Construction Costs Are Driving Up House Prices, According to the Latest Housing Market Perspectives

ST. LOUIS Is the housing bubble ready for another burst? Hold that thought, says William Emmons, assistant vice president and chief economist of the St. Louis Fed's Center for Household Financial Stability. Another possibility is that the cost of new-home construction increased rapidly, particularly in supply-constrained markets on both coasts, which drove up new home prices. According to Emmons’ report, we should not blame the recent strength in house prices nationwide on “bubbly” expectations.

The key takeaways for this quarter’s Housing Market Perspectives are:

• Three national house price indexes stood more than 50% above their 2012 troughs in the first quarter of 2019.
• Unlike the housing bubble period before the Great Recession, recent mortgage borrowing and expectations for house price gains have been subdued.
• Construction costs could be a larger factor in house price trends than either credit conditions or house price expectations.

“Construction costs have received less attention than mortgage lending and unrealistic house price expectations, but they appear to be an important part of the recent run-up in house prices.” Emmons said. “In the long run, one would expect construction costs—including the cost of land acquisition and improvement, and of the structures built upon it—to be the primary determinant of new-home prices if local markets for new housing are competitive.”

Emmons reports that the relationship between construction costs and new home selling prices turns out to be quite strong. He noted that construction costs could be a much more important determinant of house price trends than either credit conditions or house price expectations.