Putting the Market in Historical Context
As you most likely know, the American housing market is currently in a state of transition. You can’t read the news online or turn on the TV without hearing about high mortgage rates, unaffordability, and low inventory.
The pace of home sales is the slowest it's been in over a decade. And yet, we are facing a shortfall of homes for sale and of buyers at the same time. This—on its face—feels like a contradiction. How can there be both not enough houses for sale and not enough people to buy them? In partnership with KellerINK, the Keller Williams Research Team took a look at real estate history to better understand how we got here and where we may be heading.
Location. Location. Location. The Supply Crunch.
Throughout history there have been a couple of simple principles that define where people want to live. The first is proximity. A common line through the history of housing is that people don't want to regularly travel far from home. The second is social values, which shapes community involvement and access to resources.
For the sake of brevity, we'll start with the Industrial Revolution. For most Americans, this was the beginning of the "commute" as jobs moved toward industry in cities and away from rural agriculture. At the time, transportation consisted primarily of walking. The horse-drawn omnibus—and later, the trolley—aided travel over longer distances. However, people lived within a short distance of where they worked. This led to extreme density in cities and housing intermingled with industrial areas.
The transition from agrarian life to the factory created immense social friction. People thought it was causing damage to familial structures. A counter movement emerged that viewed city centers as "dens of iniquity." Thus, a social impetus for the suburb was born. Trains became the solution and soon, cities formed like spiderwebs around train stations. Each new station supported a new community that could access the city center. The spaces between rail lines remained largely empty. That changed when the Ford Model T began rolling off the assembly line in 1908. The car shaped our cities into the concentric rings we see today.
So, what does this have to do with anything today? Well, the last major transportation innovation that reshaped American cities was the car. Meaning it's been 115 years of building out cities as far as people are willing to drive. While job centers have moved in and out of city centers over time, the most recent economic upswing saw jobs moving back into cities.
There is an argument to be made that modern cities don't have room to grow outward. People have always had a limit on how much time they're willing to spend traveling to and from work on a daily basis. We saw obvious evidence of this during the COVID-19 pandemic. Remote work cut the tethers that confined people to existing suburbs. As a result, small towns, exurbs, and vacation towns began to see their housing markets explode.
If cities cannot grow outward, the only other direction to go is up. Despite windowless flop houses and "dens of iniquity" no longer characterizing multifamily housing (if they ever truly did,) the stigma of urban density has been a persistent one. The societal upheavals that helped create the suburbs a century ago are now limiting how we deal with modern challenges. Many of the policies and practices that drove these transitions were rooted in both racism and classicism.
We sit now with two obvious problems in front of us: we need more housing, and we need somewhere to put it. There are two options for where housing can go. We will either see an increase in housing in the city, which could increase density, or we will see an increase in housing in areas too far for a reasonable commute. But there are solutions! We can change zoning laws to decrease density and we can find a way to shorten commutes. One way is to simply eliminate commutes for many by implementing remote work. Otherwise, we will have to wait for those self-driving/flying/hyperloops to emerge.
Cash Rules Everything Around Me. Or Does It?
The other side of this housing coin is financing. In the last three years, mortgage rates have gone from the lowest on record to the highest in over three decades. The modern housing market is ruled by the thirty-year, fixed-rate mortgage. It’s the most common financing tool used to buy a home, and it came to prominence in the 1960s following several decades of innovation.
The Great Depression decimated the housing market when as much as 50 percent of homes in the United States faced foreclosure. The result was a litany of government organizations and policies. The goal was to address the crisis of families losing their homes and banks whose balance sheets were being wiped out.
The loans most homeowners held prior to the depression were five- or ten-year mortgages. The balances were only partially paid off over the term. This meant that when the loans came due, they had to either refinance at prevailing rates or the full value of the loan was due. If you couldn't refinance or pay, the bank foreclosed. At the height of the depression, banks were foreclosing on a thousand homes every day. The result was the creation of the Fair Housing Association (FHA) and the long-term, fixed-rate mortgage.
What banks needed to feel comfortable lending money over such a long term was a way to sell the loans to investors. The creation of Fannie Mae (and later Freddie Mac) allowed banks to have loans packaged in the securities and sold. These government-sponsored enterprises (GSEs) created a great deal of confidence in financial markets that long-term mortgages were safe bets. Perhaps too much confidence.
An Unusual Consequence
Anyone who lived through the great recession of 2008 probably remembers hearing about mortgage-backed securities. We won't go into detail about the mechanism of the housing market collapse and subsequent financial crisis here. We will, however, point out something about the mortgage-backed securities market most people probably don’t know. Mortgage rates are determined by mortgage-backed securities, and since 2009, the Federal Reserve has played a major role in that market.
In its simplest level, when there is a lot of money going toward buying mortgage-backed securities, mortgage rates are low and vice versa.
As part of its effort to combat high inflation, the Federal Reserve began reducing its participation in mortgage-backed securities markets. This has caused mortgage rates to increase even more than other interest rates.
The unusual consequence of this is that in an effort to lower prices for everything, the Federal Reserve has made home ownership less affordable.
In the past, rising interest rates often resulted in recessions. This meant higher unemployment and home sales driven by downsizing. Right now, we have record-low employment, continuing economic growth, and declining inflation. The result is homeowners with record low interest rates with good jobs and no reason to sell. We call this the "lock in effect."
In addition, construction companies are facing high rates, the risks of limited demand, and the issues we previously laid out. Not good incentives to start building hundreds of thousands of more homes.
The question now is if there is a way to bring housing affordability in line without bringing back high inflation. One solution is time. Eventually markets and interest rates will adjust after we deal with the consequences of 7.5 percent mortgage rates. Another is for the Federal Reserve to reenter the mortgage-backed securities market to bring the relationship between mortgage rates and other interest rates back in line with historical norms.
Either way, we know the market ebbs and flows. It can be helpful to look at history to inform the decisions we make today. Whether we are proactive about it and look to incite change depends on us.
— Written by Isaiah Tabach and Ruben Gonzalez