Why are houses so unaffordable?

These days a million dollar home is nothing to brag about. In most desirable California locations $1M would barely buy a run-down fixer upper. How did this happen? How is it that normal working people are being completely priced out of the markets in which they live and work? Below I will explain several factors which contribute to the unaffordable housing prices; restricted supply, low turnover, foreign investors, and low interest rates.

Restricted Supply

The population in hot markets is growing which means that more and more people need places to live. More people are competing for fewer properties. The are simply not enough homes to fill the demand, which naturally means that prices will rise. But why is the supply so low? Why can’t more homes just be built by savvy real estate developers? First of all there is only so much land, so building new housing would require larger buildings. Building larger buildings means that you would change the general vibe of the city as well as the living style. There are zoning laws in place to prevent Los Angeles from looking like Hong Kong. There is even a Coalition to Preserve LA placing billboards that say “Stop Manhattanwood”. Many say that these laws are meant to preserve the culture of the city and quality of life. Others say that this benefits the wealthy, who can afford ultra high prices, and harms the majority of people who can longer afford to live a normal life. Either way, there is a huge housing shortage which is contributing to higher and higher prices. Prohibiting new development will only drive prices even higher. Furthermore, the sacred LA lifestyle, preserved through regulations restricting development, becomes even more in demand which works to raise prices as well. When cities build taller buildings, supply increases and prices come down.

Low Turnover

Supply and demand dictate pricing in any market. When the supply of available homes is low and the demand is rising, then the prices will naturally rise. There are several government regulations which effectively restrict the turnover of available homes, thereby driving prices higher.

Property Taxes

In California, property taxes are locked in at 1.25% based on the purchase price of the home. This was implement in 1978 with Prop 13. Essentially Prop 13 ties property taxes to cost at acquisition rather than annually assessed market value. Having your property taxes tied to ultra-low purchase prices, compared to current market value, makes people not want to move. After all, moving to the exact equivalent house next door would immediately mean paying unaffordable property taxes based on the current inflated market value of the home. As more people decide to not to sell their homes, the supply of housing that actually enters the market is a lot lower than it otherwise would be. This means that the amount of homes available to interested home buyers is restricted, which causes home prices to be much higher than they otherwise would. This also means that neighborhoods that were once affordable to the middle class can now only be afforded by the wealthy. This likely explains why you can drive around a very expensive neighborhood and see some residents that drive old beat up cars. They can only afford to live in the house because they bought it a long time ago.

Rent Control

Rent control was put in place to protect residents from rising prices due to increased demand. On the surface it may seem that rent control benefits the average person because they can afford to live in an area that they otherwise wouldn’t be able to afford. However, rent controls makes people never want to leave their unit. Moving across the hall to the same size unit immediately mean paying unaffordable market-priced rents. As more people decide to remain in their units, the supply of available rental units that actually enters the market is a lot less than it otherwise would be. This means that the available supply for new residents is held down which once again causes prices to be higher than they otherwise would. As rental prices go up, people decide that they would prefer to buy a home rather than pay their landlord so much money. This increased demand for home buying effectively raises prices.

Foreign Investors

The global economy is unstable. People in volatile nations are looking for ways to secure their net worth. If they keep all of their money invested in their home country then they are risking losing their money if the economy sours, which is looking more and more likely. People believe that United States real estate is a safer investment than other alternatives. Unlike many other countries, the United States does not restrict property ownership to its own citizens or even its own residents. This means that the growing number of Americans looking to buy a home to raise a family have to compete with foreigners looking to safely park their cash. Because the financial risks are so high in places like China, people are willing to vastly overpay for a property in the US because at least it will protected from completely disappearing. This increases the demand for homes and raises the price for everyone.

Low Interest Rates

Despite what some might tell you, the real economy is not doing so well. Prices of all goods are rising and unemployment is high. The number of people on foodstamps has never been greater. To give the appearance that things are good and to pay for things we can’t afford we have found two simple solutions to get more spending money; borrow it and print it.

Borrowing

As individuals we borrow money to buy things we can’t afford even if those things don’t in any way help us to pay back those loans. If you borrow money to grow your business, then you are likely to use the money productively which will enable you to pay back the loan and earn some money for yourself. If you borrow the money to pay for something that will merely be consumed, then in the long run you are paying far more than the purchase price in order to consume that item and you may never be able to pay back the loan. The same is true for government which borrows money to pay for things that it can’t afford such as social services, welfare, military etc. The US government borrows a lot of money. In fact, our nation has doubled its debt under the George W Bush presidency and once again under the Obama presidency. We now have $19 Trillion dollars of debt and growing, which means we pay over $400 Billion in interest alone each year.

Since every year we go deeper and deeper into debt, there are many that say we will never decide to reverse this process and one day if people stop loaning us money, we will be faced with a default. This is similar to maxing out a whole bunch of credit cards. Its fun for a while, but if the creditors get wise to your plan, they will not be so comfortable loaning money forever. However, the US government has a special trick up its sleeve. A trick which allows it to create currency out of thin air and use that money to pay for is programs and to pay the interest to its creditors.

Printing

Another way the government can mask the problems with our underlying economy is to artificially hold interest rates lower than the market would otherwise dictate. An interest rate is simply a mechanism that allows a lender to offset the risk of not getting paid back for their loan. Without the ability to generate interest payments, there would be no economic reason for someone to lend money. The higher the risk, the higher the interest rate demanded by the lender.

The US government issues treasury bonds which allow it to receive lump sums of money in exchange for a promise to pay it back plus interest in the future. Banks buy these treasury bonds and then immediately sell them to the Federal Reserve which buys them with money that they don’t actually have. Nobody questions the bogus checks that the Federal Reserve writes to the banks, and this is how new currency is created out of thin air.

Imagine three people are playing poker and each buys 100 chips with $100 in cash. The winner would take home 300 chips which they could immediately exchange for $300 in cash. Now imagine a fourth player arrives with 100 fake counterfeit chips he made at home. Now the winner of the game would win 400 chips, but only $300 were actually used to buy-in. This means that the average price paid for each chip in this game is only $0.75 instead of $1. The winner would be disappointed to discover that their 400 chips will only yield them $300 in cash held in the purse. But if the winner simply leaves the table and walks over to cashier, he can exchange the 400 chips for $400 in cash and everyone is happy. No one seems to mind because introducing the 100 counterfeit chips makes no noticeable impact to cashier. But make no mistake, now that there are fake chips in circulation, all other chips are now worth slightly less.

What would it take for people to realize that the counterfeit chips have stolen value from all the other chips? If enough counterfeit chips are introduced, people will begin to realize that their chips don’t buy as much as they used to. If you flood the system with fake currency, then it will require more currency to buy the same items, hence prices will be higher. So, we have now explained that if you make new currency out of nothing, then prices will noticeably rise. Most modern economists call this rise in prices, inflation. But they are technically wrong because the term inflation actually refers to the inflation of the money supply itself, which has the effect of raising prices.

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Here is an interesting piece explaining why investing in housing may not be such a good investment. 30 Reasons To Get Out Of Real Estate And Into Real Assets

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