The Affordability Problem in Housing
Strong demand for housing may give some flashbacks to 2007/2008, but this is not necessarily a bubble. We believe the work-from-home has shifted the demand fundamentals of real estate. New millennial homebuyers face the highest interest rates in their adult lifetimes. While rates are nowhere near the crazy-high levels seen during the 1980s, the PERCEPTION of high rates (not low) is JUST AS BAD.
Mortgage rates are rising drastically as long-term Treasury rates have climbed to start ’22 making higher borrowing rates and monthly payments more expensive. This comes in the face of 36 months of rising U.S. home prices. Prices have increased by 19% over the last year and doubled over the previous ten years. Our chart above shows the median family house price relative to average annual income, which is back near the ’06 highs in the face of appreciating home values.
Affordability is Concerning… But…
Mortgage rate shocks hit home prices with a lag. Today’s shock should trim price gains back to their pre-outbreak pace. Every 100bps move in mortgage rates requires a 10% adjustment in home prices to keep payments unchanged. To put that in words, a median American household needed 34.2% of its gross income to cover mortgage payments on a median-priced home in January. A year ago, it was 29%.
Comparing the house you can afford with a $1,000 monthly house payment in early 2021 vs. today, it is down to $180k from $240k. On a $1000 per month budget, you now buy >30% less house!!
The Other Side of the Problem – Supply
We are facing a chronically undersupplied housing market. Since the GFC, home building has severely lagged the necessary trend to meet growing American demand. Freddie Mac estimates that as of 2020, the U.S. housing supply was short 3.8M units, with COVID having hurt construction. So, millions of new homes need to be built to meet demand. But it is estimated that only 600,000 new units will be added this year, and a max of 1.5M new annual starts going forward…barely enough to match new household formation.
Young people, including some forced “home” due to the pandemic, are showing signs of coming back into the housing market – a demographic tailwind. We believe the millennial cohort of the population will continue to create support for the housing market as they purchase homes, especially outside of the big cities.
Home Prices Are Rising and Driving the Wealth Effect
After considering the price appreciation from their house, the median American made more money on their home than at their job.
The Census Bureau calculated the median yearly wage in the U.S. to be $50,295. With home values appreciating $56,000 in the twelve months ending February, this is the first time in the history of this data series, which includes the housing bubble, that the yearly increase in home value has eclipsed the median annual salary. While this is unlikely sustainable, it is eye-opening.
The implications of a rising wealth effect have been apparent across the U.S. Economy. As housing prices are likely to cool (although not crash), real consumer spending suffers when house prices fall. Indeed, a -1% shock (all else equal) to real estate assets hits real consumer spending growth by up to -0.4% over one year. While that doesn’t seem like a lot, spread over a couple hundred million people, it adds up!
Lets be Honest… The Fed Created this Monster
The Fed has been accumulating a MASSIVE number of Mortgage-Backed Securities (MBS) since March of 2020. Now that the Quantitative Tightening (Q.T.) program is starting, they will be letting lots of mortgages run off its balance sheet and may even outright sell some – putting upward pressure on their yields and the spread between a Treasury and MBS (currently about 260bps).
To begin 2022, we’ve experienced the fastest mortgage rate spike of the last 30 years (+211 bps since the start of the year) – atop sky-high house prices – has driven housing affordability (i.e., incomes relative to the cost of owning a home) to its lowest level in 15 years. Despite robust job & wage growth, odds are home prices will decline this year. So while home prices look vulnerable and may see declines … we believe a related financial crisis is not likely to be in the cards. If rates were to rise just 50 basis points more or home prices would increase just 5% more, home affordability could be the worst on record. Solid credit is one big difference between now and the last housing bubble. But, even with all the pessimism here, there is still a substantial housing shortage in this country. So while we expect home prices to succumb to the affordability crunch, that’s unlikely to have knock-on systemic significance for broader financial markets.
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