Inflation is at its highest point in 40 years. The Consumer Price Index (CPI) shows overall price increases of about 8% year-over-year. Yet not every industry is equally affected. For example, federal stimulus checks boosted consumer spending at the same time as pandemic lockdowns shuttered production. As of September 2021, consumer spending on goods has increased 21.7% compared to pre-pandemic times. For services, spending increased a measly 2.8%. That October, inflation data showed an 8.4% inflation rate for commodities, but a 3.2% rate for services.
These numbers may be hard to understand in aggregate. What does the good/service divide mean for a single market, like real estate? Housing is a good in itself, but its component parts are a mix of goods and services. Due to pandemic shutdowns, the housing/real estate industry saw supply shortages and rising prices of construction material. The greatest material cost increases were lumber (114% by May 2021) and iron/steel (73% by June 2021). Policy decisions made the problem worse; the US had tariffs and quotas on steel and aluminum. The country also failed to renew a softwood lumber agreement with Canada. Skilled construction labor is also in short supply during this time period.
Because building materials impact 35 to 60% of housing construction costs, it cost more for developers to build the same number of houses. Every major region of the United States was under-building homes in 2021. The housing unit gap over the last 20 years has grown to 5.5 million. Once the loss of existing housing units is factored in, the gap grows to 6.8 million. It’s not just housing components facing a shortage. Housing itself is facing a severe supply shortfall.
Insufficiently low housing supply is enough to drive up home prices. Yet it’s not the only factor driving the price up. Demand for homes has also increased. Investors have increased their real estate purchases because land is a traditional hedge against inflation. Rental income and property values rise with inflation, but once a mortgage contract is signed, its rates remain fixed. When inflation first revealed itself, interest rates were still incredibly low. By November 2021, over 6 million homes had sold in the United States. 2020 and 2021 had the highest number of home sales since 2006.
What does this mean for the housing market in 2022? The Federal Reserve has already raised rates several times. These rate hikes have dampened demand. At the same time, steel and aluminum tariffs with the European Union have been lifted. Lumber prices have fallen from their peak, though they remain above pre-pandemic levels. Production could slowly recover, though supply remains strained. While much remains uncertain, experts still predict a 6.6% increase in home sales. They also foresee a 2.9% increase in appreciation, keeping the housing market hot. Investors are still considering real estate, but it is important to remember some drawbacks. Real estate investment is a long-term investment with high barriers to entry.