Are Housing Markets Broken?

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Many people aspire to own their own home, but it’s becoming increasingly unaffordable.
Core framework: supply and demand remains the starting point for explaining rising house prices; income and population growth boost demand and, unless supply keeps up, house prices continue to rise.
Author: HITES AHIR is a senior research officer in the IMF’s Research Department.
Publication: F&D Magazine, December 2024.

Housing differs from other goods: it is a major long-lasting purchase and investment, typically financed by borrowing, which makes demand sensitive to expectations and credit conditions.
Expectations and narratives:
- Fear of missing out can lead people to buy homes at high prices if a narrative takes hold that tomorrow’s prices will be even higher.
- Robert Shiller: house price bubbles can be driven by narratives and societal beliefs, creating collective expectations of ever-increasing prices; in 2003 he noted US house prices were substantially out of whack with people’s incomes and with rents.
Credit amplification:
- Relaxation in lending standards can strongly boost house prices (as in the run-up to the global financial crisis in 2008–09).
- Rising house prices increase the value of collateral, which can lead banks to extend more credit and further inflate the market.
- Misconceptions that house prices always rise led to risky lending and investment and the sale of high-risk loans as securities, exacerbating downturns when market instability was exposed.

Building a house requires financing, permits, approvals, and a lengthy construction period; even under the best circumstances, it takes time for supply to catch up with demand.
Canada example:
- House prices (adjusted for inflation) have risen at an annual rate of about 5 percent since 2016, driven by steady growth in income and population, including strong immigration.
- The Canada Mortgage and Housing Corporation estimates a shortage of 3.5 million homes for a population of about 41 million.
- To keep pace with growing demand, Canada must construct 500,000 houses every year, yet for the past two decades it has built only between 150,000 and 250,000 houses annually.
- Policy steps: reducing permitting times, freeing up unused government land for homes, addressing a shortage of construction workers — but these measures will take time to yield results.
Zoning and land-use regulation:
- Edward Glaeser and Joseph Gyourko show land-use restrictions limit density, curbing supply and driving up prices.
- Heavily regulated cities like New York: house prices soar beyond construction costs.
- Lightly regulated cities like Houston: plentiful affordable homes due to light regulations and ample land.

Cross-border capital inflows are boosting housing demand in many countries, driven by:
- An increase in wealth, particularly in emerging markets.
- Historically low interest rates between 2008 and 2021 prompting investors to search for yield in property.
- Capital flows to safe haven housing markets.
Evidence: prices in London’s high-end housing market tend to increase with geopolitical risks.
Policy responses to foreign demand:
- Restrictions on foreign property buyers and regulation of short-term rentals.
- New Zealand passed a law in 2018 barring foreigners from buying some residential properties.
- Canada followed five years later with a similar ban and stiff fines for those who breach the rule.

Multifaceted policy response needed because amplification of demand (price expectations, credit availability, capital flows) combined with stringent supply constraints can create large imbalances.
Managing credit availability:
- Microprudential policies: risk weighting of mortgage assets requiring banks to keep capital against risky mortgage loans.
- Macroprudential policies: limits on debt-service-to-income ratios; limits on loan-to-value ratios.
Monetary policy:
- Central banks raise policy interest rates to increase mortgage rates, making housing loans more expensive, but monetary policy is a blunt tool as rate hikes affect all sectors.
Addressing foreign cash buyers:
- Surcharge on nonresident buyers can reduce demand from cash-rich foreigners who bypass local lending rules.
- Singapore example: in 2013 the authorities doubled the rate of stamp duty paid by foreigners to 60 percent to ease housing pressures.
Core policy conclusion:
- When there are too few houses for sale, demand-focused policies alone (debt-to-income ratios, loan-to-value ratios, changes to interest rates) will not work.
- The solution must come from supply-focused policies. Above all, we must build more homes.

Are Housing Markets Broken? — HITES AHIR, F&D Magazine, December 2024.

Are Housing Markets Broken?
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