The pandemic and its related policies (both public and private) created a tremendous tailwind for home values in the residential market that is showing signs of exhaustion as high interest rates and construction bottlenecks weigh on both the demand for and supply of housing. Recent reports on housing activity have painted a rather bleak picture for the residential market:
- National Association of Realtors reported buyer traffic declined by 14%[1] and pending home sales decreased 2.0% for the third consecutive month in August[2].
- Mortgage Applications for new home sales were down 10.1% in August compared to a year ago[3] as 30-year mortgage rates are marching towards 7.0% and the Housing Affordability index has declined to its lowest position since July 2006.
- NAHB Home Builder Sentiment Index has been down every month this year. The nine consecutive month decline is the longest in over 10 years[4].
- Single family home starts are down 4% year-to-date and building permits are down 15.3% year-to-date. Although, multifamily construction remains strong posting a 28% increase on an annualized basis[5].
The dramatic downward shift in the housing activity is starting to bleed into prices. The National S&P/Case-Shiller U.S. National Home Price Index, a measure for home price values, reported home values declined 0.3% in July, its largest month-over-month decline in over 10 years. Although, the price on a year-over-year basis increased by 15.8%, the pace of gains on both a monthly and annual basis are clearly showing signs of moderating[6]. After two and half years of robust gains that saw real estate prices rise by 44%, the housing market is overdue for a breather and possibly a correction in prices. The current rate of gains is not sustainable. In the event of a housing slowdown, the combination of low housing supply and strong consumer balance sheet should help buffer the market from significant losses.
The slowdown in housing activity and peak in prices is starting to draw comparisons to the housing crisis in the late 2000s. The housing crisis during the Great Recession was exacerbated by excessive building and an overleveraged consumer that crumbled as financial conditions tightened and liquidity was drained from the market. The current environment is quite the opposite as the market is coping with limited supply, healthy consumer balance sheets, strong demographic tailwinds and rapidly rising interest rates weakening demand.
In this blog we will share a few charts and data points to draw a few distinctions between the current market and the late 2000s.
RESIDENTIAL MARKET PLAGUED BY LOW SUPPLY OF UNITS
Metrics such as new housing starts, monthly housing inventory, and vacant units indicate the current supply of housing units in the market is easing but remains tight. Housing is suffering from a structural lack of investment since the housing crash in the mid to late 2000s. Following the Great Recession, new housing construction came to a screeching halt and has still failed to eclipse the January 2006 peak of 2,273,000 monthly annualized units. According to the economics team at First Trust, the US needs 1.5 million housing starts per year based on population growth and scrappage (voluntary knockdowns, natural disasters, etc.)[7]. The monthly annualized rate bottomed at 478,000 in April 2009 and finally reached over 1.5 million right before the pandemic in January 2020. As of August, the monthly annualized number of new housing starts was 1,575,000 and has averaged 1,635,000 in 2022. More units are needed to help balance the market and moderate price increases. The lack of supply and pandemic-related increase in demand for housing provided a strong tailwind for home values.
Chart I: Privately Owned Housing Unit Starts
The good news is the number of units under construction is now at a record high, although the number of completed homes for sale is still low due to pandemic related supply and labor shortages. Additional easing in the supply of homes is evident in the monthly inventory of new homes. The inventory of new homes-to-sales ratio measures the pace it will take to sell the current inventory of new homes based on the current sales rate. After bottoming at 3.3 in August of 2020, the current monthly inventory of new homes for sale is 8.1. During the Great Recession, this metric topped out at 12.2[8]. The addition of new homes should put a ceiling and likely downward pressure on prices as housing inventory recovers and balances the market.
Chart II. New Privately-Owned Housing Units by Stage of Construction
The rental vacancy rate is hovering near 38-year lows. The current market does not have a vacancy issue like that experienced in 2006. Chart III illustrates the rental vacancy rate peaked in 2010 and has maintained a downward trend. The average vacancy rate since this data was collected in 1956 has been 7.3%. The current vacancy rate resides below that at 5.6%[9]. The strong growth in multifamily construction should help ease the tight rental market.
Chart III. Rental Vacancy Rate in United States
HOMEOWNERS ARE NOT OVERLEVERAGED
The mix of strong consumer balance sheets and strict lending standards should also help buttress housing prices. Consumer balance sheets are stronger as low interest rates, higher home values and increased wages have reduced the financial burden of homeownership. Mortgage debt as a percentage of disposable income is near record lows at 3.89%. From 1992 to 2005, the ratio stayed below 6% and then increased to as high as 7.18% in October 2007. The current mortgage debt to disposable income is 46% below the 2007 peak[10].
Throughout 2020 and 2021, homeowners were able to take advantage of historically low interest rates to lock in low mortgage rates. According to the Consumer Finance Bureau, 2020 loan originations increased by 65.2 percent, from 8.3 million in 2019 to 13.6 million in 2020[11]. A Federal Reserve Board study estimates 1 in 4 homeowners refinanced in 2021[12]. Refinancing can help lower the monthly debt burden and provide homeowners with additional disposable income. Providing an added boost to the ratio has been wage inflation. Workers on average have seen a healthy increase in wages over the past 18 to 24 months.
Chart IV. Mortgage Debt Service Payments as a Percent of Disposable Income
The housing collapse in the 2000s ushered in stricter lending standards. Mortgage lenders were partially culpable for the credit crisis that helped lead to housing prices collapsing in the late 2000s. Credit was extended to many borrowers that posed high risk of default. The chart below provides a distribution of credit scores by loan origination. Per the Experian credit risk scoring system, a credit score below 670 is considered subprime. Subprime borrowers tend to have poor to fair credit history and typically receive unfavorable loan terms, such as higher interest rates, due to higher credit risk. At the beginning of 2007, roughly 26% of the loan originations went to borrowers with credit scores below 659. The median credit score was 712. Since then, the credit profile for borrowers has improved. The most recent data indicates the median credit score is 773 and with only about 7% loan originations to borrowers with credit scores of 659 or below[13].
Chart V. Mortgage Origination by Credit Score
MILLENNIALS PROVIDE STRUCTURAL TAILWIND FOR HOUSING DEMAND
Millennials are providing a demographic tailwind for housing demand as they reach prime household formation age. Millennials have surpassed the Baby Boomers as the largest living generation and accounted for over half the mortgage applications in 2021[14]. As millennials have children and form households, this will provide a steady rate of demand for the next ten to twenty years.
HIGH INTEREST RATES TAKING A BITE OUT OF DEMAND
The dramatic rise in mortgage interest rates in 2022 is having an impact on demand for housing. The weekly average 30-year Fixed Rate Mortgage is up over 100% in 2022, rising from 3.11% to 6.29%[15]. Based on a mortgage of $300,000, the monthly mortgage payment has increased 44% from $1,282.68 to $1,854.96. Bloomberg’s Chief Economist for Financial Products, Michael McDonough, provided a great visual to show the impact of higher rates on purchasing value. Based on a $2,500 mortgage payment and assuming 20% down payment with average 30-year mortgage rates, you could have purchased a home in 2021 for $758,572. With current interest rates, that amount is down to $476,452[16]. Higher rates are having an adverse impact on affordability and buyers’ ability to afford real estate at current prices and interest rates.
Chart VI. Bloomberg: Home Purchase Value based on $2,500 Monthly Mortgage Payment
Source: Bloomberg
CONCLUSION
The combination of underinvestment in housing supply, tough lending standards and solid home equity values should help support the market from large losses. The housing crisis in the 2000s had a unique dynamic that was highly overbuilt and overleveraged. Once financial conditions tightened, access to credit and mortgage lending that helped fuel the housing expansion dried up resulting in the market collapse. The current market is being dragged down as it rebalances from outsized returns over the past two years and adjusts to a higher interest rate environment.
[1] National Association of Realtors Research Group; NAR SentriLock Home Showings Report: August 2022 .
[2] Pending Home Sales Dropped 2.0% in August. (n.d.). www.nar.realtor.; September 28, 2022
[3] August Purchase Mortgage Applications for New Homes Decreased 10.1 Percent. (n.d.). MBA. Retrieved September 30, 2022, from https://www.mba.org/news-and-research/newsroom/news/2022/09/20/august-purchase-mortgage-applications-for-new-homes-decreased-10.1-percent?utm_source=ground.news&utm_medium=referralPercent
[4] Builder Confidence Falls for Ninth Straight Month as Housing Slowdown Continues. (n.d.). Www.nahb.org. Retrieved September 30, 2022, from https://www.nahb.org/news-and-economics/press-releases/2022/09/builder-confidence-falls-for-ninth-straight-month-as-housing-slowdown-continues
[5] Multifamily Starts Surge in August as Single-Family Production Remains Weak. (n.d.). Www.nahb.org. Retrieved September 30, 2022, from https://www.nahb.org/news-and-economics/press-releases/2022/09/multifamily-starts-surge-in-august-as-single-family-production-remains-weak#:~:text=Multifamily%20Starts%20Surge%20in%20August%20as%20Single%2DFamily%20Production%20Remains%20Weak
[6] S&P Dow Jones Indices LLC, S&P/Case-Shiller U.S. National Home Price Index [CSUSHPINSA], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/CSUSHPINSA, September 28, 2022
[7] Wesbury, B., Stein, R., Elass, S., Opdyke, A., & Gill, B. (2021, April 12). First Trust Monday Morning Outlook [Review of First Trust Monday Morning Outlook]. Housing Boom to Continue. https://www.ftportfolios.com/Commentary/EconomicResearch/2021/4/12/housing-boom-to-continue
[8] U.S. Census Bureau and U.S. Department of Housing and Urban Development, Monthly Supply of New Houses in the United States [MSACSR], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/MSACSR, September 28, 2022.
[9] U.S. Census Bureau, Rental Vacancy Rate in the United States [RRVRUSQ156N], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/RRVRUSQ156N, September 29, 2022.
[10] Board of Governors of the Federal Reserve System (US), Mortgage Debt Service Payments as a Percent of Disposable Personal Income [MDSP], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/MDSP, September 29, 2022.
[11] (2021). Data Point: 2020 Mortgage Market Activity and Trends (p. 6) [Review of Data Point: 2020 Mortgage Market Activity and Trends]. Consumer Financial Protection Bureau. https://files.consumerfinance.gov/f/documents/cfpb_2020-mortgage-market-activity-trends_report_2021-08.pdf
[12] (2022). Economic Well-Being ofU.S. Households in 2021 (p. 4) [Review of Economic Well-Being ofU.S. Households in 2021]. Board of Governors of Federal Reserve System. https://www.federalreserve.gov/publications/files/2021-report-economic-well-being-us-households-202205.pdf
[13] Household Debt and Credit Report - FEDERAL RESERVE BANK of NEW YORK. (n.d.). Www.newyorkfed.org. https://www.newyorkfed.org/microeconomics/hhdc
[14] Pradhan, Archana; Millennial Homebuyers Dominate in High-Tech and Midwest Metros; October 4, 2021; https://www.corelogic.com/intelligence/millennial-homebuyers-dominate-in-high-tech-and-midwest-metros/#:~:text=According%20to%20the%20CoreLogic%C2%AE,home%20purchase%20applications%20in%202021
[15] Freddie Mac, 30-Year Fixed Rate Mortgage Average in the United States [MORTGAGE30US], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/MORTGAGE30US, September 28, 2022.
[16] Weisenthal, Joe; Bloomberg; Here’s How Much Less House You Can Buy Thanks to the Mortgage Spike; September 29, 2022; https://www.bloomberg.com/news/articles/2022-09-28/here-s-how-much-less-house-you-can-buy-thanks-to-the-mortgage-spike
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.