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Are we starting to see cracks in the U.S. real estate market?

Lately, commercial real estate has dominated the headlines (and for good reasons). I’ve touched on it before, whether from excess capacity crushing margins (read here) or worrying amounts of “double defaults” sitting on bank books (read here).

But residential housing? That’s flashing some warning signs too.

Now, you might be thinking, "But housing prices keep going up - isn’t that a good thing?"

Yes - if you already own property. Rising prices generally benefit homeowners, especially since real estate makes up the majority of assets held by the bottom 90% of U.S. households.

• The bottom 50% have 49.1% of their assets in real estate.
  
  
• The 50-90% wealth bracket holds 39% of their assets in real estate. 

Figure 1: The Federal Reserve, March 2025

These are some of the highest levels of real estate-to-asset ratios since 2007 - right before the last housing crash.

Put simply, the bottom 90% of U.S. households rely heavily on property values to build wealth - so when prices rise, it creates a "wealth effect,"¹ making homeowners feel richer and spend more.

Think this is just a conspiracy theory? Well, some of the world's most powerful central bankers have explicitly supported the wealth effect.

For example:

• “Rising asset prices will help increase household and corporate wealth, which in turn will stimulate spending and investment.”
  — Haruhiko Kuroda, former Bank of Japan Governor (2013)
  
  
• “Higher asset prices will boost consumer wealth and help increase confidence, which can also spur spending... In a virtuous circle, this supports economic expansion.”
  — Ben Bernanke, former Federal Reserve Chairman (2010)

This makes one thing clear. Monetary authorities closely monitor asset prices because they drive consumer spending - especially housing.

But here’s my problem with that. . .

Many economists focus on growth and wealth as objective measures - but rarely ask how they’re created. For example:

• Overbuilding just to hit economic targets can create a crisis later, as excess supply overwhelms demand eventually (as seen in China today).
  
  
• Injecting money to boost asset prices may fuel a short-term wealth effect and growth spurt, but it also drives higher inflation (as we’ve seen since COVID-19).

That’s why we need to watch these trends closely – both the short-term objectives and the potential long-term effects.

So, is this another boom for housing? Or the beginning of a bust?

Well, right now, the latest data shows it could go either way.

How Bad Is the Housing Affordability Crisis? These Numbers Say It All.

The Federal Reserve Bank of Atlanta (aka the ATL Fed) tracks home affordability. And their latest numbers are staggering.

Right now, the cost of owning a home eats up 47% of the median household’s income. That’s the highest level since 2006.

The general rule? Housing should take no more than 30% of income. But today, the typical family is spending nearly half. And that doesn’t even include HOA fees - another $250 a month on average. Worse, HOAs are becoming the norm. In 2023, 65% of new single-family homes were in HOA communities, up from 49% in 2009².

Figure 2: Federal Reserve Bank of Atlanta, March 2025

More troubling is that the affordability gap is widening at a record pace - meaning a household now needs $124,150 to afford a typical home, which is over 55% more than the $80,000 median income (and that’s before taxes).

Thus both higher home prices and rising interest rates are squeezing homebuyers dry.

No wonder in January alone, over 41,000 home purchase agreements fell through, according to Redfin. That’s 1 in 7 deals canceled - the highest rate since 2017. At the same time, pending home sales hit their lowest level on record (excluding the pandemic)³.

As demand drops, supply is stacking up. That could push home prices down as sellers compete for buyers.

Either way, affordability remains a major issue. Housing devours a huge share of household income, forcing people to either cut spending elsewhere or rely on debt. So far, most have chosen debt (as the credit card and various consumer debt markets show) - but that’s not sustainable in the long run.

Note that this is simply aggregated data across the country (using median levels and averages). Property markets are wildly diverse across the country and so are incomes.

But keep an eye on this.

Could Climate Issues Wipe Out Trillions in Real Estate Value?

Whether people agree or not, climate change is becoming a problem in the housing market.

In short, its wild weather changes and storms are driving up insurance costs (or canceling coverage altogether), lowering property values, and making some areas nearly unlivable.

A recent study by First Street Foundation⁴ projects that climate change could erase roughly $1.5 trillion in U.S. home values by 2055 – with some of the hardest-hit areas including parts of California (the largest U.S. housing market by far) and New Jersey - where buyers are already wary of flood and wildfire risks.

Insurance premiums have skyrocketed in disaster-prone regions.

• A recent U.S. Treasury report found that homeowners in the top 20% of climate-risk zip codes paid an average of $2,321 per year in insurance premiums between 2018 and 2022 - 82% more than those in the lowest-risk areas⁵.

Meanwhile, in Los Angeles, insurers are pulling out of fire-prone areas like Pacific Palisades altogether, forcing homeowners to pay substantially higher premiums - or go without coverage altogether.

This creates a vicious chain reaction:

Higher weather risk → Higher insurance costs → Costlier Repairs → Reduced buyer demand → Falling property values.

And as I wrote two months ago, for four straight years, insurers have paid out more in claims than they’ve collected in premiums (which is potentially fatal for an insurance firm long-term).

Now, state-backed “insurers of last resort” are stepping in, absorbing trillions in risk to try and keep a lid on all this.

But the risk isn’t disappearing - it’s just shifting from private insurers to the government. And someone still has to pay.

Climate change is no longer a distant threat to housing - it’s getting too close for comfort.

Rising insurance costs and falling property values could have major ripple effects on the U.S. economy. This is one to watch in the years to come.

Why Housing Prices Stay High - Despite Everything

So, with all this in mind – one has to wonder:

“With affordability crumbling, climate risks mounting, and higher interest rates - shouldn’t prices be falling?"

For the most part – you’d imagine. But what many analysts didn’t factor in was that there’s a structural housing shortage in the U.S.

Or said another way, newly built homes have not kept pace with population growth.

Taking a look at housing completions per 1,000 people - showing us that the 2008 crash caused a sharp drop in new housing construction, and despite a slow recovery since, it still hasn’t kept pace with demand, fueling the affordability crisis.

Figure 4: U.S. Census Bureau, St. Louis Federal Reserve, Dunham, 2025

It’s gotten so bad that some estimates indicate a housing deficit of approximately 4.5 million homes⁶. This shortage has intensified affordability challenges, making homeownership increasingly elusive for many Americans, and as a byproduct – pushed rent prices far higher.

What’s caused this? Several factors have - such as:

• Underbuilding since 2008 – The crash halted construction, and it never fully bounced back.
  
  
• Pandemic-era mortgage rates locked homeowners in place – Many refinanced at 2-3% rates. Thus with current rates near 7%, they won’t sell just to buy another expensive home at a much higher interest rate.
  
  
• Wall Street investors buying up homes – Institutional buyers have snapped up single-family properties, keeping supply tight.
  
  
• Restrictive zoning laws – Many cities favor single-family homes over multi-family developments, limiting new housing.

Of all these, I believe zoning is a big issue going forward.

For instance, ​restrictive zoning laws limit the types of housing that can be built in certain areas - often favoring single-family homes over multi-family units like apartments. And there is tons of evidence that the cities with the most restrictive zoning laws have the highest prices⁷.

But the rental market is just as tight.

With fewer homes for sale, more people are forced to rent. That pushes rents even higher.

• In 2006, there were 10 renters for every home listed for sale. Today, it’s 30 to 1⁸.

This imbalance has sent rents soaring, far outpacing income growth and deepening the affordability crisis.

But there’s some good news though. . .

Not all cities are stuck in this cycle. Austin Texas, for example, has cut regulations and sped up development. This led to a surge in new apartments and thus supply.

• Rents in Austin have dropped 22% since peaking in August 2023, according to Redfin.
  

• Median asking rent is now $1,399 - $400 less than three years ago.

Figure 5: Bloomberg, February 2025

So, while cities like San Francisco and Chicago face criticism for excessive permitting rules, Austin’s pro-development approach has provided relief - for renters, at least.

But that came at a cost. Developers and landlords are now feeling the squeeze.

This poses a problem – since roughly $1 trillion in commercial mortgages will mature in 2025 – which is 20% of the $4.8 trillion total – and up from $929 billion in 2024, according to the Mortgage Bankers Association⁹.

Yikes.

The Bottom Line

The housing market is caught in a tug-of-war between affordability, supply shortages, climate risks, and policy constraints.

On one side, lower home prices and rents would be a relief for buyers and renters, potentially saving them hundreds per month - thereby freeing up money to save or spend elsewhere (boosting other sectors of the economy).

But on the other side, declining prices would be a blow to recent home buyers, whose property values could drop relative to their mortgage. Meanwhile, lower rents could add to the pain in commercial real estate - pushing landlords and investors deeper into distress.

Like anything in economics, it's a double-edged sword - some win, others lose. It just depends on which side someone lands on.

My guess? With affordability stretched and supply pressures building, something has to give.

Will it be policy changes? A market correction? Or will homeownership slip further out of reach?

As always, this is just some food for thought.

Sources:

1. A Study on the Wealth Effect and the Economy
2. Are HOA Communities Becoming More Popular? - Virginia REALTORS®
3. US Homebuyers Canceled Contracts at Record Rate for January - Bloomberg
4. Property Prices in Peril | First Street
5. Americans in Disaster-Prone Areas Are Paying 82% More for Home Insurance - Business Insider
6. Housing Shortage, Not Volatile Rates, Is Biggest Obstacle for Buyers, Zillow CEO Says - WSJ
7. Opinion: Restrictive zoning is the main factor squeezing the supply of housing<!-- --> - MarketWatch
8. Homes for sale in short supply as there's now 30 renters for every house on the market in US
9. 20 Percent of Commercial and Multifamily Mortgage Balances Mature in 2025 | MBA
   

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