April 4, 2022
We need to talk about U.S. Housing.
Summary
There is not a shortage of housing, only a shortage of sellers.
New home construction is outpacing population growth and going to lead to overbuilding.
Higher mortgage rates are going to cause havoc to this housing market, with the peak appearing near.
A picture is worth a thousand words, but a chart is worth a thousand pictures.
To say that it is a sellers market is an understatement. Prices have been rising relentlessly, to the dismay of countless home buyers. As of January, 95% of realtors surveyed suggested that buyers outnumber sellers. In February, over 57% of homes were sold within 2 weeks of listing. Median home price is up 15% from 2021 and 30% from 2020. This is while the 30 year mortgage rate has exploded higher from 3% in November 2021 to over 4.5% this week.
The rise in prices are so dramatic, in fact, that for the first time, the average increase in home value exceeded median U.S. income in 2021. If that isn't moral hazard, I don't know what is.
The result is a red hot market where everyone and their uncle is trying to buy a house on cheap debt. And it makes sense, given that mortgage rates are below inflation by at least 4%. The widely held opinion is that homes are a great investment and everyone should buy now because they are just going to get more expensive. Often repeated, I hear urgency from buyers, realtors, and lenders alike that mortgage rates are going up so its best to lock in low rates now.
But it begs the question, what happens after rates rise?
Let me tell you a little about Ponderosa Pine trees. Ponderosa are beautiful trees that can grow into colossal giants of 100 feet tall with diameters of 50 inches. It's difficult to imagine anything capable of defeating them.
The Mountain Pine Beetle knows how. This tiny insect is less than 1/4 inch wide. The beetle infects the Ponderosa by burrowing under the bark and eating the phloem that transports sugar throughout the tree. A fatal threshold of infestation won't be easy to spot, at first. The tree will still be green despite mortal wounds. The next year the tree will turn brown and there will be no doubt; the giant is dead.
A trained eye can spot trees that are dead - but just don't show it yet. Pitch tubes appear where beetles have burrowed into and out of the tree. A diagnosis is based on the amount of pitch tubes. The U.S. housing market is like a giant Ponderosa covered in pitch tubes. The market looks healthy today but this is deceiving. U.S. housing is infected and a dead man walking.
Homebuyers Are Seeking Protection From Rising Cost of Living
One of the top cited reasons for buying a home is that rents are rising. A fixed mortgage is essentially rent control for a household. Nationwide, rents are up 16% year-over-year. Rent for single family housing is up 35% over the same time. In addition, US CPI has been climbing since 2020 and is now over 7% annually. Costs are rising and people are looking for ways to find stability.
They are turning toward fixed mortgage rates as a way to achieve that stability. As an illustration, over 65% of resale homes received multiple offers in February, up from 51% the year prior. In addition, 41% of homes sold over list price.
Ratio: House Price Index to Rent CPI {blue}
House Price Index to Rent Ratio (Federal Reserve Economic Data | FRED | St. Louis Fed)
In 2006, the house price index to rent CPI ratio peaked just under 1.7 and fell back to its long term mean of 1.2. Today, the ratio is rising fast and approaching 1.6. History suggests the ratio is not sustainable. Curiously, data from the NMHC shows that rent delinquency has reached a new three year high of 8% in December 2021. This is despite the end of most rent eviction moratoriums.
The Real Housing Shortage
There is not a shortage of housing. There are plenty of places for people to live in the U.S. The issue is that too few of them are currently for sale.
The number of housing units per capita in the U.S. peaked in 2008 around 0.428. Today the ratio has climbed to 0.427. The number of units per working age person was approximately 0.665 in 2008 while today it is 0.693 per person.
Ratios: Total housing units per capita {blue}, Total housing units per working age person {red}
Housing Units per Capita (Federal Reserve Economic Data | FRED | St. Louis Fed)
A top argument is that the millennial generation is large and entering the home buying market. This is true but cannot be viewed in isolation. It is important to examine housing construction related to total population growth.
The change in population in persons per new housing start peaked in 2011 at 4.5 new persons per start in the aftermath of the great recession. This appears to be a large deficit that is commonly mentioned. Please note that the long term mean of this ratio is approximately 1.5 persons per start and that the ratio has been under 1 since 2019.
Ratio: Population change, persons per new housing start
Housing starts per capita (Federal Reserve Economic Data | FRED | St. Louis Fed)
The number of housing units under construction per growth in population and the number of housing units started per growth in population have both soared higher since 2020, demonstrating the huge increase in construction that has occurred in the last two years. While construction was relatively low in the 2010s, this was in response to overbuilding in the 2000s relative to means.
Ratios: housing units under construction per growth in population {blue}, housing units started per growth in population {red}
Number of new homes per capita growth (Federal Reserve Economic Data | FRED | St. Louis Fed)
The numbers are even worse when comparing new home starts to growth in working age population. Working age population growth has been negative since 2019. Typically, new home starts are correlated with growth in working age population. Since 2016, the relationship has diverged. Today, new homes starts are on pace for 1.6 million new units while the working age population is expected to decline by 600,000.
Growth in Working Age Persons (thousands) and New Housing Starts (thousands)
Federal Reserve Economic Data | FRED | St. Louis Fed
This build up of homes under construction is due to labor and supply shortages that are delaying construction timeframes. Progress in this area is slow and continues to impact construction time. This condition can be seen in the new houses for sale data which shows a large increase in homes under construction and not started while new houses completed are subdued. Notice that the peak in houses under construction and not started preceded the peak in home prices in 2006.
New Houses for Sale: Completed {blue}, Under Construction {red}, and Not Started {green}
Federal Reserve Economic Data | FRED | St. Louis Fed
Housing construction examined in the context of housing units per capita do not support the theory that current market activity is a result of years of under-building. There is another reason for the tight market and it begins with vacancy rates. The amount of vacant housing units for sale plummeted during the pandemic and has failed to recover since. I have previously noted that two primary reasons that homeowners are hesitant to move is concerns about the pandemic and ability to procure a new house. Vacancy is one of the primary differences between this housing market and that of 2008.
Vacant Housing Units for Sale
Federal Reserve Economic Data | FRED | St. Louis Fed
The Real Cause Of The Housing Shortage Is That Everyone Wants To Own Houses
Second home buyers, including investors, have jumped dramatically in the last two years. Year to date, investors accounted for a decade high 33% of all home transactions. Contrary to popular belief, data from Hoya Capital shows that most home investors are not institutional, which only account for 1-2% of the SFH market.
According to data from NAHB the percent of new homes sold as second homes to buyers was 15% in February 2021. Data from Redfin found that a record 18.2% of U.S homes sold to investors in Q3 of 2021. This compares to 11% in the peak of 2008. In 2021, the growth in second home purchases outpaced the growth of first home purchases approximately 2 to 1.
Previously, Freddie and Fannie had restrictions on the percentage of second home and investment home purchases that they would acquire at 7% of total acquisitions. This policy was increasing the mortgage rates available to buyers of second homes in early 2021. But in September of 2021 those restrictions were suspended, thus enabling purchases at low rates.
Homeowners are very motivated not to sell their homes right now. Most have locked in ultra low mortgage rates never seen before between 2-3%. If they sell, they lose those plush rates. Because the market has been performing extraordinarily well many homeowners are keeping the homes they own to speculate on the market. Still others are stuck in the home they have because they cannot afford the prices and higher rates that exist today.
This is why cash sales have trended up to 23% of existing home sales as of July 2021. Homeowners with significant equity in existing houses are using that equity to make competitive cash offers on new homes. In addition, investors are piling into houses with cash offers.
A correlation has existed since 2016 between owner occupied housing units per working age population and active listings. In 2016, there was 0.36 owner occupied units per working age person and the number of active listings were 1.5 million. Today, there are almost 0.40 owner occupied units per working age person and active listings are 400,000. For years people have been buying multiple houses for themselves and taking the supply off the market.
Ratio: Owner occupied housing units per working age population {red}, housing active listings (inverted) {blue}
Owner Occupied Units per Working Age Population and Active Listings (Federal Reserve Economic Data | FRED | St. Louis Fed)
This Is Not 2008 Over Again
There are several distinct differences between the housing market of today and that of 2008. For one, the number of Adjustable Rate Mortgages (ARM) is far less. In 2005, nearly 40% of all mortgages were ARM. Today, less than 1% are ARM. Compared to 16% in 2006 today the risk of mortgage default is only 2.3%. The market is better protected from rising rates and foreclosure because lending standards are much higher now.
Another difference is in housing vacancy. Homeowner vacancy was over 2.5% in 2008 while rental vacancy was over 10%. Today, homeowner vacancy is under 1% and rental vacancy is under 6%. Usually this would indicate a housing shortage. However, this isn't the case.
Vacancy Rates for Rentals and Owned Homes (Federal Reserve Economic Data | FRED | St. Louis Fed)
The home-ownership rate is not at new highs, indicating that less people own homes and a few people own multiple homes. The home-ownership rate spiked in 2020 during the pandemic, likely a cause of homeowners suspending plans to list their homes while renters entered the housing market to escape urban centers and take advantage of low rates. Yet, with all this home buying the home ownership rate is on par with pre-pandemic levels. Household debt service as a percent of disposable income usually correlates to home-ownership rates but has diverged since the start of the pandemic.
Homeownership Rates and Debt Service (Federal Reserve Economic Data | FRED | St. Louis Fed)
The monthly supply of houses on the market has recovered to pre-pandemic levels after a brief constraint.
Federal Reserve Economic Data | FRED | St. Louis Fed
An interesting similarity with 2008 is a spike in the interest of stagflation, as indicated by google search trends. This is in response to mounting inflation and energy costs, which mimic that of 2006-2008.
The Daily Shot
Another eerily similar condition is the profit margins of homebuilders. In 2007 profit margins of large homebuilders D.R. Horton and Lennar peaked at 28% and 15%, respectively. Today, both companies are experiencing profit margins in excess of those highs. Notice how quickly profit margins declined when the housing market began to unwind in 2008.
Finally, the number of realtors per capita has climbed to a new long term high in the U.S. The same condition occurred during the 2006-07 run up in housing. This occurs because excessive speculation in housing encourages participation in real estate sales as commissions become outsized.
Chart by Author (Data from National Association of Realtors)
The New Housing Bubble
The real mortgage payment has hit a 20-year high of $2,350 per month. This month, the median home sale price to median income ratio hit a record high of 6, which is far from the mean when compared to mortgage rates. At 4.5% mortgage rates, this ratio should be under 5. This implies a 17% drop in home prices just to reach mean. The ratio was similarly positioned in 2006 at a ratio of 5.1 when the mean was 4.4. By 2008, it dropped.
This has caused a decade-low 29% of consumers saying that now is a good time to buy a home. And yet, according to Redfin, a record high 32.3% of homebuyers are seeking to relocate outside of their home metro area. This is primarily due to remote work capabilities and seeking out more affordable locations.
By nearly every metric housing affordability has cratered to record lows or near record lows. In February, before even higher mortgage rates, the affordability index from Macrobond was near 2007 lows.
The Daily Shot
The affordability index from Trahan Macro is at the lowest levels since 1989. As a leading indicator, it suggests an imminent drop in housing start growth.
The Daily Shot
In December 2021, the Federal Reserve announced a reduction in mortgage backed securities purchases. Mortgage rates have been aggressively climbing since. The Fed indicates they will continue to reduce their MBS assets. The reduction is not yet showing up in balance sheet data because the purchases can take weeks or months to settle, but I expect to see the reduction in assets in the data soon.
Federal Reserve Economic Data | FRED | St. Louis Fed
The Case-Shiller House Price Index {red} is at all-time highs. On 3/29/2022 the 10-year treasury minus 2-year treasury yield curve inverted. This occurred during the previous peak in the Case-Shiller index in 2007 and is an indicator of recession. The spread between 30 year mortgage rates and 30 year treasury rates has been climbing recently, which also happened prior to the previous housing peak, and indicates higher perceived risk in housing. The real mortgage rate is deeply negative today around -3.5%. With the Fed reducing its MBS assets I expect mortgage rates to continue climbing toward positive territory. This means that 5 or even 6% mortgage rates are likely.
TradingView
It is too simple to examine the Case-Shiller Housing Index directly. John Wake and the team at Realestatedecoded.com do an excellent job of adjusting the Case-Shiller index for inflation and the cost of financing. Their data is in the chart below. I have included the adjusted index for Miami and Phoenix because they have been top relocation destinations for home buyers. This data has a 3-5 month lag. January data is an average of November-January data. The true impact of higher mortgage rates won't be captured in the data until June, at least. Nonetheless, January housing affordability across the U.S. was nearly at the 2008 peak and some cities, including Seattle, have surpassed that peak.
Realestatedecoded.com (used with permission)
If mortgage rates rise to 6.5% it would cause an approximate 30% reduction in affordable house price from current levels. The monthly payment for a mortgage on a median priced home has already exceeded 30% of median household income. The same condition occurred in 1990, just prior to the housing contraction of 1991, and in 2007 prior to the contraction in 2008.
Federal Reserve Economic Data | FRED | St. Louis Fed
Summary
The U.S. Housing Market is really screwed up. Everyone is trying to buy and first time homebuyers have been left in the dust. In any market, when everyone is bullish that is a good sign the top is near.
There is not a shortage of housing. I would venture a guess that 99% of homebuyers currently live in a residence. The shortage is in the number of home sellers. The low mortgage rates and pandemic-related reasons that are causing so many people to relocate started the momentum in housing that snowballed into a speculative frenzy. Inflation and rising rents have fueled that frenzy. Then, the threat of rising rates caused a panic in buyers to get into a house at any price to lock in their "once-in-a-lifetime opportunity."
Prices and profit margins have signaled homebuilders to build more. Homebuilders have responded in kind, in the face of significant production challenges. This situation is going to lead to overbuilding.
The number of units under construction already far outpaces population growth. Profit signals to stop building will be too little too late, just like 2008.
Now rising mortgage rates are crushing homebuyers. There is a lag of 30-90 days after rates rise before it impacts home sales and prices as many homebuyers have locked in rates over that time.
This spring and summer will be interesting, indeed.
Wow, what a mess.
This isn't 2008 all over again. But, it's darn close. There won't be an adjustable rate trigger.
Widespread foreclosures are unlikely. But This isn't 2008 all over again. But, it's darn close. Recent homebuyers will find themselves underwater on 0, 3, and 5% down payments that prove insufficient.
I expect the Fed to sell MBS assets until something breaks. I expect a recession by 2023. Sometime after it begins, I believe the Fed will begin buying MBS again and mortgage rates will be sub-3% again. I know many do not see this as a possibility. Not only do I think it is possible, I think it is probable.
It's impossible to know when home prices peak or when the seller market will end. But one thing is certain: there's too many pitch tubes.
U.S. Housing is a dead man walking.
This article was written by Garrett Duyck
Generalist investor and Seeking Alpha Contributor. Focusing on macroeconomics with the goal of achieving highest risk adjusted return by emphasizing strong cash flow, dividends, and margin of safety.
~~A picture is worth a thousand words but a chart is worth a thousand pictures~~
Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours.
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