The Expert Podcast

Once again, we're seeing the construction industry pull back on the volume of construction. The question is, what does this mean for the real estate market, and what does it mean for the construction industry? It's no secret that home prices have gone up, interest rates have gone up, but more importantly, the cost of building a house is dramatically higher. For a while, it was blamed on the lumber price spike, where lumber prices went up from $500 per thousand board feet up to $1,500, a threefold increase. Now, it's back down to about $650 or $700 per thousand board feet, so it's not quite as high, but there are still shortages and much higher prices on all the other items that go into a house.

Look at this picture of a house in this article. You can see that there's lumber that goes into the house, but there are many more things you have to consider. You have all these windows, roofing, plumbing, electrical, doors, finished work, sheetrock, paint, cabinets, and flooring. The lumber is usually about 25 percent of the cost factor of a new home build, including labor. Even though lumber has come back down, all of the other factors that go into a house—such as labor, finishings, permits, taxes, and the builder's carrying costs because of interest—have all gone up. What's happened is that the rise in the cost of building a house has exceeded what builders think the market will bear. It's almost as if you build a brand-new house, and you can't even sell it for enough to support your cost. You can't get back what you put into it.

So, what are builders doing? They're pulling back on how many houses they're building. No surprise there, no secret there. But what does it mean? Well, right now, the reason that housing prices went up in the first place, not counting construction costs, has to do with inventory. Think about it: a used house, a pre-owned house, doesn't have any building costs. The building costs were baked in when it was constructed 5, 10, or 15 years ago, so the lumber price spike and labor spike don't affect the price of a resale home. Why did those prices skyrocket? Well, it's because of supply and demand. There were many more buyers who wanted to buy a house than there was inventory available. That's why houses had 5, 10, 15, or even 20 offers on the same house. Well, only one of those people ended up with the house, and all the others are still in the market.

Certainly, there are more houses in the marketplace now. More people are putting houses for sale, but there's still the same number of buyers. In most markets, the price hasn't really crashed. Sure, some markets have seen a little bit of a pullback in price, and some of the inflated prices are being discounted a little bit, but it's not like the market has gone back down to 2018 levels. There are neighborhoods that we looked at that in 2017 or 2018 were $350,000 to $450,000 houses, and now they've jumped up to $750,000 to $800,000. Some of these houses were asking $820,000 to $830,000, but now some are listed at $720,000 to $740,000. Very rarely are they over $800,000, and there are still a few priced at $799,000, but they're not going back down to $400,000 or $450,000 or even $500,000. The prices are still going to be in the sevens.

On top of that, there's also a higher interest rate. It used to be 3%, 2.5%, or 3.5%; now it's 5% or 6%, and it's probably going to go higher again for resale houses. So, there are still the same number of people who want to buy houses. What's going to happen is that, in two, three, or four years, when this current home building pullback starts to affect the resale market, there will be even more of a shortage. Experts predict that right now, there are already 5 million homes short of what the market needs, and that's assuming building continued at the rate that it was going. Well, now the rate is going to slow down.

There's still more people coming into the market every day: new families being formed, people moving from other countries, people becoming adults, and people who were 18, 19, or 20 years old now turning 24 or 25 and needing to buy a house. There are many reasons why there needs to be what's called household formations. These new households have to come from somewhere, or people who were renting now want to become buyers. This always happens. There has never been a long-term period where fewer homes are needed. There's always more demand for homes. The population is not shrinking, and the demographic that wants to be a homeowner is not shrinking either.

So, now you have a pullback that started maybe four or five months ago and will probably continue for at least a year or a year and a half. By the end of 2023, who knows what will happen, but for the last half of 2022 through 2023, there won't be a very aggressive home builder construction frenzy to build a bunch of new houses. Builders are still in shock from what happened in 2008. They're still cautious about putting money into speculative homes, so they're going to play it cool. They're going to play it cautiously. What will happen is this will put more pressure on available inventory.

So, once we get into 2024, 2025, or 2026, there's going to be an even more serious housing crisis with not enough houses to go around—a shortage of inventory. Whatever happens to prices in the next year—maybe they soften a little, or maybe they don't spike as much as they did—the housing shortage will catch up to it. Houses are not going to go back down to where they were in 2016, 2017, or 2018. They may level off for a while, but the housing shortage being created today won't show up for two or three years. That's where you make your money: you look at what's going to happen down the road. It's like playing chess; you look three moves ahead.

There's no housing being built right now, and years from now, people are going to need them, and they're not going to be there. That's supply and demand. House prices will go up. Let us know what you think in the comments.