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 low interest rates, a severe housing shortage, and a strong economic recovery following pandemic-related stimulus. The Case-Shiller Home Price Index hit a 17% year-over-year increase in May 2021, surpassing the previous peak of 15% recorded in September 2005 during the housing bubble. Today, national home prices are 38% above that earlier high.

Many analysts are drawing comparisons to the 2005–2006 housing bubble, but this cycle has distinct characteristics. Unlike the speculative lending and risky financing practices that fueled the last boom, today’s market is more about supply and demand. Lending remains aggressive but not as reckless. There's no longer a flood of TV shows about people quitting their jobs to flip houses for quick profits.

The current surge is being driven by tight inventory and strong demand. The pandemic caused a sudden economic shift—initially leading to uncertainty, layoffs, and reduced spending. Governments responded with massive fiscal stimulus, which helped revive the economy. However, the result was a temporary lull in production and supply, leading to shortages across many industries. This combination of increased consumer spending power and limited goods has created a unique environment.

Source: Federal Reserve and Case-Shiller
Takeaway: Home prices are now 38% above the prior peak, with a 17% annual growth rate in May 2021, exceeding the 15% seen in 2005.

Long-term home price trends are ultimately tied to affordability, which depends on wages and interest rates. When wages rise and rates fall, buyers can afford higher prices. Conversely, when wages stagnate or rates climb, affordability declines, putting pressure on prices. In 2020, average wages grew only 5%, far below the 17% home price gains. This gap is not sustainable in the long run—either wages must rise significantly, or home prices will need to slow down to match buyer capacity.

As we've seen, the current housing market is not driven by speculation but by fundamental factors like supply constraints and strong demand. This makes the current situation different from the 2005–2006 bubble, where financial engineering played a major role.

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 drop in available housing inventory. According to Altos Research, the number of homes for sale has fallen to its lowest level since data collection began. Inventory levels were around 1.0–1.2 million in 2015–2016, then gradually declined through 2019. The pandemic accelerated the trend, as builders paused projects due to economic uncertainty. By 2021, inventory was 50% below normal, creating a significant housing shortage.

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

While inventory levels are still low, recent data suggests the trend is beginning to moderate. Altos Research noted that inventory is slowly rising, and demand is pulling back slightly. Some homes are now seeing price reductions, and fewer sales are happening immediately. Mike Simonsen, an industry expert, explained it well: “A car going 100 mph down the highway and you take your foot off the gas—it’s rapidly decelerating, but it’s still going really fast.” The same applies to the housing market today.

Strong demand continues as the economy absorbs the effects of pandemic-era stimulus. Rich Barton, CEO of Zillow, described how the pandemic has changed work dynamics, allowing people to live farther from traditional job hubs. This shift, known as the "great reshuffling," is reshaping where people choose to live and could lead to broader geographic distribution of talent and housing demand.

Building Materials & Labor Costs Are Rising

Inflation is back, and it's hitting the construction sector hard. Prices for building materials have soared, with overall residential construction costs rising 19% over the past year. Before 2021, the average annual increase was under 2%. Now, with rising material costs and labor shortages, the housing market is feeling the pressure.

Source: NAHBNow and Bureau of Labor Statistics

Companies are also reporting higher inflation concerns. Bank of America found that mentions of the word "inflation" during earnings calls jumped 1,100% year-over-year in Q2 2021. This reflects growing concerns about cost pressures across industries.

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

Construction input costs have spiked dramatically:

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

With construction costs making up about 60% of a new home’s price, these increases are directly affecting home values. Builders often pass these costs along to buyers, though the timing can vary due to contract terms and delays.

Source: NAHB Cost of New Home Construction Survey
Takeaway: Construction costs make up roughly 60% of a new home’s price, with typical builder profit margins between 8–10%.

Our team at Equipment Radar developed a tool to help model how changes in construction costs affect home prices. You can explore it here: [Airtable Interactive Spreadsheet].

With rising material and labor costs, it’s reasonable to expect that home prices will remain elevated. If these costs persist, the housing market may see continued upward pressure.

Residential Construction Stands To Benefit

Construction companies and equipment dealers are well-positioned to benefit from the current housing shortage. As demand for new homes grows, so does the need for more equipment and machinery. Additionally, with labor shortages, construction firms are likely to invest more in automation and technology to boost productivity.

Conclusion

The current home price surge may be more durable than the 2005–2006 bubble, given higher construction costs and limited inventory. While a short-term pause is possible, a sharp decline similar to the past is less likely. Moreover, the post-pandemic world has changed—fiscal stimulus is expected to return quickly if needed, providing further support to the housing market.

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