Residential Affordability Crisis Driven by Supply Shortage, Not Demand

The residential real estate market is in a state of stasis, not stability, driven by a fundamental supply-demand imbalance and exacerbated by the "rate lock" phenomenon. While national prices may appear flat, this masks significant regional variations and an affordability crisis that disproportionately impacts first-time buyers. The conversation with Benjamin Keys reveals that many proposed governmental interventions risk stimulating demand rather than addressing the core issue of insufficient supply, potentially leading to unintended consequences like further price inflation. This analysis is crucial for anyone navigating the housing market, from prospective buyers and sellers to policymakers, offering a clearer understanding of the systemic forces at play and the delayed payoffs of supply-side solutions.

The Unseen Cost of "Stability": Why the Housing Market is Stuck

The prevailing narrative around the housing market is one of "stability," particularly for 2026. But Benjamin Keys, Professor of Real Estate at the Wharton School, reframes this as "stasis," a state of being stuck rather than a healthy equilibrium. This isn't just a semantic difference; it points to a deeper systemic issue: a profound imbalance between the demand for housing and the available supply. While national home prices might appear flat, this hides a complex reality where affordability is a major crisis for many households, forcing them to dedicate an "extraordinary fraction of their income" to housing. The core problem, as Keys articulates, is the simple fact that "we simply don't have enough affordable housing units in the cities where people want to live." This lack of supply, coupled with other market dynamics, creates a ripple effect that impacts everything from individual homeownership dreams to broader economic trends.

The most significant factor contributing to this stasis, particularly on the residential side, is the "rate lock" phenomenon. With over half of all outstanding mortgages carrying interest rates below 4%, homeowners are disincentivized to move. This isn't just a minor inconvenience; it's a powerful force that drastically reduces the number of homes available on the market. Keys highlights this, noting that "most of those people are going to sit on those mortgages. That is one of the strongest performing assets in their portfolio, is a below-market mortgage." This dynamic, unprecedented in modern mortgage history, leads to fewer transactions and a scarcity of available properties. The pandemic accelerated this by pulling forward a significant number of transactions, as people "re-optimized" their living situations. Now, with higher rates, the music has stopped, leaving many "happy where they are" and further constricting supply.

"The music stopped, interest rates shot back up, and now those people are happy where they are. And so I think that that pulled a lot of transactions forward in time as well. And all of that leads to a more depressed housing market when it comes to transaction volume and when it comes to the availability of properties."

-- Benjamin Keys

Government interventions, often announced with little fanfare, frequently fall into the trap of stimulating demand rather than addressing the supply deficit. Policies like the proposed 50-year mortgage or efforts to buy mortgage-backed securities, while seemingly aimed at helping buyers, risk simply bidding up prices. Keys warns that such demand-side policies "are going to have unintended consequences," where a portion of the benefit is "captured by the existing owners in the form of higher prices." This is a classic example of a first-order solution creating second-order problems. The immediate goal is to help buyers, but the downstream effect is increased competition for scarce resources, ultimately benefiting those who already own property. The more durable, albeit slower, path to affordability lies in policies that "stimulate supply," which requires making it easier to build new housing and ensuring construction financing is available.

The Fading Starter Home and the Rise of Insurance Costs

The concept of the "starter home," once a crucial entry point into homeownership, is becoming a relic. High fixed costs of construction, stringent zoning regulations, and rising material and labor expenses have shifted development towards higher-end properties. Builders face a higher hurdle to get permits, and as Keys points out, "housing construction costs are up about 60% over the last 10 years." This makes it difficult for developers to build at the lower end of the market, where the need is greatest. The result is a market where the "most affordable tier of housing is not what's being built," leaving first-time buyers struggling to find an accessible entry point. This isn't just about price; it's about the loss of a critical step in wealth building and community integration.

Beyond the direct costs of purchasing, a new and significant factor is impacting housing values: insurance costs. My research, as Keys notes, shows that rising insurance premiums, particularly in disaster-prone areas, are directly affecting house prices. While these areas may have seen significant price appreciation during the pandemic boom, he estimates that "they would have risen maybe $20,000 more had it not been for rising insurance costs." This is a direct pocketbook issue for households and a clear signal that climate change and disaster risk are no longer abstract concerns but tangible economic forces shaping real estate asset values. The market is beginning to price in these risks, creating a new layer of complexity for buyers and sellers alike.

"Now, these are areas that have in general already seen house prices rise quite dramatically over the COVID housing boom. But we estimate that they would have risen maybe $20,000 more had it not been for rising insurance costs. So these insurance costs are really a pocketbook issue for households at the moment, and it is affecting asset values in a very direct way."

-- Benjamin Keys

The commercial real estate market, while facing different pressures, also exhibits a slow response to changing conditions. The shift to remote and hybrid work models is gradually reshaping demand for office space. While conversions of office buildings to residential units are occurring, such as the Flatiron Building in New York, the process is slow due to the long-term nature of leases. The impact on retail is also a knock-on effect, dependent on the return of foot traffic to downtown areas. Even the prospect of manufacturing repatriation, while potentially boosting industrial real estate, is unlikely to offset the broader trends in office space demand driven by white-collar work-from-home dynamics.

Key Action Items

• Advocate for Supply-Side Policies: Engage with local and national representatives to champion policies that streamline permitting, reduce zoning barriers, and incentivize new housing construction. (Longer-term investment in systemic change; pays off in 2-5 years).
• Explore Creative Financing for First-Time Buyers: Investigate and support initiatives that help first-time buyers overcome the initial affordability hurdles, such as down payment assistance programs or shared equity models. (Immediate action; potential for delayed payoff if market dynamics shift).
• Understand Local Market Dynamics: Recognize that national housing trends are averages. Deeply research specific regional and local market conditions, including supply pipelines, employment growth, and insurance risk, before making investment or purchasing decisions. (Immediate action; ongoing effort).
• Renegotiate Leases Strategically (Commercial): For commercial tenants, proactively assess evolving space needs and explore flexible lease agreements or subleasing opportunities to align costs with actual usage. (Immediate action; pays off quarterly).
• Factor Insurance Costs into Home Valuations: Buyers and sellers in disaster-prone areas must incorporate current and projected insurance costs into their financial calculations and property valuations. (Immediate action; ongoing consideration).
• Support Zoning Reform Initiatives: Actively participate in or support local efforts to reform restrictive zoning laws that limit housing density and diversity. (Longer-term investment; pays off in 3-7 years).
• Monitor Rent Trends for Opportunity: Renters should actively shop around, as significant discrepancies often exist between new and existing tenant rates, offering opportunities for cost savings. (Immediate action; pays off monthly).