’s easy to feel like things will never get back on track, or anywhere close to the track. But optimism is crucial for solving problems this big, and optimism is exactly what we at Villa feel about the potential long-term solutions we’re working towards.
To tap into your own optimism on the topic, check out Part 2: The Path Forward is Prefab Construction in Infill Locations.
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