A New Home Shortage Is Looming

According to the National Association of Realtors (NAR), the inventory of available homes (new and existing) fell to 1.48 million at the end of 2017, the lowest level on record. In February 2018, there was only a 3.4-month supply of existing homes available – well below the desired 6-month mark.

New homes are not expected to fill the gap in demand. Approximately 1.3 million new homes are required just to keep up with normal population growth. NAR predicts that only 900,000 will be built in 2018.

Why are new home starts so low? The housing crisis drove many builders out of business, and those who remain are being careful about the homes they choose to build.

The National Association of Home Builders (NAHB) claimed 240,000 members in 2007, before the recession took effect. Approximately 140,000 members remain. The surviving builders are focusing on higher-end homes to reach a decent profit margin. Increasing land prices, high regulatory costs, and labor shortages have forced builders to mostly abandon the starter home market, where the need is the most critical.

According to the construction data startup BuildZoom, there are 100,000 fewer construction workers as of 2016 than there were in 2010, when the housing market was hitting bottom. NAHB estimates that regulatory costs have added an average $85,000 to the cost of a home between 2011 and 2016. Neither situation is likely to improve anytime soon.

High demand and short supply are predictably driving up home prices. In 2017, the Case-Shiller National Home Price Index shot up 6.3% – approximately three times the inflation rate and twice the income growth rate over the same time period.

In essence, plenty of homes are available for people who can't afford them. Those who can afford homes often find themselves in bidding wars. First-time homebuyers who were already struggling to find affordable homes are falling further behind and may have to settle for renting in the short term.

Prospective homebuyers, especially first-timers, must accurately assess what they can afford. Jordan Goodman, the personal finance expert and author known as "America's Money Answers Man," notes that people often don't think about having to actively bid for a house. They overspend on emotion without considering their practical limits.

"You have to go in there knowing the maximum that you can spend for your budget," says Goodman. "Do not get sucked into a bidding war ... get something you can afford and know in advance what that maximum is going to be." Homebuyers may have to target homes in the price range below their expected budget, in anticipation that they may have to spend more than the original asking price.

As you set your upper limit for a home purchase, don't forget about other associated expenses. Greg McBride, Chief Financial Analyst for Bankrate.com, reminds us that beyond down payments and closing costs, "you have moving expenses, and then you're going to want to furnish it ... all of that costs money. You need to be able to do all of that without wiping out your emergency savings." If you have no emergency savings, address that before you start.

Establish proper fiscal discipline before you even try to enter the housing market. As McBride notes, "If you haven't figured out how to save money before you buy a house, you're not going to figure it out after you buy a house."