Why the US housing shortage is likely to get worse

Rising interest rates and economic headwinds are making it harder for the U.S. to fill a severe shortage of affordable housing, and the problem is likely going to get worse.  

The Federal Reserve has been working for months to stanch the sting of inflation by raising rates and slowing the housing market. Home sales and construction have fallen off a cliff this summer as a result.

Sales of new and existing homes have also fallen for months on end after the Fed drove up mortgage rates. But experts say that these rate hikes, coupled with supply shortages and a historically low inventory will only exacerbate the shortage. 

"With mortgage rates up, it's really just put a lot of buyers on the fence and into the rental market because they simply can't afford mortgage payments,” said Daryl Fairweather, chief economist at Redfin, in a Thursday interview.  

Fairweather said the mortgage payment on a medium-price home is up almost 50 percent from last year. 

“A lot of buyers just can't stomach that. They're either cutting their budgets for housing or going into the rental market,” she said. 

Sales of existing homes have fallen for five straight months, according to data released this week from the National Association of Realtors, and are down 14.2 percent over the past 12 months. While prices have started to fall in some of the country’s hottest local housing markets, the median home price still rose to $416,000 in June, up 13.4 percent from last year. 

“We are seeing more and more people being priced out of the housing market as these rates continue to either climb or just stay at this higher level than we've seen over the last couple of years,” said Yelena Maleyev, economist at KPMG, in a Thursday interview. 

The Fed, perhaps counterintuitively, is making homes more expensive to buy now with the hopes of eventually making them cheaper. The bank has hiked interest rates aggressively since March, which drove the average fixed 30-year mortgage interest rate up to 5.5 percent in June, according to Freddie Mac. 

Fed interest rate hikes are meant to slow the pace of home sales by making mortgages more expensive. With fewer buyers able to afford higher rates, sellers will eventually be forced to lower their prices. 

Maleyev said the decline in home sales will eventually force home prices down, one of several of the Fed’s goals with higher rates. The Fed is also hoping to curb the economic activity that comes with home sales and prompt homeowners to spend less money as the value of their house declines. Those factors combined should help reduce pressure on prices throughout the economy, bringing inflation down. 

Higher rates are meant to bring home prices down after more than a decade of steady annual increases. The COVID-19 pandemic also unleashed a surge of demand for housing while federal stimulus efforts — including ultra-low interest rates — fueled a rapid increase in both sales and prices.  

The number of new American households exploded in 2021 as COVID-19 vaccines unlocked a rapid recovery, rising 2.3 million above pre-pandemic levels, according to a report from ApartmentList.com 

But higher interest rates are likely to keep homebuilders from constructing enough homes to meet those needs. The pandemic itself froze home construction for months, then created a series of supply and labor shortages, delays, backlogs and obstacles to completing homes on budget and schedule.   

"Builders are now thinking demand is going to start to cool, especially because of these unsustainable prices,” Maleyev explained.  

“At the same time, they're still facing the same hurdles they faced before — long lead times, supply chain bottlenecks, inflation in their inputs, lack of labor, lack of land,” she continued. 

Next week, the Fed is poised to hike interest rates by another 0.75 percentage points, the second increase of that size in two months. The move from the central bank will, as a result, push mortgage rates higher. 

The bank has already boosted rates by 1.5 percentage points since March and will likely hike by another 1 percentage point at least by the end of the year. 

Maleyev and Fairweather said it can be difficult for federal policymakers to boost the housing supply because housing markets are usually shaped by state and local regulations, many of which make it hard to build affordable homes.  

President Biden’s quashed Build Back Better plan included more than $200 billion meant to boost the supply of affordable homes and unwind restrictive zoning laws, but the provisions will likely die with the rest of the package at the end of the year.  

A bill to reverse the steep decline in U.S. immigration, which could help fill the home construction labor shortage, is also unlikely to pass into law given deep partisan divides on the issue. 

"People exited the construction industry and never came back [after the 2008 recession], which contributed to the lack of labor,” Fairweather said. 

“Now we're in a position where housing has gotten so expensive and land has gotten so expensive that it's just really expensive to build.”