The Real Reason House Prices Skyrocketed
What The Real Estate Industry Won’t Tell You
[An earlier version of this piece appeared in Forbes.com and got over 300,000 views!]
For more than two years house prices have been increasing faster in metro Phoenix than in any other city in the S&P/CoreLogic Case-Shiller Home Price Index. The median single-family house price in metro Phoenix increased $100,000 in 2021 and is continuing to increase crazy fast in 2022, according to Phoenix MLS data.
#1 Reason For Skyrocketing House Prices
Almost everyone agrees the main culprit causing our skyrocketing house prices in Phoenix and the United States is the extremely low number of houses for sale. What we don’t agree on is what’s causing the low supply of houses for sale.
In metro Phoenix at the end of 2019 (before Covid), 9,700 single-family houses were for sale. At the end of 2021, only 4,500 single-family houses were for sale in the Phoenix MLS.
The real estate industry loves to say the only solution is to build more houses in the future. Their unspoken point is we can’t stop house prices from soaring today.
What The Real Estate Industry Won’t Tell You
The industry conveniently ignores the other part of the supply equation: the number of houses sold. The number of houses for sale is equal to the number of houses put up for sale, minus the number of houses sold. (Very few houses have been pulled off the market unsold.)
The supply of houses for sale is so low today because investors bought up so many houses that they pulled down the supply of houses for sale. Mathematically, when investors buy more houses, fewer houses are for sale.
Let’s compare 2021 to the last year before the pandemic, 2019. At the end of 2021 we had 5,200 fewer single-family houses for sale in the Phoenix MLS than at the end of 2019. But in 2021 investors bought 5,900 more single-family houses than in 2019.
If investors had bought the same number of houses in 2021 as they did in 2019, by the end of 2021 the number of houses for sale would have gone up to pre-Covid levels, and the size of the median house price increase would have gone down to pre-Covid levels.
Much Higher Landlord Purchases Caused Home Prices To Skyrocket
In the hottest real estate market in the country, Phoenix, the supply of single-family houses for sale would have been back to pre-Covid levels by the end of 2021–except that investors bought a lot more houses in 2021 than they did before.
Investors bought more than twice as many houses than in 2019. Live-in buyers, however, actually bought fewer homes in 2021 than in 2019.
Why did landlords buy so many more houses in 2021? There are a lot of reasons, including the rise of short-term rentals which has taken thousands of houses out of the Phoenix housing supply and put them into the Phoenix lodging supply.
One national, long-term, systemic cause is that real estate investors get huge tax breaks that live-in owners don’t get. Landlords naturally buy a lot more houses because of those tax breaks.
Those government incentives also make real estate booms (and busts) a lot larger than they would be if the government didn’t, essentially, pay landlords to buy single-family houses.
We have more investor-owned houses to begin with because of those tax breaks. Then when the market gets hot, even more investors jump in and buy than would if we didn’t have those tax breaks. House prices increase a lot more because of those tax breaks.
Why Increased Demand Increases House Prices So Much
In economics jargon, for single-family houses, both the price elasticity of supply and the price elasticity of demand are incredibly inelastic. That means house prices are super sensitive to unexpected increases in demand.
When the number of houses sold jumps up for any reason, house prices jump up an unusually large amount because it will take so long for the supply of houses to increase enough to match the increase in sales.
In addition, the demand for single-family houses is also incredibly inelastic which means those higher prices don’t reduce the number of houses sold very much. Prices have to increase an unusually large amount to reduce sales.
Together, the two extreme inelasticities mean small increases in demand for houses can lead to house price increases that seem totally out of proportion. That is, relative to other goods, an increase in demand for houses causes an extreme increase in prices.
There’s more. Because houses are partially an investment good for live-in homeowners and are 100% an investment good for landlords, house prices can act more like stock prices than consumer goods prices. Like with stocks, fast price increases cause optimistic buyers to buy expecting prices to go even higher. Unfortunately, the most optimistic buyers set the prices for both stocks and houses.
Rapidly increasing house prices make buying houses more attractive to those momentum traders which causes house prices to increase even more in a feedback loop. In addition, if you start with a given amount of money, you can borrow a lot more money to buy houses than you can to buy stocks. That enables house prices to increase even faster in a hot market.
Quickest Way To Increase The Supply Of Houses For Sale
A quick solution to the low Phoenix and U.S. supply of houses for sale is to level the playing field and to stop giving any tax breaks to landlords that live-in owners don’t get. Make it so everyone gets tax breaks on one house, if they own it and live in it, but that’s it–no tax breaks at all related to any other single-family houses or condos they buy in the future. Then watch U.S. house prices become less crazy in both good times and bad.
Economically, if we had done this a year ago, the U.S. would be well on its way back to normal levels of supply now and, in addition, we would greatly reduce the size of future housing booms and busts. Far greater economic stability for households would create far greater economic growth in the future–with no out-of-pocket cost to the government. The homeownership rate would also increase–with no out-of-pocket cost to the government.
We have a lot of other economic knobs we could turn to stabilize U.S. housing supply and prices–if needed–but first, the government should at least stop making things worse with its huge, landlord tax breaks.
Here’s one crazy example. Last year the typical house in metro Phoenix appreciated $100,000 but, if it’s owned by a landlord, our genius government pretends the house depreciated in value and gives the landlord a tax deduction for the imaginary fall in value! No wonder investors have been buying more and more single-family houses for decades and U.S. house prices have become more and more unstable.
Many good points in your analysis, but am I to understand that you want to take away tax rules that apply to every other business/employer? Have you considered that real estate investing is like every other business with real costs of doing business that should be deductible? Should Boeing not be able to depreciate the cost of their very expensive manufacturing facilities? Under your scenario, no business with real hard costs would survive in the united states.
Have you ever considered the fact that institutional investors (hedge funds/big banks) are buying up real estate at unprecedented levels because our government is allowing them to borrow money at virtually no cost? The small investor does not have that ability. Perhaps more realistic loan terms would solve this problem and keep the keep the reckless institutions in their own lane. As interest rate rise to normal levels, I suspect that the institutions will run from this business and leave scorched earth in their wake. Let's wait and see which one of us is right. I, for one, am getting out and selling to institutional investors, as we speak, and intend to go back in and mop up the mess that they leave in their wake.
Consider this: without landlords, many, who cannot afford to buy a house, at any price, will add to homeless count.
Many good points in you analysis, but am I to understand that you want to take away tax rules that apply to every other business/employer? Have you considered that real estate investing is like every other business with real costs of doing business that should be deductible? Should Boeing not be able to depreciate the cost of their very expensive manufacturing facilities? Under you scenario, no business with real hard costs would survive in the united states. Have you ever considered the fact that institutional investors (hedge funds/big banks) are buying up real estate at unprecedented levels because our government is allowing them to borrow money at virtually no cost? The small investor does not have that ability. Perhaps more realistic loan terms would solve this problem and keep the keep the reckless institutions in their own lane. As interest rate rise to normal levels, I suspect that the institutions will run from this business and leave scorched earth in their wake. Let's wait and see which one of us is right. I, for one, am getting out and selling to institutional investors, as we speak, and intend to go back in and mop up the mess that they leave in their wake. Consider this: without landlords, many, who cannot afford to buy a house, at any price, will add to homeless count.