House prices in the US today are higher than they were in 2006, the year the housing market started to collapse. But today’s high prices don’t make the market vulnerable to a similarly severe downturn because these prices are mostly the result of unmet demand caused by inadequate supply.
Today, we are not building the housing we need to build. In 2006, high home prices were caused by easy access to credit, which encouraged speculation, fueling demand and overinflating prices.
But even though a housing-fueled economic crisis is not imminent, high home prices do have significant impacts on the larger economy.
Today’s high prices are driven by inadequate supply, not easy credit
Access to easy credit was a hallmark of the buildup to the housing crisis, but following the Great Recession, it became more difficult to obtain a mortgage, especially for low-income households and those with less-than-perfect credit. Since 2000, fewer applicants with lower credit scores have been approved for mortgages, causing median credit scores to rise, particularly at the lower end. The median credit score increased 43 points (from 695 to 738) between January 2000 and April 2018 while the credit score of the bottom 10th percentile increased 67 points (from 581 to 648) between January 2000 and April 2018.*
The total number of new homes for sale has dropped since the crisis, as has the number of new housing starts. Although up from its lowest years, the current level is still below that of the 1960s, when the total population was 60 percent lower than in 2018.
Residential housing’s contribution to the gross domestic product ranged from 4.5 to 5.3 percent from 1980 to 2000, with an average of 5.0 percent. It peaked at 5.9 percent in 2005 and then plunged to 2.5 percent in 2010. Since 2016, the share has inched back up to 3.3 or 3.4 percent, still significantly below the historical average.
Estimates put net new housing supply in 2017 at almost 350,000 units lower than net new household formations. Not only is supply low, but there is a mismatch between the type of housing being built and the type of household demand. As building costs increase, a greater portion of construction occurs at the higher end of the market, despite greater demand for low-cost homes.
This mismatch disproportionately drives up housing costs at the lower end of the market, where demand significantly exceeds supply. Since 2014, the annual increase in house prices for the lowest 20 percentile has exceeded the aggregate house price increase.
What this means for the larger economy
We’re not vulnerable to a housing collapse today like we were in 2006, but high home prices caused by inadequate supply will reverberate in the larger economy in at least four ways.
1. Significantly increased rent burdens.
Higher home costs at the lower end of the market impedes homeownership among lower- and middle-income households and increases rent burdens as demand further exceeds supply. Based on the decennial census and the American Community Survey, we estimate the share of households paying more than 30 percent of their income on rent increased from 39.8 percent in 2000 to 49.7 percent in 2016.
The share of rent-burdened households rose most significantly for households earning between $20,000 and $50,000, from 27.3 percent in 2000 to 62.3 percent in 2016.
2. Reduced demand for consumer goods.
If housing accounts for a greater share of household income, households will have less to spend on other goods. An increase in housing supply and decline in housing costs could result in greater consumption of other goods and services that stimulate growth and employment gains in other sectors, which could have a multiplier effect.
3. Misallocated labor.
Stringent housing supply leads to a misallocation of labor as higher housing costs prevent workers from moving to or remaining in cities with greater employment opportunities. A recent report found housing constraints lowered economic growth by 36 percent between 1964 and 2009.
4. Exacerbated wealth disparities.
When house prices increase because of supply restrictions, low-income renters face higher rent burdens and greater difficulty finding an affordable house to own, especially when the credit market is tight.
On the other hand, existing homeowners will see their wealth continue to grow. This widens the wealth gap between owners, who already have higher-than-average income and wealth, and renters, whose income and wealth are lower than average. Because homeownership is an important tool for building long-term wealth, and children of homeowners are more likely to be homeowners, this can further exacerbate wealth inequality for future generations.
Whatever the cause, high home prices put homeownership further out of reach for families who could benefit from this powerful wealth-building tool. We urge policymakers to examine all reasonable methods for increasing the US housing supply.