One Federal Reserve governor knows all too well how difficult the housing market has become.
“Trust me, I know it is red hot because I am trying to buy a house here in Washington,” said Fed Governor Christopher J. Waller in his speech this week to the Alrov Institute and the Rutgers Center for Real Estate. “And the market is crazy.”
Waller’s personal experience was only a slice of his address that focused on the reasons behind the growing affordability crisis in both the for-sale and rental markets, “a singular feature of the U.S. expansion since the COVID-19 recession.”
Housing costs are also a key factor for inflation — a major concern for the Federal Reserve as it pursues higher interest rates to tamp down runaway consumer prices.
“So, my colleagues and I … share your interest in what is happening and will happen in real estate markets,” Waller said.
“Housing costs—measured either by rents or by the average monthly payment by homeowners—have increased substantially during the pandemic,” Waller said. “As housing costs continue to increase, housing will likely become an ever-larger share of household budgets.”
Rents have risen 6.5% since January 2020, according to the Consumer Price Index, but Governor Waller noted that may be an underestimate since the index measures rent under current leases and ‘can be slow to reflect market conditions.” The impact will hit harder on lower-income households who spend more of their budget on housing.
In the for-sale market, home prices are up 35% since the beginning of the pandemic, Waller said citing the Zillow Home Value Index.
“That rate of increase is much faster than the previous five years and even faster than during the housing boom of the mid-2000s,” Waller said.
The Fed’s efforts to lower interest rates in the wake of the pandemic helped lower rates for 30-year mortgages by 1 full point from January 2020 to January 2021, “which helped dampen the costs of rising house prices over that period,” Waller noted.
Last year, rates remained around 3% before rising at the end of the year. But that’s not the case now, Waller noted, as the 30-year fixed rate this week neared 4.5%. That caps off three months of rapidly rising rates, partly due to the central bank’s intention to unwind certain monetary policies that kept rates low.
“So, while lower rates may have made home purchases a bit more affordable early in the pandemic, the more recent rebound in mortgage rates and the continued rise in prices have made home purchases less affordable for many people,” Waller said.
The other side of the housing price equation is demand.
“Looking over the past two years, one would think the large increase in home prices would have made it more difficult for renters to become first-time buyers,” Waller said. “Surprisingly, we have not seen evidence of that yet.”
He noted that the share of renters between 20 and 45 who bought a home last year was the highest since the Great Recession. In 2020, Black families represented 7.3% percent of home purchase loans, the highest level since 2007, Waller said.
“Lockdowns as well as remote work and school may have spurred people to seek homes with more space, leading to an increase in demand for larger and otherwise better homes,” Waller said.
For instance, Zillow's Home Value Indexes showed single-family home purchases increased more than condominiums since January 2020 and the purchases of second homes have increased.
Household formations have also changed. Although some millennials returned home during the beginning of the pandemic, the number of “adults aged 18 to 30 who are the heads of their own households is now back near its 2017-2019 average,” Waller noted.
The newfound flexibility around work arrangements also play into the demand equation.
“While low COVID case rates may induce some workers to return to the office, some may only return part-time, while others may not return at all, as many organizations have made adjustments to function effectively with remote workers,” Waller said.
“The supply side has been pushing…towards tighter housing markets and more expensive shelter,” Waller said.
Supply chain problems initially due to pandemic-related worker shortages have increased with inflation. “Even with increased materials costs, suppliers have been unable to keep up with demand.”
“I am hopeful that at least some of the pandemic-specific factors pushing up home prices and rents could begin to ease in the next year or so,” Waller said. “While prices for lumber and other materials may come down, labor supply will likely continue to hold back the pace of new construction.”
Ronda is a personal finance senior reporter for Yahoo Money and attorney with experience in law, insurance, education, and government. Follow her on Twitter @writesronda