Some Mechanics of Housing Supply & Demand (and how lag screws it all up)

photo credit: Alanah.Montreal

A recent story on All Things Considered offers a good example of how housing markets respond to “shocks.”  The most recent shock, the mortgage crisis, shifted a lot of prospective homebuyers to put off the task of purchasing a home, instead opting for safer, short-term rental options.

In the feature, NPR reports that rents in New York fell immediately following the financial crisis, which makes sense.  In the short-run, many people have less income they’re willing to put toward rentals.  But over the intermediate run (i.e. now), we’ve got a different market of consumers, many looking for spaces as renters, not homeowners.

However, housing supply doesn’t track exactly with demand – largely because it takes time to build.  This is the concept of supply lagging behind demand.  So, in the interim, supply is less than demand, and rents rise.  Over the long run, supply should meet demand, and rents should fall to an “equilibrium” level.

One major caveat here: the “new” consumer market prefers rental units now, but will that be a long-run outcome?  Are we perhaps building too many rental units for the future?  Will consumer desire for homeownership rise back up to pre-crisis levels?  Hard to say; overbuilding of housing stock was certainly a part of the financial crisis, and something worth keeping in mind.

[Thanks to my friend Neal for sending this article my way.]

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5 thoughts on “Some Mechanics of Housing Supply & Demand (and how lag screws it all up)

  1. Michael Hankinson says:

    “Overbuilding of housing stock was certainly a part of the financial crisis, and something worth keeping in mind.”

    I agree with this statement broadly, but we can also benefit from unpacking it. Areas of Nevada and Arizona were drastically overbuilt, leading to utter devastation of home values. However, many urban areas face high zoning and regulatory barriers, preventing construction and inflating urban housing costs beyond affordability.

    Point is, location/market heterogeneity should demand a more nuanced strategy moving forward. Rather than “are we building too many units?”, maybe we should pay more attention to “where are we building these units?”

    In all, great note on the trickiness of a supply lag.

  2. Ben says:

    Great points, Mike. Literally just got out of a lecture on this topic. Whenever people forecast housing demand based on prices (backward-looking), they’re going to make errors and overshoot the actual market. Prices in the West were bound to rise as developers created units in a region of constrained supply of land (something like 90% of Nevada land is not privately-held). Factor in the building on price-based demand assumptions, rather than GDP/population/etc, the West gets overbuilt. Local markets make all the difference.

  3. […] heard plenty of reasons to be pessimistic about the housing market.  Tight credit markets, overbuilt supply, and high vacancy rates are just a few things I’ve covered.  Before you lose all confidence, […]

  4. […] of supply and demand before, and I’ve also talked about how housing construction (new supply) lags behind demand.  But, the impact of housing construction on the market is something I’ve neglected.  Just […]

  5. […] housing isn’t just an negative economic indicator, it’s also a hazard to the households who are left behind.  It’s a classic externality […]

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