US Home Supply Is Increasing, Higher Construction Costs Could Keep Prices Elevated

Home Price Gains Are Greater Than The 2005/2006 Housing Bubble Peak

U.S. home prices have surged over the past year, driven by a mix of factors such as historically low interest rates, a severe housing shortage, and a strong economy recovering from pandemic-related stimulus. The Case-Shiller Home Price Index recorded a 17% year-over-year increase in May 2021, surpassing the peak of the 2005/2006 housing bubble, which had reached 15% in September 2005. Today, national home prices are 38% above their previous peak.

While some analysts warn about a potential new housing bubble, the current cycle is fundamentally different from the one that led to the 2008 financial crisis. Back then, speculative lending and risky financial products were rampant, but today’s market is more about supply and demand. Lending practices are still aggressive, but not as reckless as before. There's no longer a wave of TV shows about people quitting their jobs to flip houses for quick profits.

This time, the surge in home prices is fueled by tight inventory and high demand. The pandemic caused a sudden shift in economic activity—initially, uncertainty led to business slowdowns, layoffs, and reduced spending. Governments responded with massive fiscal stimulus, which helped revive the economy. However, this also created a mismatch between consumer demand and available goods, leading to shortages across many sectors.

Source: Federal Reserve and Case-Shiller
Takeaway: Home prices are now 38% above the previous peak, with a 17% year-over-year gain in May 2021, outpacing the 15% growth seen during the 2005/2006 peak.

Long-term home price trends are ultimately shaped by affordability, which depends on wages and interest rates. When wages rise and borrowing costs fall, buyers can afford higher prices. Conversely, if wages stagnate or interest rates climb, affordability declines, putting downward pressure on prices.

Average wages increased by about 5% year-over-year in 2020, far below the 17% growth in home prices. This gap is not sustainable long-term. Either wages will need to rise significantly, or home prices will have to stabilize as affordability becomes a bigger concern.

Home Price Increases This Cycle Are Not As Speculative – It's More About Supply And Demand

Earlier this year, Emily Badger and Quoctrung Bui of the New York Times published a widely-read article titled “Where Have All the Houses Gone?” highlighting a sharp decline in available homes. According to Altos Research, the number of homes for sale has dropped to its lowest level since data collection began. Inventory levels, which hovered around 1.0–1.2 million in 2015–2016, fell steadily through 2019. The pandemic accelerated this decline as builders delayed projects due to economic uncertainty. Currently, inventory is 50% below normal levels, creating a significant housing shortage.

Source: Altos Research
Takeaway: U.S. home inventory is about 50% below normal as of August 2021.

Altos Research noted that while the tight supply trend is starting to ease, it's still far from normal. "Inventory is still 50% below normal," said Mike Simonsen. "It’s like a car going 100 mph and you take your foot off the gas—it’s still moving fast." This suggests that even as inventory increases slightly, the housing market remains extremely tight.

Demand remains strong as the economy continues to benefit from pandemic-era fiscal support. Rich Barton, CEO of Zillow, highlighted how the shift to remote work has changed housing dynamics. “The pandemic has unlinked work from location,” he said. “This flexibility is reshaping where people choose to live and could lead to a more distributed workforce.”

Building Materials & Labor Costs Are Rising

Inflation is back, and it’s hitting the construction industry hard. NAHBNow reported that overall building costs have risen 19% over the past year. Between 2015 and 2020, the average annual increase was less than 2%, but in 2021, it jumped to over 12% (19% year-over-year).

Source: NAHBNow and Bureau of Labor Statistics

Companies are increasingly mentioning inflation in earnings calls. Bank of America found that mentions of the word "inflation" rose 1,100% year-over-year in Q2 2021. This reflects growing concerns about rising costs across industries.

Source: Bank of America Research
Takeaway: Mentions of "inflation" in company earnings calls rose 1,100% year-over-year in Q2 2021.

Homebuilders are facing higher costs for materials and labor. From December 2019 to August 2021, the following price increases were observed:

• Copper +56%
• Steel +44%
• Drywall +26%
• Lumber +17%
• Insulation +13%
• Asphalt +7%
• Labor +6%

Construction costs typically make up about 60% of a new home’s price. These rising costs are passed along to buyers, though the impact may take 6–12 months to fully reflect in home prices due to contract terms and delays.

The National Association of Home Builders’ 2020 survey showed that construction costs account for roughly 60% of a new home’s price. This means even small changes in material and labor costs can have a significant effect on home prices over time.

Source: NAHB Cost of New Home Construction Survey

Source: NAHB Cost Of New Home Construction Survey
Takeaway: Construction costs represent ~60% of a new home’s purchase price, with builder profit margins typically between 8–10%.

To help understand how these cost changes affect home prices, our team at Equipment Radar developed an interactive tool. You can use it to model and forecast the impact of rising construction costs on home prices. Visit our Airtable spreadsheet here.

With input costs continuing to rise, the cost of new homes is likely to stay elevated. A significant portion of recent price gains can be attributed to higher material costs and replacement value. If construction costs remain high, we can expect home prices to remain stable or even grow further.

Residential Construction Stands To Benefit

With limited housing inventory nationwide, construction companies and equipment dealers are well-positioned to benefit. More machines and tools will be needed to meet demand. Additionally, as labor shortages persist, construction firms are likely to invest in automation and technology to boost productivity.

Conclusion

The current surge in home prices may be more persistent than the 2005/2006 bubble, largely due to higher construction costs and limited inventory. While a short-term pause is possible, a dramatic drop like the 2008 crash seems unlikely. Moreover, the post-pandemic world has changed, with governments more willing to provide stimulus in response to economic downturns. This dynamic could help sustain home prices in the near term.

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