We need to be paying closer attention to what's happening beneath the surface of the housing market. It's beginning to look a lot like 2007.
On the surface, things look great. We see headlines such as:
- Millennials Help Sustain Twin Cities Housing Market Boom
- Real estate CEO: Record-low housing inventory is 'freaking us out'
- Houses selling fast: 'If you wait, boom it's gone'
- Building to a boom: Subdivisions filling in quickly as real estate market rebounds
However, below the surface, there are worrying signs - and they have to do with buyers, not sellers. Two articles in recent weeks have caught my eye. The first is titled "Run-up in home prices is 'not sustainable': Realtors' chief economist".
"The continuing run-up in home prices above the pace of income growth is simply not sustainable," wrote Lawrence Yun, chief economist for the National Association of Realtors, in response to the latest price reading from the much-watched S&P CoreLogic Case Shiller Home Price Indices. "From the cyclical low point in home prices six years ago, a typical home price has increased by 48 percent while the average wage rate has grown by only 14 percent."
Yun also pointed to rising mortgage interest rates as a factor that would weaken affordability. The average rate on the 30-year fixed mortgage is nearly a full percentage point higher today than it was at its most recent low in September 2017.
. . .
Meanwhile the home price gains are widest on the low end of the market, where supply is leanest. That is why home sales have been dropping most on the low end. Evidence is now mounting that a growing number of first-time buyers are giving up and dropping out of the market altogether. Sales to first-time buyers dropped 2 percent in the first quarter of this year compared with the first quarter of 2017, according to Genworth Mortgage Insurance.
There's more at the link.
Mr. Yun makes a very important point. For those who are relatively wealthy, the increase in housing prices over the past few years has been inconvenient; but for those living on limited incomes, it's been disastrous. The lack of affordable "starter homes" has also been getting worse, as builders focus on providing more expensive houses on which their profit margin is higher. On the street where Miss D. and I live, where most houses are smaller units in the 1,300-1,500 square feet range, prices have shot up by 20%-30% since we moved in, two and a half years ago. That's driven purely by demand, because the homes on this street are relatively good-quality, largely "move-in-ready" brick buildings, offering a lot compared to others in their price range, so that demand remains high. However, less desirable buildings nearby, at a lower price, are hard to move, because banks will finance their purchase price, but are reluctant to grant increased mortgages to pay for their upgrading.
That brings us to the second article, titled "The Headwind Facing Housing". Here's an excerpt. Bold, underlined text is my emphasis.
In 1981 mortgage rates peaked at 18.50%. Since that time they have declined steadily and now stands at a relatively paltry 4.50%. Over this 37-year period, individuals’ payments on mortgage loans also declined allowing buyers to get more for their money. Continually declining rates also allowed them to further reduce their payments through refinancing. Consider that in 1990 a $500,000 house, bought with a 10%, 30-year fixed rate mortgage, which was the going rate, would have required a monthly principal and interest payment of $4,388. Today a loan for the same amount at the 4.50% current rate is almost half the payment at $2,533.
The sensitivity of mortgage payments to changes in mortgage rates is about 9%, meaning that each 1% increase or decrease in the mortgage rate results in a payment increase or decrease of 9%. From a home buyer’s perspective, this means that each 1% change in rates makes the house more or less affordable by about 9%.
. . .
To put this into a different perspective, the following graph shows how much a buyer can afford to pay for a house assuming a fixed payment ($2,333) and varying mortgage rates. The payment is based on the current mortgage rate.
. . .
The consequences of higher mortgage rates will not only affect buyers and sellers of housing but also make borrowing on the equity in homes more expensive. From a macro perspective, consider that housing contributes 15-18% to GDP, according to the National Association of Home Builders (NAHB).
. . .
Rising rates not only impact affordability but also the general level of activity which feeds back into the economy. In addition to the effect that rates may have, also consider that the demographics for housing are challenged as retiring, empty-nest baby boomers seek to downsize. To whom will they sell and at what price?
If interest rates do indeed continue to rise, there is a lot more risk embedded in the housing market than currently seems apparent as these and other dynamics converge. The services providing pricing insight into the value of the housing market may do a fine job of assessing current value, but they lack the sophistication required to see around the next economic corner.
Again, more at the link. Highly recommended reading.
The second article graphically illustrates the challenge facing many older Americans. Many of them have invested in large, comfortable houses, but made little or no provision for retirement funding. They expect to sell their homes for a considerable profit, and use that profit to bankroll their retirement. However, if housing prices fall rather than rise, and/or new buyers can't obtain mortgage financing for those large, comfortable houses because they can't afford the monthly repayments at higher interest rates, what are the owners going to do? The same factors that make mortgages more expensive for prospective buyers will probably restrict or even prevent them from taking out home equity loans secured against their houses, because - on their newly-reduced retirement income - they won't be able to afford the higher payments, either!
The current headlines about the housing "boom" seem very comforting and reassuring. However, below the surface, I'm seeing more and more counter-currents. If I were buying right now, I'd hesitate to stick my toe in that water unless I had an ironclad guarantee that I'd be able to continue to afford the payments. That depends more on the job market than anything else - and that market's not looking great for the long term. More and more part-time workers, who earn less money: more and more automation where robots and artificial intelligence systems replace (expensive) full-time employees . . .
That's not a happy thought. Mish Shedlock sums it up thus. Again, bold, underlined text is my emphasis.
Among other effects, debt boosts asset prices. That’s why stocks and real estate have performed so well. But with rates now rising and the Fed unloading assets, those same prices are highly vulnerable. An asset’s value is what someone will pay for it. If financing costs rise and buyers lack cash, the asset price must fall. And fall it will. The consensus at my New York dinner was recession in the last half of 2019. Peter expects it sooner, in Q1 2019.
If that’s right, financial market fireworks aren’t far away.