Podcast Summary
Record high mortgage rates and low housing affordability: Unprecedented housing market changes, low inventory, and ongoing discussions about market structure complicate the outlook for the housing market
The housing market is experiencing unprecedented changes, with mortgage rates reaching record highs and housing affordability at an all-time low. These shifts have raised concerns about the overall health of the housing market, as many anticipate a negative impact on home sales. However, the low inventory and structural need for more housing in the US may complicate matters, as some experts suggest that this market may behave differently than in previous economic downturns. Additionally, there are ongoing discussions about market structure issues and the way mortgage rates are set, adding to the uncertainty. Join us on the Odd Lots podcast as we delve deeper into these topics with our guest, Jim Egan.
Housing affordability crisis unlikely to lead to crash due to fixed-rate mortgages: The housing affordability crisis is mainly affecting first-time buyers and prospective buyers, but most current homeowners are protected from affordability shock due to fixed-rate mortgages, ensuring their affordability remains stable for the next 30 years.
Despite deteriorating housing affordability reaching levels not seen in the last 35-40 years and worsening at an unprecedented pace, a housing market crash is unlikely due to the significant shift in mortgage market structure. With over 90% of the mortgage market being fixed-rate, current homeowners are protected from the affordability shock. However, this affordability crisis primarily affects first-time homebuyers and prospective buyers. The historic increase in mortgage origination volumes in 2020 and 2021 allowed most buyers to secure historically low rates, ensuring their affordability remains stable for the next 30 years.
High-interest rates making it hard for homeowners to sell: Homeowners with lower mortgage rates are locked in, reducing home sales volumes without a corresponding drop in prices. Challenges for first-time buyers and existing homeowners persist, making it a tough market for all involved.
The current high-interest rate environment is leading to a lock-in effect for homeowners with lower mortgage rates, making it difficult for them to sell their homes due to the prohibitive cost of taking out a new mortgage. This trend is expected to result in a continued decrease in home sales volumes without a corresponding drop in home prices. The lack of affordability for first-time homebuyers, coupled with the challenges faced by existing homeowners looking to sell and buy again, is making it a challenging time for everyone involved in the housing market, including buyers, sellers, renters, and real estate professionals. Furthermore, the absence of mortgage resets and a deteriorating labor market, which were major factors leading to sales during the housing crash, are not currently present. Instead, credit availability, specifically the product risk aspect, is a significant factor to consider. The proliferation of adjustable-rate mortgages with short reset periods that were popular before the financial crisis has largely disappeared. These products, which made up a significant portion of the mortgage market during that time, effectively do not exist today. This shift in the mortgage market has helped to stabilize home prices but has also contributed to the current challenges in the housing market.
Differences in the current housing market from pre-2008: The current housing market is tighter due to reduced refinancing and low inventory, limiting affordability issues and mass defaults, but inventory levels are crucial to watch as they could impact home price growth and potential downturns.
The current housing market is different from the pre-2008 housing market due to the lack of reliance on mortgage refinancing and the low inventory levels. Mortgage borrowers are less likely to face affordability issues when their mortgage payments reset because they cannot refinance, as credit availability has tightened significantly. This, in turn, reduces the risk of mass defaults and foreclosures that could lead to a decrease in home prices. However, the inventory situation is crucial to watch. Although sales volumes have decreased, months of supply, which measures the time it would take for existing inventory to be sold at the current sales pace, has been increasing due to the low inventory levels. With months of supply currently sitting around 4, the housing market remains tight, and historically, this has led to continued home price growth. However, it's essential to note that the low inventory situation could limit how low home prices could go in the event of a market downturn.
Housing market to experience continued downturn with sales potentially falling below 2014 levels: Affordability pressures, high mortgage rates, and ongoing supply chain issues and labor market challenges are contributing to a housing market downturn, with sales potentially falling below 2014 levels, and the industry still recovering from a decade of growth in building volumes.
The housing market is expected to continue experiencing a downturn, with home sales potentially falling to below 2014 levels. This is due to affordability pressures for new buyers and existing homeowners locked into high mortgage rates. The conditions are reminiscent of the Great Financial Crisis, but the sales decline is happening faster. Home builders are unlikely to ramp up production significantly in this environment due to ongoing supply chain issues and labor market challenges. Despite the structural housing shortage, the industry is still recovering from a decade of growth in building volumes, with single unit starts only back to 1997 levels and units under construction at 2004 levels. This backlog needs to be cleared before new construction can significantly impact the market.
Housing market pullback in single unit starts, high multifamily construction, aging population impact: The housing market is experiencing a pullback in single unit starts due to affordability and mortgage rates, with fewer starts expected in Q4 2023. High multifamily construction continues, while the aging population could lead to economic sellers and downward pressure on home prices in the next decade.
The housing market is experiencing a pullback in single unit starts due to affordability pressures and mortgage rate moves. This trend is expected to continue into Q4 2023, with fewer single unit starts compared to 2022. Meanwhile, the number of multifamily units under construction is still high and has surpassed pre-Great Financial Crisis levels. Another demographic factor to watch is the aging population of homeowners, particularly those over 65, who hold a significant percentage of owned homes in the US. As this cohort continues to age, there is potential for an increase in economic sellers, which could put downward pressure on home prices beyond current expectations. However, it may be another decade before this trend significantly impacts the market. Some indices have already shown home price declines, but the overall impact on prices is not yet clear.
Home prices to decrease by 3% YoY in December 2023: Despite some localized declines, national home prices are forecasted to decrease by 3% YoY in December 2023, bringing prices back to January 2022 levels but still above pre-pandemic prices, due to limited distress sales, tight supply, and rising interest rates.
While home prices have shown some signs of decline in certain areas, such as California, Denver, and Seattle, these decreases are not expected to signal sustained declines due to a lack of distress sales and tight housing supply. The current forecast calls for a national home price decrease of 3% year over year in December 2023, which would bring prices back to January 2022 levels, still significantly above pre-pandemic prices. The recent change in forecast was due to earlier than expected price declines, weaker sales volumes, and revised expectations for interest rates and mortgage affordability. As interest rates continue to rise, mortgage rates will also increase, exacerbating affordability issues and potentially dampening demand.
Factors Widening Mortgage-Treasury Spread: Mortgage-backed securities investors' structural short position on rate volatility, the Fed and banks stopping mortgage purchases, and high rate volatility have led to a larger spread between mortgage rates and treasury rates. Homeowners' increased equity and refinancing activity also contribute to this trend.
The gap between mortgage rates and benchmark interest rates has widened due to a few factors. Mortgage-backed securities investors are structurally short on rate volatility because homeowners are more likely to prepay their mortgages when interest rates drop, leaving investors with longer securities when rates rise. Additionally, the Fed and banks have stopped buying mortgages, making it harder for overseas investors to enter the market. These factors combined with the high rate volatility have led to a larger spread between mortgage rates and treasury rates. Furthermore, despite borrowers being less able to refinance due to being out of the money, homeowners have more equity in their homes, leading to an increase in refinancing activity for both lower rates and cash out equity. As a leading real estate manager, Principal Asset Management leverages local insights and global expertise to uncover opportunities in the housing market. Investing always comes with risk, including possible loss of principal. To learn more, visit principalam.com.
Fed's absence as a market stabilizer and shift to quantitative tightening: The absence of the GSEs and the Fed's shift from buying MBS to quantitative tightening has led to increased mortgage rate volatility due to decreased buyer demand in the market.
The absence of the GSEs as a market stabilizer, coupled with the Fed's shift from buying Mortgage-Backed Securities (MBS) to quantitative tightening, has contributed to the widening spread between mortgage rates and treasuries. These factors have put more pressure on other buyer bases, leading to increased mortgage rate volatility. Jay Bacow, JP Morgan's co-head of Securities and Derivatives Research, emphasizes that the mortgage spread's historical behavior depends on the Fed's involvement in the market. When the Fed is a large buyer, the spread should be tighter due to increased demand. Conversely, when the Fed is not buying, the spread should be wider. Additionally, advancements in housing technology and the potential for homeowners to invest in energy efficiency and renovations could sustain renovation activity, especially in a lock-in environment where people may be reluctant to move due to unfavorable market conditions.
Household formations driven by headship rates and age groups: New household formations impact real estate demand, particularly in the twenties and early thirties. Low mortgage rates and pandemic drove a recent surge in household formations, leading to increased demand for single-family homes in suburban areas and a widening home price gap.
Household formations, which represent the creation of new households, are driven by headship rates, or the percentage of people in a given age group who are forming their own households. Household formations are particularly important for understanding demand in the real estate market, as new households lead to an increased need for housing. The steepest increase in household formations typically occurs as people move through their twenties and early thirties, as they branch out on their own. However, household formations reached 50-year lows in 2019 due to factors like student loan debt and the Great Recession. In 2020 and 2021, the pandemic and low mortgage rates led to a spike in household formations, as people sought to move to less densely populated areas and take advantage of their increased buying power. This shift towards single-family homes in less densely populated areas has contributed to a widening gap between home prices in suburban and urban areas.
Factors Shaping the Housing Market: Population Shifts, Affordability, and Changing Preferences: Population shifts from urban to suburban areas, affordability pressures, and changing preferences among younger generations have led to changes in household formations and a lower homeownership rate, with single family rentership becoming another pillar of housing in the US. Supply remains the key variable to watch in the housing market.
The housing market has seen significant changes due to various factors including population shifts from densely populated areas to suburbs, affordability pressures, and changing preferences among younger generations. These shifts have led to changes in household formations and the desire to own homes, despite affordability concerns. The current homeownership rate is expected to remain below historical levels, and single family rentership is seen as another pillar of housing in the country. Looking ahead, the key variable to watch in the housing market is supply, as an increase in supply could lead to lower home prices. The current moment is unusual with record-breaking housing market indicators, and the idea of "locking in" or not selling during a seller's market has shifted in recent times.
Market conditions unfavorable for buyers and sellers, leading to a freeze in transactions: Unfavorable market conditions have caused a freeze in transactions, preventing significant price drops due to lack of supply and surging mortgage rates. Spreads between 30-year mortgages and treasuries have spiked up to levels last seen during the financial crisis.
We're currently experiencing market conditions that don't favor buyers or sellers, leading to a freeze in transactions. The lack of supply in the market could prevent significant price drops. Additionally, the absence of mortgage bonds, which are used to fund mortgages and keep interest rates low, has contributed to the surge in mortgage rates. The Fed, as a non-profit seeking entity, can absorb the volatility in the bond market during quantitative easing. However, during quantitative tightening, this volatility must be priced, leading to widening spreads between mortgage rates and treasuries. These conditions have caused the spread between 30-year mortgages and treasuries to spike up to levels last seen during the financial crisis in March 2020. A new podcast, Money Stuff, featuring Matt Levine and Katie Greifeld, will delve into Wall Street finance and other topics every Friday.
