supply, demand, housing, price, interest rates

Housing prices have been increasing significantly over the last fifteen years as low interest rates made larger and more extravagant homes affordable. Is it getting to the point that no one can afford to enter the housing market anymore?

Not quite. Though many people have decried the run-up in housing prices in the last few years, much of the increase is easily explained. Interest rates have been at historic lows for several years, making the overall cost of buying a house much cheaper. Lower prices increase demand for housing. In the very short run, though, the supply of housing is fixed, so the ultimate change in price depends entirely on changes in housing demand.

The number of housing units can be increased, but only with changes in zoning laws and actual construction. Particular zoning restrictions or specific laws on property taxes may make it easier for families to remodel their current houses rather than buying new houses. Remodeling limits the supply of housing further, because fewer houses will be built and put on the market than otherwise.

So what will lower the price of housing? Lowering demand will help. As the Fed gradually increased interest rates over the last year, the cost of borrowing will increase the cost of borrowing, reducing demand for housing. At the same time, to lower the price of housing, the country must also increase the housing stock. Rewriting zoning laws to allow for new construction and then building more housing quickly will significantly help “burst the bubble.” Until then, can I buy your two-bedroom, one bath shack for $459,000?