The concept of a free market hinges on the balance of supply and demand. When one group needs something, another group stands ready to produce it, resulting in an exchange that benefits both sides. Ideally, competition keeps prices low. This is the essence of capitalism.
However, this ideal seems increasingly out of reach. The market appears to be failing more frequently, particularly in sectors with limited competition like monopolies or oligopolies. In these cases, products are delivered, but at exorbitant prices. The housing market is a stark example: despite soaring prices, the supply isn’t meeting the demand.
House prices in Europe are skyrocketing, reaching historic highs. Despite this, there remains a critical shortage of homes, mirroring trends in the United States. Many European countries cannot freely increase supply to meet rising prices, indicating a profound demand issue.
Government intervention in housing is so extensive that it’s hardly a market anymore, often leading to inefficiencies reminiscent of communist economies. In the Soviet era, mismanagement led to factories producing mismatched quantities of goods, like left shoes without right shoes. Similarly, the current housing market sees construction targeting those who can’t afford homes, leaving a void for potential buyers with purchasing power.
Disposable income and housing prices
Historically, house prices align with trends in disposable income. For the first time since the housing bubble that precipitated the Great Financial Crisis, prices have surged beyond long-term income trends.
In the U.S., rising interest rates have further strained the housing market. Homeowners with low-rate mortgages are reluctant to sell, reducing mobility and tightening supply. The common 30-year mortgage, with the option to refinance at lower rates, exacerbates this immobility.
Mortgage market impacts
Post-crisis mortgage restrictions in Europe have similarly stifled housing construction, contributing to a significant shortage. Even in the U.S., new housing is lagging despite high demand. Rising construction costs mean that only homes with profitable margins are built.
Homebuilders are enjoying historically high margins—gross margins over 25% and net margins near 15%—indicating a lack of competition. Larger builders, with their scale advantages and lower capital costs, dominate the market but don’t compete aggressively, a clear sign of market failure. This failure is underscored by high inventories; half a million unsold homes match pre-crisis levels, driven by fear of high inventory costs amid rising interest rates.
Changing preferences and regulation
The pandemic shifted housing preferences, with many opting for suburban or rural homes, facilitated by remote work and online services. This sudden demand shift requires time for supply to catch up.
Regulations have also tightened in the U.S., limiting new construction and preserving existing home values. This regulatory environment discourages new developments, further constraining supply.
A call for market forces
The housing market’s woes stem from several factors: stricter post-crisis mortgage rules, lack of competition among builders, a pandemic-induced shift in demand, and increased regulatory barriers. These elements collectively hinder the market’s ability to adapt quickly to changing conditions—a core strength of free markets.
Despite these challenges, few governments are inclined to embrace more market-driven solutions for the housing crisis. The intricate balance between regulation and free market principles remains a contentious issue, with significant implications for Europe’s housing future.
Han Dieperink is the chief investment officer at Auréus Vermogensbeheer. He has previously served as the chief investment officer at Rabobank and Schretlen & Co.