Over the past several months, our market commentary has focused on the bond market, equity volatility, COVID variants and arcane economic datapoints: finance geek stuff. In what you may find a welcome reprieve from such clutter, we bring you a look at the U.S. housing market.
A primary residence is often a person’s largest single asset. In this part of the country, price appreciation has surprised proud homeowners and real estate professionals alike. A general concern may be emerging that the housing market is going a bit crazy.
Background
One of the unifying themes of the COVID era is that the pandemic accelerated existing economic trends. House price appreciation is a clear example. Record low mortgage rates and changing preferences due to the pandemic explain the recent rise. But as the chart shows, US home prices have, for several years, outpaced price increases in other areas of the economy.
There are multiple explanations for the long-term increase in home prices. One argument is based on the idea that the home builders who survived ‘08 have deep scars and a strong desire to avoid repeating the over-building mistakes of the bubble years. For that reason, the argument goes, homes are only built when the economic case for new projects is absolutely bullet proof and qualified buyers are identified. For every new job added to the economy over the past decade, just 0.5 houses were constructed. The long-term average is 0.7.
The data seems to confirm the “underbuilt” theory of lack of supply for entry level homes in particular. In the late 1970s, an average of 400k new units of entry-level housing were built each year, according to data from housing agency Freddie Mac. By 
the 2010s, that number had fallen to 55,000 new units a year. For 2020, an estimated 65,000 new entry-level homes were completed. Homes at this price point have seen the fastest rate of appreciation since the ’08 housing crisis. Don’t let the category “entry-level” fool you; this category represents a majority of the country’s housing stock and is an important steppingstone for the younger generations. As such, this is a real estate market analytical bell-weather.
Freddie Mac estimates that the US is under-supplied by 3.8 million single family homes. Not only is the US building an insufficient number of new homes to meet demand, but there are also fewer existing homes available for sale. As of the end of the 2nd quarter, there were roughly three licensed Real Estate agents for every one home for sale; typically that ratio is 1:1.
The Pandemic brought an increase in housing demand while highlighting the decade long trend of insufficient new home construction. Changing preferences and increased affordability due to record low mortgages rates help explain recent home price appreciation. Our clients often ask how sustainable this increase in home prices will be.
Looking Forward
When home prices behave like stock prices it is instinctive for people to get nervous and start asking questions about the health of the market. It is natural to wonder if current conditions are similar to the 2007-2008 timeframe, portending a similar bleak outcome.
One of the most important differences between the two periods is the availability of credit. Following the housing crisis, the Federal Government implemented several important regulations designed to prevent excess in the market. Anyone who has refinanced a mortgage or purchased a new home in the past ten years is aware of the extensive documentation and property appraisals required. Gone are the days when the ability to fog a mirror was the only requirement to secure a loan for just about any property at any price. Today, mortgage lenders review property values, income, and assets extensively and stop just short of a DNA analysis before approving a loan.
In 2020 several national lenders were requiring liquid assets equal to two years of mortgage payments for non-conforming (jumbo) mortgages. Conforming mortgages (backed by the Federal Government) added an “adverse market fee” of 0.5% of the value of the loan to all mortgage refinance applications. This fee is used to fund insurance to protect government housing agencies from loan defaults. During the housing bubble years, such strict underwriting and fee requirements would have been laughable.
The durability of the housing market may be influenced by two factors: the financial health of mortgage borrowers, specifically related to income, and the participation of investors.
For owner-occupied homes, affordability may become a limiting factor on future appreciation. The average monthly mortgage payment (before taxes and insurance) for first-time home buyers today is roughly $1,050, which represents ¼ of median monthly household income. This measure was $1150 in 2007, which marked the peak of the housing bubble adjusting for current wage levels. This suggests that on a national level the housing market is closing in on the highest prices the market can sustain relative to income. Further gains at the national level are therefore limited to household wage and salary growth, which is currently 3.4%.
Not every home sold is owner-occupied. In the runup to the housing bubble investors bought homes for income or appreciation potential, leading, in some cases, to outright speculation. Currently, there is increasing demand from large investors due to bullish housing expectations. Low bond yields are also pushing institutional investors into non-traditional investments in search of income. For example, Cerberus Capital Management, a large private equity firm, owns 24,000 homes in the US through a portfolio company named Keyfirst Homes. Cerberus recently secured a $2.5 billion loan at 1.99%, using their home portfolio as collateral, with the intention of buying additional properties. This type of investor can out-bid traditional home buyers and influence the market in unhealthy ways. It certainly does not help the narrative that they are named after a three-headed dog that guards the gates of hell in Greek mythology.
Investor appetite for investment properties skyrocketed during the pandemic, moving from 6% to 10% of all home sales in 2020. While this is a substantial uptick, 10% pales in comparison to the 15% peak seen in 2006. However, there is a caveat. Investment home sales, as a data category, is not terribly precise. The purchaser could be an investor intending to rent or flip, or the buyer could be someone purchasing a second home. Desire for second homes certainly increased because of the pandemic. Unfortunately, the exact percentage breakdown between these two types of buyers is unknown. Overall, speculative interest is creeping into the housing market, but not at level that should (yet) cause concern.
As old traders say, “Nothing cures high prices like high prices.” Elevated home values are forcing consumers to rethink buying, as shown by the accompanying chart. Current home buying conditions, according to the Michigan Consumer Survey, haven’t been this low since the early 80’s, when mortgage rates were in the mid double digits and borrowers were familiar with balloon payments and assignable mortgages. Despite the 16% year-to-date surge in home values nationally, the most current data suggests price appreciation is beginning to moderate and additional supply is becoming available for sale. As of June, the number of homes sold in a month had returned to its pre-pandemic rate.
By no means do we think we are on the cusp of a housing crisis. Given the demand/supply imbalance, the strong financial health of the US consumer and banking sector, such an outcome appears extremely remote. Housing prices should be increasing by 3-6% depending on location and price point moving forward. Certain desirable areas such as Spokane, Boise and Austin are likely to see higher rates of growth given the newfound ability of many employees to work from home. Overall, the housing market is another example of an area where the pandemic took an existing trend and sped it up. Now that trend appears to be slowing to a more normal pace.