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Low Housing Inventory: A Logical Explanation

05/20/2016 03:54pm ET | Updated May 21, 2017
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The real estate market has faced a unique set of circumstances from 2012 to today, all leading to a dramatic decrease in overall housing inventory. But what's causing the massive shortage? Let's take a look at the key factors driving this nationwide real estate trend.

Finger pointing has historically been aimed at builders. Report after report says construction has slowed way down and there aren't enough new developments. So builders are just failing at keeping up with consumer demand, right? Well, not exactly.

While that may have a mild impact, the real issue exposed by a recent Trulia report and examined by USA Today suggests that there are a variety of additional factors working in tandem to create an inventory shortage.

First - high prices are squeezing out mid-level home buyers:

A wide price gap between mid-level starter homes and next-level-up homes is creating a much different scenario. What's happened is, young or first-time buyers invested in a mid-level starter property several years go. Fast forward to today; those homeowners are ready to upsize and are looking to purchase a larger home, only to find that they can't afford one.

The increase in housing costs and the equity built in inexpensive starter homes purchased years ago leaves would-be buyers at a loss. Instead of moving up, they're battening down the hatches and staying put in what was meant to be their starter home.

Second, first-time buyers are struggling to get into the market:

Because starter home buyers are unable to move up the next tier, their homes are locked up and are not re-entering the market. That means, young buyers who would be purchasing starter homes continue to rent because there's no inventory in their price range to invest in. This is especially prevalent in cities in the south and west portions of the country. Trulia reports that in the last four years, starter home inventory has decreased over 80% in San Diego and over 86% in San Antonio.

The shortage is also causing price hikes across the board. In fact, the level of demand has caused the US median home price to increase by a staggering 8.2% in just one year. That's more than enough to block out aspiring homeowners working with limited funds.

Third, a portion of homeowners are still underwater:

Unfortunately, a lot of buyers who went into the market pre-crash are still recovering from the financial losses they faced when the market bottomed out. Whether that's because they had to refinance or take out a second mortgage or their home value simply hasn't recovered because they're in a slower-to-heal market, many are still underwater on their homes. That means there's another subset of homes that won't be hitting the market anytime soon.

Fourth, cash buyers are holding on to lucrative rental properties:
When the market crashed, foreclosures were everywhere and it was a great time to be a real estate investor in a position to buy. Today, those investors are enjoying the ongoing cash flow provided by low-cost homes they snatched up at rock bottom prices.

The thing is, since rental demand is so high and investors are making good money, there's no incentive for them to sell. That means a huge portion of the inventory that would normally be accessible to first-time and trade-in buyers is off the market for the foreseeable future. In fact, research shows that over a third of all starter homes are currently owned by US investors.

What can be done to solve the issue?
The key to fixing the issue is to address the widening price gap between mid-level starter homes and next-level-up homes. In 2016, the median list price of a premium home across the nation is $542,805. To contrast, the average price of a mid-level starter home is only $267,845. Unless that gap becomes smaller, starter home buyers are going to continue to struggle to move into a nicer property because they can't afford it - plain and simple.

The thing is, this is a relatively new problem. The price gap between starter and next-level-up homes increased by a national average of 17.3% between 2012 and today. As with any real estate trend, some markets and buyers are feeling the effects far more significantly than others.

It's also important to note that this issue doesn't stop with the housing market. It's deeply rooted in US economics and wage disparity. The middle class is disappearing and the wealthiest Americans are getting wealthier. That, in turn, is impacting the price of premium homes, creating an even larger population of middle-class Americans who can no longer afford to invest in higher value properties.

The silver lining for homeowners & real estate investors:
If you live on the west coast or in another area with crazy high housing demand, you're in a great position to sell and make a killing at closing. This is especially valuable if you're looking to move to a more affordable market.

As for investors or homeowners looking to make some extra money, it's the perfect time to take steps towards generating passive income with rental properties. While you won't be helping to solve the low inventory issue, but you will have a guaranteed source of income for the foreseeable future.

The insights highlighted in this study provide a unique, thoughtful look at the cause and effect of the current US market inventory shortage. Though this data provides some answers to the questions we have today, the housing market is fluid. In due time, the economy will shift again and we'll be faced with a new set of market conditions and all the questions that come along with it.