Making sense of this red-hot housing market can seem difficult. A once-in-a-lifetime global pandemic following a world economy with a decade of nascent growth does not seem like ideal conditions to spur a real estate boom but, alas, it’s here.

Economics can be complex but you don’t need a PhD to understand what is fueling the surge in real estate prices. Geico is right, “Even a Caveman can do it.” The easy answer is Supply & Demand. This shouldn’t surprise anyone; it is a fundamental concept, and it plays a part in almost all areas of economics and underlies most of the economic choices we make.

This post will focus on the Demand forces at work driving real estate valuation growth. Part 2 will focus on the Supply factors at work, and Part 3 will discuss the current risks inherent in the current housing market.

Consider the Numbers

The Case-Shiller National Home Price Index is up a staggering 18.6% annually as of June, and growth has accelerated, topping the 16.8% annual rise in May. June’s sales figure was the strongest annual rate of growth in the Case-Shiller index since its inception in 1987. The US median existing home sales price is up 17.8% annually as of July to $359,000.

Locally, Orange Country saw its median home price rise 17.6% to a record $900,000, and the median condominium price rise to $627,000; Los Angeles county’s median price rose 23.1% to $790,000.

Factors Driving Demand

Two broad factors are driving this phenomenal surge in real estate prices: 1) greater Demand v. Supply in the housing market; and 2) stimulative economic factors encouraging Demand. In essence, more people want to buy real estate and there are incentives making what we already want to buy even easier.

Undeniably, ultra-low interest rates are the most significant juice that has enticed demand. Real estate is the sector most sensitive to interest rates. This is because those purchases are large and usually happen with borrowed money. If money is cheap, or astonishingly cheap in the present case, then consumers are able to take on and service larger loans. Currently, the 20-year US Treasury yield is 1.86%; and the fixed rate for a 30-year mortgage is 3.01%. For perspective, current inflation is running over 5%.

Money is cheap because the government wants it cheap, ostensibly, due to the extraordinary worldwide economic stress caused by SARS CoV-2. Low interest rates are (assumed to be) economically stimulative but the Federal Reserve wanted to add even more juice to the economy so it restarted its QE bond buying program in March 2020. In its latest iteration, the Fed is buying $40 bn in agency mortgage-backed securities every month (in addition to $80 bn in Treasurys). The ultra-low risk-free interest rates and the telegraphed and methodical purchases of MBS by the deep-pocketed Uncle Sam has been an artificial cap on rates and a bonanza for all real estate investors. Remember, yields and prices are inversely related. Strong purchase demand by the Fed raises prices of sought-after assets, thus lowering those assets’ yields.

Investors Stepping In

The other factor juicing real estate demand is the growth of large institutional investors taking stakes in residential housing. Historically, Wall Street’s approach for investing in residential real estate has been along conventional lines: taking stakes in homebuilders, the retail hardware & renovation sector, home appliance manufacturers and mortgage REITs. Five years ago, Blackstone started this new trend of committing serious capital to residential real estate; others have followed. In just the last three months alone, over $11 bn has been committed by Blackstone, Invesco and Goldman Sachs to residential real estate purchases. Redfin reported that in just the second quarter alone, 68,000 homes were purchased by investors.

There are also social factors at work. Corporate responses to the pandemic has demonstrated that many workers do not have to be tied to their offices, at least full-time. Many are asking: “If I can do my job anywhere, why can’t I do it in… (fill in the blank:) Boise City or Coeur d’Aene, Idaho or Austin or Boulder or the Bahamas.” When you also factor that these locales may offer a significantly lower cost of living, the decision to move is even more enticing, thus the surging demand in many locales.

Finally, and this cuts directly against the rationale for the extraordinary tactics the Federal Reserve continues to take in response to the pandemic, the economy, for the most part, is strong. This growth is not just strong relative to the pandemic lows (the S&P and NASDAQ are above pre-pandemic highs) but by fundamental measures. Unemployment is down, job openings are plentiful, and productivity is growing. This is not to dismiss continuing struggles. The pandemic and resulting lockdowns have decimated many businesses and sectors of the labor force, battles over masking and the vaccines continue to disrupt daily life and the worrying effects of the delta variant are all lingering concerns. Despite these difficulties, the economy is still growing and moving forward.

Summary

In summary, it is clear that strong Demand is the driver of this surge in residential real estate. The drivers of this demand are: ultra-low interest rates providing cheap money, the increasing purchases from institutional and individual investors, a strong economy for much of the country, and the ability for many workers to work from wherever they choose. All these factors are driving this incredible housing market to new highs.

Next question: what are the Supply factors at work in this market?