The Real Estate Market is BROKEN (The End of Homeownership)

The US housing market is officially broken. Buying a house has never been as unaffordable as it is today. The rise in property values is helping cause a Great Divide that is straining the social fabric of this country. On the one side, you have property owners: individuals and families that have seen their wealth increase significantly due to higher real estate values. But on the other side, you have non-property owners: people that don't own property and are getting increasingly priced out of ever obtaining home ownership.

In this video, we are going to answer three questions: how we got here, what this means for average Americans, and finally, why homes in the US may never be affordable again. Now, let's get into it. For generations and generations of Americans, home ownership has been relatively attainable by most measures. One way to get a sense of home affordability is to look at a metric known as the home price to median income ratio. As its name suggests, this metric measures how expensive buying a house is relative to the typical family's income.

So, if the typical house is selling for $200,000 and the "quote unquote" normal family income is 50k, the home price to median income ratio is four—calculated by dividing the home price by the household income. For much of the post-war period, this is roughly where this metric landed, somewhere between 4 and 5. This meant that for decades, home ownership was well within the reach for average middle-class families. Of course, it took effort in savings, but a young family with normal careers could reasonably expect to be able to afford to purchase a house.

Things are quite different now. Instead of the normal 4 to 5, the home price to median income ratio is a staggering 7.5, the highest on record. On nearly every single metric, it has never been as challenging to buy a house. Take a look at some other measures of home affordability. The Case-Schiller US Home Price Index is at an all-time high—50% higher than 2019 levels and over four times what it was back in 1990.

Then there was the Goldman Sachs housing affordability index. The lower the number, the less affordable housing is. We can see that home affordability has never been lower. Current readings are even worse than the lows hit at the peak of the last real estate bubble. No matter how you slice it, the US real estate market is not looking good.

To understand how the US real estate market got in this mess in the first place, you have to understand how home prices work. Houses are what economists refer to as a commodity. Like all so-called commodities, home prices are heavily influenced by the laws of supply and demand. Let's use this graph here to demonstrate. This concept of supply and demand is incredibly important. Once you understand what I'm about to tell you, you will start to be able to see why the housing market is acting so crazy.

On this line, we have supply—think of this as the supply of houses available to be purchased. The other line here is demand—think of this as the number of buyers in the market looking to purchase a property. Importantly, it also represents how much these potential buyers are willing and able to pay. That point at which our two lines cross is the price at which houses are selling for. As we are about to see, shifts in supply and demand can lead to significant price movements.

Let's start with the supply side of the equation. If you've been looking for a house anytime in the last 3 years, you know what I'm about to say firsthand: the supply of houses for sale in the US is extremely limited. This chart shows the number of active listings during each month—think of this as the number of houses that are currently for sale.

As we can see, ever since 2020, there have been significantly fewer homes available on the market. Historically, there had been anywhere between 1.2 and 1.4 million active listings at any given time, but over the course of the past 3 years, it has been more like 400,000 to 600,000. This is just 30 to 50% of what's normal. The number of active listings even went as low as 346,000 during February 2022.

Going back to our supply and demand graph, let's see what happens to prices as supply decreases. Notice how now the supply and demand line cross at a higher price. The biggest driver of this lack of supply is that the United States went through a more than decade-long period where not enough houses were being built.

As we can see here, at the peak of the construction boom in the early and mid-2000s, 1.75 million new houses were built during the course of a year. If you were a home builder or in the construction industry, times were great—new houses were popping up throughout the country, and businesses supporting this building frenzy were making a ton of money. However, as the old saying goes, every good thing must come to an end.

Eventually, the bubble popped. Many of these home builders went under, and skilled workers left the construction industry. The US construction industry lost a staggering two million workers as building activity screeched to a halt during the recession. As the economy recovered, new home construction remained low, as many home builders and tradesmen had shifted to different industries.

From 2009 to 2020, less than 1 million new houses were being built each year in a country with more than 330 million citizens. There simply weren't enough houses being built to keep pace with population growth and new family formations. This lack of supply is one of the biggest frustrations and annoyances of millions of young Americans.

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The lack of supply of houses isn't the only challenge the US real estate market is facing. The historically low interest rates of 2020 and 2021 have created an effect known as golden handcuffs. In the United States, the overwhelming majority of houses are purchased using what is referred to as a 30-year fixed-rate mortgage. With these fixed-rate mortgages, the interest rate at the time of purchase remains the same for the entire period the loan is outstanding.

As we can see here, mortgage rates in 2020 and 2021 were around 2 to 3%. People that bought a house or refinanced an existing mortgage during this time were able to lock in an insanely low interest rate. On the other hand, today's buyers are not as fortunate. Current mortgage interest rates are above 7%, well above 2020 and 2021 levels.

This strange dynamic is further worsening the supply problem, and here's why: it is estimated that a whopping 62% of homeowners have an interest rate on their mortgage below 4%. Virtually all of these tens of millions of mortgages are non-transferable, meaning that if someone wants to sell their current house and buy a different one, they lose that low interest rate. They would be trading their 2% interest rate for a new mortgage at a 7% rate. This may not sound like a big deal at first, but just wait until you see the numbers.

Borrowing $400,000 at a 2% interest rate results in a monthly mortgage payment of $1,478. If we increase that interest rate up to 7%, that monthly payment skyrockets to $2,661. The amount borrowed is exactly the same, but the payment is nearly double due entirely to the higher interest rate. These higher interest rates are making it so that people that would normally be looking to sell their house simply can't afford to move.

These locked-in low mortgage rates are being called golden handcuffs—both a blessing and a curse. Good in the fact that homeowners are saving thousands of dollars in interest every year, bad in the fact that homeowners with these low rates can't afford to sell and switch out their low rate for something much higher. This dynamic is yet another driver of the low supply of homes available on the market.

Up until this point in the video, we have focused on all the challenges facing the supply side of the equation. The US has underbuilt houses for decades, and low mortgage rates are keeping people from listing their house for sale. These are two large factors leading to low supply and high home prices, and this makes sense intuitively.

However, this only tells half the story. To truly understand why the real estate market is broken, you also have to understand what is going on with demand. Let's go back to our supply and demand graph. If you recall from earlier, our demand line here represents the number of buyers in the market and how much they're willing and able to pay. This is an important distinction.

Historically, a buyer's purchasing power is closely tied to interest rates. As we talked about earlier, the lower the interest rate, the lower the monthly mortgage payment. Put another way, the lower the interest rate, the more a buyer can afford to pay for a house. Let me explain. Let's say someone is looking to have a monthly mortgage payment of $2,000. They determine that this is what they can afford to pay each month based on their income.

At an 8% interest rate, our buyer here can afford to borrow $280,000 and have the monthly payment still be around $2,000. If interest rates were to fall to 5%, the amount our buyer can borrow increases to $380,000. If rates fall even further to 2%, our buyer can now borrow a staggering $550,000—all while keeping the mortgage payment around $2,000.

Once you understand this concept right here, you can begin to understand why the real estate market went absolutely bonkers in recent years. Mortgage rates fell to historically low levels starting in 2020. Buyers can now borrow larger amounts of money to purchase a house. Using our supply and demand graph, this higher buying power resulted in demand increasing, demonstrated by our demand line getting pushed further out to the right.

The result of this increased demand was higher home prices and bidding wars. With this background, the crazy real estate market of 2020 to 2022 should start to make some sense. However, something changed this year that makes me say that the US real estate market is now fundamentally broken.

Interest rates are no longer at historically low levels; in fact, interest rates have increased so much that they are now at multi-decade highs. Logically, these higher rates should have caused demand to weaken and home prices to decline significantly. However, that has not been the case. Home prices across the country have barely budged. Put simply, the real estate market isn't functioning properly.

First-time home buyers are getting hit on both sides: home prices are at all-time highs, and interest rates remain elevated. I don't want to sound all doom and gloom, but the days of home ownership being the bedrock of the US middle class may be gone for good. Short of any massive government regulation, the only true solution to solving America's home affordability issue is building millions of new houses. If the country is able to increase supply while demand remains steady, prices will start to come down over time.

There is just one big problem: building new houses is not cheap. In fact, according to the National Association of Realtors, the cost to build a new house increased by 42% from 2019 to 2022. The typical newly built single-family house now costs a staggering $645,000. This is causing a problem for first-time home buyers. The vast majority of new construction is happening at price points that are only affordable to the wealthy—AKA people that are existing homeowners with equity in their house or families with sky-high incomes.

There are simply not enough starter homes being built in the United States. More and more potential first-time home buyers are competing for a limited number of entry-level houses. The result is that an increasing number of families are getting priced out of home ownership.

I'm curious to hear what your thoughts are. Drop a comment and let me know what you think. So, there you have it. Make sure to hit that subscribe button because it's my goal to make you smarter with each video I make. Talk to you again soon.