To say the real estate market in 2020 has surprised many people would be an understatement. The median existing home price in August was $310,600, an 11.4% increase from a year ago, according to the National Association of Realtors (NAR).
This is the exact opposite of what many would-be homebuyers and real estate investors expected when the COVID-19 pandemic hit. Instead of becoming a better buying opportunity, residential real estate has become even more of a seller's market.
With that in mind, I'm hesitant to call this a housing bubble. There are two very good reasons why prices have climbed so high.
1. Supply and demand are imbalanced
First, like any other type of asset, real estate prices are mainly governed by old-fashioned supply and demand. When there's a massive amount of inventory on the market, we'll see home prices fall. Conversely, when there aren't many homes for sale, that's when prices start to rise, exactly what's happened recently.
Total housing inventory on the market was 1.49 million units at the end of August, according to the NAR. This is 18.6% fewer homes on the market than the same time last year. There is now about three months' worth of unsold inventory on the market, a historically low level and less than the four-month inventory level in August 2019.
Buyers have snapped up homes rather quickly. The average home was on the market for just 22 days in August, down from 31 days in August 2019.
2. Money is very cheap right now
Another factor driving home prices higher is record-low mortgage interest rates. In simple terms, when borrowing gets cheaper, buyers can afford to spend more to buy a home.
In August 2019, the average 30-year fixed-rate mortgage APR was 3.683%. Today, it's 2.875%.
Consider what this means. Let's say it's August 2019 and you want to buy a home for $278,800 (the median home price at that time, according to the NAR). With a 20% down payment and the average mortgage rate, you would have a principal and interest monthly mortgage payment of $1,024 on a 30-year loan.
Fast forward to today. Let's say you want to buy a home at the higher current median sale price of $310,600 and you get a 30-year mortgage at the 2.875% average APR. Even though the amount of money you borrow will be significantly more now, your monthly payment would be $1,031 for principal and interest -- an increase of just $7 over the average payment from a year ago. Someone who put a 20% down payment on the average home and used a 30-year fixed mortgage to finance the rest would have paid just 0.7% more than a year ago.
In other words, even though the average price to buy a home has increased by 11.4% over the past year, the cost of paying a mortgage on the average home has barely budged. And not surprisingly, the percentage of buyers who chose to pay cash for a home has declined over the past year -- after all, when money is so cheap to borrow, why not take advantage?
The bottom line
While a double-digit increase in home prices may not be what you would expect in a pandemic, we aren't necessarily in a housing bubble. Generally speaking, bubbles occur when asset prices rise with no apparent justification -- think tech stocks in the late 1990s. Unlike bubble situations, the 2020 rise in home prices is quite easy to explain. When you factor in the cheap cost of borrowing, it really doesn't make homeownership much more expensive than it was.