Home Prices: Going Up Says The Magic 8-Ball

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Thinking about buying or selling a home? In central Indiana, home prices have never been stronger. Will this trend continue? If so, how long? While the future is hard to predict, there are several positive factors - and then there’s the Magic 8 Ball...

F.C. Tucker's recent numbers showed the average home sale price has increased almost 7 percent over the past 12 months in central Indiana. At the same time, the inventory of existing homes for sale is less than three months. What does this mean for home buyers and sellers?

Forecasting can be tricky. Will prices continue to rise? My Magic 8 Ball says, "it is decidedly so!" But at some point in time the outlook will become "not so good." What forces influence the future direction of home prices? Simple answer: supply and demand.

Low Interest Rates + High Employment = Strong Demand

On the demand side, employment and home affordability are the crucial factors. When interest rates are low and people are gainfully employed, they can afford to buy homes. Demand stays strong.

Currently, the unemployment rate in Indiana is 3.6 percent and 30-year mortgage rates are approaching the 4-percent mark. Demand for homes is high. Over the next year, the Federal Reserve is likely to increase interest rates, but only modestly.  So the impact on home affordability will likely be low.

Looking ahead, both unemployment and interest rates should remain low, although interest rates could slowly creep upward. As a result, my Magic 8 Ball says demand for homes should remain strong for the foreseeable future.

High Demand + Low Inventory = Higher Prices

On the supply side, having less than a three-month supply of homes means it's a sellers' market. If you're looking for a new home, you need to be primed to make an offer quickly so "your" home doesn’t get snapped up by another buyer!

In today's market, many homes are selling in days, not weeks. And often with multiple offers. The old adage, "You snooze, you lose," pretty much sums it up! In a sellers' market, it becomes more common for buyers to offer above the sellers’ asking price to get the home. Not necessarily a good financial strategy for a buyer, but it is reality nonetheless.

Will Inventory Rise to Meet Demand?

With home prices moving upward, won’t there be more homes for sale? Higher prices are certainly an incentive for homeowners to sell. But these sellers will now become buyers in a sellers' market. Unless a homeowner is truly downsizing, it may be difficult for a seller to make a profit.

You'd think it would be prime time for homebuilders to ramp up building, right? Normally, higher home prices motivate builders to increase the number of new homes on the market - sometimes significantly. But the Magic 8 Ball says, "not likely this time round." Why? One vital factor necessary to support increased building is missing. And, no, it’s not a scarcity of available land or a dearth of construction companies.

The biggest constraint to new real estate building is a lack of skilled workers. Currently, the commercial real estate industry employs 4.2 million workers. That’s 500,000 workers short of the labor needed to keep up with the pace of new projects (MFS, Associated Builders and Contractors). Residential building isn’t faring any better. The National Association of Homebuilders noted an 81-percent increase in unfilled U.S. construction jobs over the past two years (Fortune, September 2016). Carpenters, electricians, dry wall setters, plumbers - they're all in high demand. Unfortunately, that’s a growing trend.

So When Will Home Prices Stop Rising?

Although it's unlikely we’ll see any of these occur this year, the following changes could derail the strong housing market momentum:

  • Interest rates moving higher at a faster than expected rate
  • An economic slowdown that increases unemployment
  • New home builders are able to attract skilled labor, enabling a substantial increase in home supply

Summary

At some point, economic forces will slow the rise in housing prices. I don't need my Magic 8 Ball to make that prediction! While prices appear to be headed higher now, know that they can take a downward turn and stay low for a period of time. Don’t bet your financial security on housing prices going higher indefinitely, because experience tells us it just won’t happen.

Bill Wendling, CFA, is a Senior Portfolio Manager with Bedel Financial Consulting, Inc., a wealth management firm located in Indianapolis. For more information, visit their website at www.bedelfinancial.com or email Bill.

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