In most healthy real estate markets, reduced supply leads to increased demand and all is well. That is still the case today for the most part, but today’s market is much different than those in the past. Limited supply and increased demand has instead created a problem.

Hot Markets

According to the National Association of Realtors, home sales hit a nine-year high in 2015. For a more recent snapshot, homes sales increased 0.4% in January 2016 while the median home price jumped 8.2% to $213,800. The hottest markets for home price increases?

  • Portland, Ore.: 11.4%
  • San Francisco: 10.3%
  • Denver: 10.2%

With the unemployment rate at 4.9%, wage growth at 2.5% over the past year, and the average 30-year fixed mortgage rate at 3.65% versus a historical average of 6%, it would seem as though real estate is in a perfect spot. Those low mortgage rates won’t last forever, which has helped drive demand because potential homebuyers want to lock in low rates while they still can.

With all of this bullish information for the real estate market, what could possibly go wrong?

Real Estate Market Risks

While there are a lot of potential homebuyers who want to lock in low rates, there are more potential homebuyers who are being squeezed and therefore unable to pull the trigger on a purchase. The problem is that limited supply and the aforementioned competition are leading to price increases that aren’t affordable for most consumers. 

On the supply side, home listings for January slid 2.2% year over year. According to the Consumer Conference Board Consumer Confidence Index, consumers planning on a home purchase at some point over the next six months currently stands at 5.3% versus 7.4% in January. Furthermore, the average homeowner isn’t looking to upgrade their home due a lack of confidence in the economy. If you happen to be wondering where that lack of confidence comes from, that question can be answered in more than one way.

First is plunging commodities and layoffs throughout the energy sector. Anyone who lives in related areas, such as Texas and North Dakota fully understands. These layoffs will lead to reduced incomes, which will then hit consumer spending and housing. Will this deflationary trend be geographically contained? 

Second is China, which is exporting deflation. Most Americans just know that China is in economic trouble, but it’s more trouble than advertised, including bank fraud, market manipulation, excessive debts, and overcapacity. China was relied upon as the big growth driver for the global economy for well over a decade. That can no longer be relied upon.

Third is the strength of the U.S. Dollar, which negatively impacts multinationals. Most Main Street consumers might not be aware of this, but if they work for a multinational, they’re already concerned because they know cost cuts might be around the corner – with reduced headcount being the best way to cut costs.

Fourth is the Federal Reserve running out of ammo. This theory can get repetitive, but it bears repeating. Let’s add a little tidbit on this go round. Even John Maynard Keynes believed that monetary policy’s effectiveness waned over time.

Fifth is simply subpar stock market performance, which has a psychological impact on consumers. 

Let’s assume you’re still not sold that real estate could present more risk than what is often stated in the media. If that’s the case, consider two quotes below.

Industry Quotes

Ralph McLaughlin, chief economist at Trulia, an online residential real estate site for home buyers, sellers, renters and real estate professionals, recently said: “The real takeaway from the numbers is that despite demand being high, the future is looking somewhat muted for homebuyers.”

Nela Richardson, chief economist at Redfin, a residential real estate company that provides web-based real estate database and brokerage services, also recently said: “So far, sales have been bulletproof to price increases, but this is unsustainable in a slowly recovering economy unless inventory improves.”

The Bottom Line

The real estate market is performing well in most areas and holding its own in others. However, this might not be sustainable because limited supply is driving up prices too much for demand to remain high. The simplest way to put it: Prices are moving faster than incomes.