Understanding the Housing Market Puzzle#

Reason 1: The Goalposts Have Moved (Lower Down Payments)#

Houses don’t need to be affordable for you to buy one. If that sounds confusing, there’s an entire industry working hard to make it true.

You don’t save the entire price of a house; you save for a down payment.

The truth is, housing costs are completely out of line with wages. Wages haven’t kept up with house prices.

• Wage Growth vs. Price Growth (Example over 3 years):
  • According to Zillow, the average home sold for $230,000 in 2020.
  • By the start of 2023, the average price was $330,000.
  • That’s a jump of $100,000 in less than three years.
  • According to Forbes, the average American makes $59,000 before tax.
  • After federal tax and FICA, take-home pay is about $49,000.
  • If this average person saved a ridiculous 70% of their take-home pay ($34,300 per year), their savings would grow by roughly$100,000 over three years.
  • Result: Even saving a massive 70% wouldn’t get them any closer to their goal because the house price grew just as fast as their savings.

So, the average home earns as much as the average person just from its price increasing!

However, most people only save for a down payment. A 20% down payment only grows at one-fifth the rate of the full price in absolute terms. This allows people to still potentially get into the market.

• Down Payment Realities:
  • A National Association of Realtors report found the average down payment for a first-time homebuyer is just 7%.
  • For repeat buyers (who likely have equity), the average is only 17%.

If you only need a small deposit, house prices can increase to many times your income before buying becomes impossible.

• Lower Down Payment Makes It Possible: If you only needed to save a 7% down payment ($23,100 on a$330,000 house), a 10% savings rate ($4,900 per year from average take-home pay) over three years would get you close enough ($14,700 saved, plus some market growth perhaps). This would require discipline but isn’t impossible with sacrifice.

If even that feels too hard, Zillow recently announced they are trialing a 1% down payment loan product. This is designed to help people who couldn’t save much make the biggest financial commitment of their lives.

• Zillow’s 1% Down Program:
  • Buyer pays a 1% down payment.
  • Zillow contributes an additional 2% at closing as a grant (money you don’t have to pay back).

So, even though houses are “making more money than you are” through price increases, the price of entry (the down payment) is being reduced just as fast.

But hold on – that just gets you the down payment. What about making the monthly mortgage repayments, especially if you couldn’t even put 20% down?

Reason 2: Nobody Wants to Sell (Low Inventory)#

The market isn’t necessarily getting more expensive because nobody can afford to buy, but because nobody is selling.

People who locked in low interest rates don’t want to give up their 30-year fixed rate below 3%. So, nobody wants to sell their current home right now.

At the same time, there are still plenty of people who want to move.

• Home Sales Dropping:

  • According to data from the National Association of Realtors, home sales in America are at their lowest level in a decade, even though the population has grown.
  • In 2021, about 6 million homes were sold.
  • Currently, only about 4 million homes are selling at an annualized rate.

• Why Potential Sellers Stay Put:

  • The rental market is often even more unaffordable.
  • If they move and buy a new home, their new mortgage will have a much higher interest rate than their current one.
  • Moving can be disruptive to social and family lives, especially for those who already moved during Covid.
  • The average homeowner stays in their home for 13.2 years. After a lot of buying activity in the last three years, many Americans are just settling in and aren’t considering selling anytime soon.

This situation creates more competition in the rental market because the slower housing market keeps people renting longer. Supply is constrained because people aren’t moving from renting to owning.

• Buyers Waiting: New potential buyers are also choosing to wait, hoping that interest rates will drop.

• Household Size Increasing: For the first time in 160 years, the average number of people living in a household recently increased, according to Pew Research. After a long trend of smaller families and people moving out on their own, this shift happened because more young adults are choosing, or being forced, to live with their parents for longer to avoid the unaffordable housing market.

The market is still active, but regular buyers and sellers are mostly sitting on the sidelines, waiting for moving into a new home to become more affordable.

Reason 3: Who is Still Buying?#

The people who are still active in the market are the third reason this situation can keep going on longer than you might think. There are three main groups:

1. All-Cash Buyers: These are people who have money from selling their old home and want to buy a new one without needing a mortgage.

   • Example: A Boomer who bought their home in the 1970s for “three nickels” and wants to downsize now. The current high prices are ideal for them because the difference in value between their large old home and a smaller new property is larger, giving them more cash.

2. People Moving Interstate: Unaffordable housing is pushing people out of expensive cities.

   • While most people prefer to stay near friends, family, and familiar places (the average American lives only 18 miles from their hometown), the cost of living can force a move.
   • If you’re really struggling in a high-cost city, moving to a cheaper city can improve your lifestyle by lowering rent and property prices.
   • Moving from a city like San Francisco, Seattle, or New York to almost anywhere else means you can buy a lot more house for the same money.
   • However, your higher income from having worked in those expensive areas can actually push up prices in your new local market. In trying to avoid rising prices, you can inadvertently make it worse there. (Shout out to Patrick Boyle’s question about where my friend How Money Works should live – probably Dubai if he’s a flashy YouTuber type into malls, designer goods, and indoor skiing, unlike me who stayed in my crappy one-bedroom San Francisco apartment because moving is a pain).

3. Investors: Investors are primarily focused on the return on their assets.

   • Prices are high, and investors using loans are also paying higher interest rates.
   • In return, they are charging higher rents to long-term tenants or making money from short-term rentals on sites like Airbnb.
   • Make no mistake, even for investors, prices are still very high.

Signs of Potential Change?#

But this situation can’t last forever. This is the worst it’s been. As much as I hate admitting those stupid finfluencer thumbnails might be right, things are starting to change.

This explains why the market has largely resisted a major sell-off and why prices could potentially go even higher, even though it doesn’t seem logical.

• An updated Redfin report shows that investor purchases have significantly slowed down.
• Surveys from local agents in cities like Las Vegas, Austin, Miami, and Houston indicate that institutional purchases have completely stopped.

Earlier this year, the private equity company Blackstone (not to be confused with the index company BlackRock) had to block investors from withdrawing money from its $71 billion REIT. This sparked concerns that the whole system might be overvalued.

If investors pull their money out of these trusts too quickly, the investment managers (like Blackstone in this case) would be forced to sell properties from their portfolio to get the cash.

BlackRock was accused of overestimating the value of properties in its portfolio. It’s hard to prove that until they are forced to sell something.

• The Ripple Effect: As soon as just one property needs to be sold, all other similar properties in that trust have to be revalued downwards to match the sale price.
• A significant drop in the trust’s value could trigger more investors to withdraw, forcing the manager to sell more properties, which pushes prices down even further.

But don’t get your hopes up too much. If you own shares in a REIT, the easiest way for you to get your money out is usually to sell your shares to another investor. This doesn’t require the fund manager to actually sell any of the properties themselves to give you cash.

Bonus Reason 4: The Rise of Generational Wealth#

There’s a bonus fourth reason why prices might stay high: Wealthy families are getting better at holding onto properties across generations.

In the past, family wealth often struggled to last beyond the first two generations. But now, investing is so easy and can be so profitable that we might be entering a new era where family dynasties could potentially last for centuries.

One group of American billionaires is already there. Go watch my new video over on How History Works to find out why the Rockefeller fortune isn’t likely to disappear, ever.

(Video URL: https://www.youtube.com/watch?v=1zjcZ661ups)

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