Real Estate Frenzy

Answers to the burning questions about the volatile housing market.

How crazy is the current for-sale housing market? Take a look at Richfield.

The city has never been anyone’s idea of a sizzling metro housing market. It’s a first-ring suburb where ramblers are plentiful. There are no mansions. It has traditionally offered a more affordable place to buy a home.

But in March the median sales price in Richfield was $326,250, a 14.6 percent increase from a year earlier. Houses were selling for an average of 105.7 percent of their original listing price. According to the Minneapolis Area Realtors (MAR), the city had an inventory of 0.3 months—basically a week—of homes for sale.

What the heck is going on out there? Twin Cities Business looked for answers to a few questions about the intense and often confounding housing market.

Q: Why is the market crazy?

The current market is the result of the confluence of several factors.

Mortgage interest rates are at historic lows: “When the economy reopened, what the consumers were watching was record-low mortgage rates,” says Lawrence Yun, chief economist for the National Association of Realtors. “People rushed into the market.”

Inventory of homes for sale is at rock-bottom: “Today we have an all-time low in inventory and consequently home prices are just moving straight up because of the housing shortage,” says Yun.

The U.S. has been underbuilding homes since the Great Recession: “The inventory shortage that we have is the result of a decade of underproduction by the home builders. … the builders have been under the historical average for 13 straight years,” says Yun. “The cumulative effect of underproduction is we simply don’t have enough homes.”

Market momentum adds more fuel to the fire: “It certainly has that feel of the bubble environment in terms of buyers just eagerly trying to make a bid … they’re bidding up the prices, they are bypassing home inspections, they need to decide quickly,” says Yun.

The pandemic is driving people to spend more on their homes: “People have been saving a bundle of money,” says Mark Wright, senior vice president and director of research at the Federal Reserve Bank of Minneapolis. “With everybody working from home, people have taken a good hard look at their living arrangements. Many have decided, especially if this stays around as the new normal to some degree, it’s worth spending a little bit more on your home, upgrading a little bit, [adding] an extra bedroom or so.”

Realtor Joey Oslund of Edina-based RE/MAX Results has been in the business for more than 15 years. But he’s never seen anything like the deluge of interest in a Bloomington home that hit the market for $400,000 in March. The home, with three bedrooms and a two-car garage, offered a design dating to the 1970s.

He posted the house online as a “coming soon” listing at 5 or 6 one evening. By the time he went to bed, there were already 75 showings booked. The next morning that number had climbed above 110.

“At one point we had over 190 [showings] scheduled,” recalls Oslund. Many potential buyers dropped out when it became clear what a circus the process had become.

“We started receiving offers immediately,” says Oslund.

Ultimately, there were 148 confirmed showings at the house stretching from Thursday to Monday. The bid deadline was set for Monday evening. Oslund says that he had 32 offers in hand for the home, seven over $500,000. Agents continued calling to ask if they could put in a bid; Oslund told them not to bother.

At the end of the day the house sold for $510,000—27.5 percent above its listing price—with no contingencies and no inspection.

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Is this market crazier than when he started out in 2005? “100 percent,” says Oslund.

He points to Richfield, where prices have zoomed. “Richfield is kind of like the new St. Louis Park. People really want to be there,” says Oslund. “So the price has really exploded there more than other places.”

Oslund says he initially thought that the pandemic would put a damper on the market. Once the Fed chopped interest rates, he says that one client bought a home with a 2.25 percent interest rate. And he sees no signs the hot market will change soon.

“We’re at least a couple years from anything that would be considered a slowdown,” says Oslund.

At the same time, Oslund sees a downside to the current mania. “A lot of people are getting priced out very quickly.”

He has seen many cases where the prevailing bid price is far above others. Given that, the true value of the home is not necessarily what the winning bidder paid.

“In reality,” says Oslund, “that house was only worth that because [of] one buyer who’s willing to pay it.”

It started last summer.

Housing prices have been steadily climbing since the end of the Great Recession. But in recent years, the increases were generally moderate.

That changed about a year ago, when MAR saw double-digit gains starting in July 2020. For the 10 months from July 2020 to April 2021, median home sale prices posted double-digit gains for every month except August, which was still close to the mark with an increase of 9.8%.

What happened in July?

As the pandemic hit, the Federal Reserve lowered the interest rate twice in March 2020, taking it from 1.75 percent to 0.25 percent—effectively zero. That has translated into rock-bottom financing rates. Also, bank home underwriting tightened as the economy contracted. But by last summer it had loosened somewhat.

Q: Is it a bubble or a housing shortage?

As prices have skyrocketed, people have started mentioning the “B” word.

“I wouldn’t call it a bubble,” says Bill McBride, who writes Calculated Risk, a closely followed national economics blog.

“To call it a bubble you really need prices out of whack with fundamentals, and you also need to see some speculation,” says McBride. “In 2005, speculation was easy to find. I saw people buying houses and just letting them sit vacant for six months and then adding 20 percent and selling. Now we don’t see any of that.”

But the party won’t last forever.

“I would say that prices are higher than fundamentals would suggest they should be. I do see potential for some declines,” says McBride. “I think prices are still going to go higher for a few more months at least—18 percent [price gains] a year is not sustainable.”

Finance professor David Vang of the University of St. Thomas says he’s starting to sense the emergence of a bubble. “The values are getting up pretty high compared to the income levels,” says Vang. “It’s hard to imagine prices increasing by 10 percent or more for several years in a row. At some point things do have to settle out.”

In November, Vang sold his own house in less than 48 hours.

Yun says that today’s market differs substantially from the housing climate before the crash of 2008. “There’s all the elements of the feel of a bubble, but the factors are fundamentally different.” Before the Great Recession, he says, there was significant overbuilding. That’s not the case today.

The overheated market is a national phenomenon. The National Association of Realtors (NAR) reported that the median sale price for existing homes—single-family, townhome, and condos—climbed to $329,100 in March. That was both an all-time high and a 17.2 percent increase compared to March 2020.

The median price for a single-family home was even higher, at $334,500 in March, an 18.4 percent increase from 2020. The median price for condos was lower, at $289,000, but still up 9.6 percent.

A few NAR statistics from April tell the story:

  • 83% of homes on the market in March sold in less than a month.
  • 23% of the sales were all cash buyers.
  • First-time buyers represented 32% of sales.
  • Individual investors and second-home buyers bought 15% of homes.

Fears that the pandemic might kill the housing market were misplaced.

“I live in California; I hear that all the time: ‘Everybody’s fleeing California.’ Oh yeah, really?” says McBride. “I think that whole idea that ‘New York is going to die’—I’ve seen that all over the place. I think that’s completely wrong.”

Q: Are skyrocketing material costs killing new construction?

“We’re as busy as we’ve ever been,” says Todd Polifka, president of Woodbury-based Custom One Homes.

Prices on nearly all materials keep going up, along with labor costs, which is making new homes more expensive. Custom One focuses on homes $1 million and up.

“It’s everything. It’s just not lumber,” says Polifka. “We’ll get notices on anything from garage doors to sheetrock to anything that has copper in it, anything that has metal in it. People’s labor costs are going up. You’re seeing increases across the board.”

The firm’s clients have not been affected much financially by the pandemic. Low interest rates are also an advantage for new home buyers. “Say you’re buying a million-dollar house and the interest rate is at 3 percent; maybe your price adjusts by $25,000 to $50,000 when you multiply it by the interest rate,” says Polifka. “[The rising price is] not enough of a detractor.”

Polifka says that his company is getting more requests for amenities like sport courts and exercise rooms. “We’re seeing people that are spending more money on the home,” he says.

He acknowledges that home builders have been underbuilding since the Great Recession, which still casts a long shadow. “The industry got burned with the recession, and people haven’t forgotten,” says Polifka.

Q: Are institutional buyers bidding up home prices for rentals?

A January overview from JLL, a Dallas-based commercial real estate services firm, indicated that 16 million U.S. homes are in the single-family rental (SFR) market. If that’s accurate, it would represent 11.5 percent of the total homes in the U.S.

“If there was a person that was looking to rent a house, they would go to [an] investor and get approved as a tenant. And then that renter would go shop for a house that the investor would buy,” says Jeff Martineau, a realtor with Coldwell Banker Burnet who focuses on the western suburban market.

According to JLL, “SFR homeowners are reporting record-high occupancies and rent growth. According to data from DBRS Morningstar, rents in institutionally owned SFR portfolios have grown more than 3 percent annualized in 2020. Stay-at-home orders and reduced mobility, along with renters working and schooling from home, is pushing more individuals and families to rental homes with more space.”

It’s not clear what percentage of home sales in the metro can be traced to investors; MAR does not track data on institutional buyers. But investor activity may have cooled since the market exploded last year, says Martineau.

Who are these investors? Some are real estate investment trusts (REITs) that focus specifically on single-family homes to rent. JLL reports that institutional investors—those that own more than 100 houses—own less than 3 percent of single-family home rentals. The majority are owned by individual investors, smaller investment groups or companies, and family offices.

A data point: Maryland-based Invitation Homes Inc. reported that it owned 1,126 homes in the Minneapolis market at the end of 2020. For the Twin Cities, Invitation reported drawing an average monthly rent of $1,940. Its local portfolio had a 97.1 occupancy rate.

“To call it a bubble you really need prices out of whack with fundamentals, and you also need to see some speculation. In 2005, speculation was easy to find. I saw people buying houses and just letting them sit vacant for six months and then adding 20 percent and selling. Now we don’t see any of that.”

Bill McBride, national economics writer

Q: Is the overheated home market slowing the apartment market?

Although rents declined and vacancy increased, the great rental apocalypse of 2020 never materialized.

New York-based Moody’s Analytics reported that rents dropped by 3 percent nationally in 2020. Dense urban areas like New York, the San Francisco Bay area, and Washington, D.C., were hardest hit.

But Moody’s is upbeat about the year ahead, with a forecast of a multifamily market rebound and rent increases of 2.1 percent. It also forecasts the vacancy rate stabilizing at 5.2 percent nationally, which makes for a balanced market between landlords and renters.

“We anticipate that the combination of returnees and first-time movers, now attracted by lower rents, will be enough to stabilize the apartment sector in key urban centers,” Thomas LaSalvia, senior commercial real estate economist at Moody’s Analytics, said in a statement.

Minneapolis-based Colliers International tracks the local market closely. According to its research, metro rental rates started dropping last summer at roughly the same time the housing market took off. Twin Cities apartment vacancy started climbing in mid-2019 and continued to rise through the pandemic.

But there’s a notable gap for occupancy between core cities and the burbs. Colliers has urban apartment vacancy in the metro topping 7.8 percent, while suburban vacancy is roughly 3.9 percent. That gives tenants an edge in the cities, while landlords have an advantage in the suburbs. Urban rental rates are averaging $1,445 per month versus $1,335 in the suburbs.

Jeff Budish, executive vice president with the local Colliers office, says that lifestyle issues are a big factor for people weighing owning versus renting or city versus suburbs,

“One thing I’m watching very closely is the daily commute,” says Budish. “It’s one of the pressures of people moving to the suburbs or moving downtown. When it became common in Minnesota to see a 30-minute-plus commute to get downtown, I think a lot of people opted to live urban just so they could be near their jobs and near the entertainment at night [but] during Covid there hasn’t been a commute at all.”

Budish sees commuting traffic as a key indicator for the market: “Once it comes back, I think nine months after that or 12 months after that, that’s when you’ll start seeing the movement back to the urban core.”

Q: Can the private sector still afford to build affordable housing?

Minneapolis-based developer Alatus LLC is pitching a $61 million project with 288 units in St. Paul near the intersection of University Avenue and Lexington Parkway. The project called for half of the units to be market-rate and half to be affordable for people making 60 percent of the area median income (AMI). AMI is a federal standard that defines rental rates for affordable housing. For 2021, the rates for those at 60 percent of AMI were $1,180 for a one-bedroom unit and $1,417 for two-bedroom units.

The site is owned by the St. Paul-based nonprofit Amherst H. Wilder Foundation. The developer was not seeking any zoning variances or any public money. Normally, city leaders would  embrace a transit-oriented development with some affordable units. Not so this time.

The proposal became a case study in the challenges a for-profit developer faces building affordable housing. The St. Paul Planning Commission voted 8-7 against the project in January. Alatus appealed but the City Council upheld the commission on a 4-3 vote.

St. Paul Mayor Melvin Carter threw a curveball, vetoing the council’s decision. Carter argued that St. Paul needed more mixed-income housing.

The Alatus proposal fueled intense community debate. Opponents argued that the “affordable” units in the project weren’t affordable at all and should instead be aimed at people making 30 percent of AMI—in 2020, $590 for a one-bedroom unit and $708 for a two-bedroom unit.

Chris Osmundson, director of development for Alatus, says that for-profit developers have no market incentive to build units targeted at that level of affordability.

“I know the biggest concern, appropriately, was really the deeper affordability levels: 30 percent area median income types of rents and income thresholds. Those really do need to be publicly subsidized,” says Osmundson. “They generally don’t actually even break even from an operational standpoint.”

The battle is ongoing. Project opponents have asked state Attorney General Keith Ellison for a legal review of the mayor’s decision, but St. Paul City Attorney Lyndsey Olson has declined to ask for one.