Is the accommodation in a bubble? Why US real estate prices are still likely to rise.
About the Author: Ken shinoda is a portfolio manager with Jeffrey Gundlach and Andrew Hsu of the DoubleLine Total Return Bond Fund.
As an investor in mortgage backed securities, I keep an eye on the US real estate market. A few years after the start of my career, I saw this sector up close in the epicenter of the global financial crisis, an episode of terrible destruction but also of extraordinary opportunity. Very early on, I learned to always watch for the next bubble or the next crash. Home prices were up 19% year-on-year as of Oct. 31, after a record 12-month gain of 20% through the end of August. Some market players see another real estate bubble. This may be true in some areas. Local markets that have welcomed home buyers from America’s most densely populated and epidemic-hit cities may cool as people realize Gotham is not dead and head back to the office. However, I think prices are likely to climb higher nationally.
The same forces that supported house prices through the economic shock of the Covid-19 pandemic and which in fact fueled the ongoing recovery remain in place today. The demographic demand for single-family housing remains strong while the supply is extremely low. Affordability, despite the scorching appreciation in home prices, is still reasonable.
The pandemic has acted as a âbig acceleratorâ in the corporate world, causing a radical digitalization of internal operations, supply chains and customer relationships. The Great Accelerator has also acted on the housing market. The effects of Covid-19 accelerated the shift from renting to buying for many people who had been left on the sidelines. The formation of new households, including by parents of young children, had already entrenched the desire for more living space in a large segment of the population. Then came the Covid-19 and the closures of workplaces. Business leaders quickly made a religion out of the benefits, let alone the necessity, of hybrid work and working from home. The WFH has accelerated the demographic demand of millennials for single-family housing.
The formation of new households, the main driver of housing demand, is not going to go away any time soon. From 2019 to 2029, most millennials (people born between 1981 and 1996) will move into the 35-44 age group. This is the ideal age to buy a first home. The largest generation since the baby boomers, American millennials represent a population of 72.1 million. At the current 65.4% homeownership rate, this represents strong demand for housing.
The supply of single-family housing was at historic lows at the start of the pandemic and the rest. In January 2020, the stock of existing and new homes for sale stood at 1.6 million homes. In comparison, the peak of available-for-sale homes was 3.9 million homes in the summer of 2007. Since then, the US population has grown by 31 million. The inventory currently stands at 1.5 million. New home construction, while resuming, is being slowed by shortages of materials and labor.
Affordability is a function of income, mortgage rates and house prices. From these, one can calculate the average monthly mortgage payment of the average household and the percentage of that payment of the monthly household income.
At the height of the housing bubble in 2006, the median US home price hit $ 230,300 with 30-year fixed mortgage rates at 6.76%, assuming a 20% down payment. The monthly payment on this mortgage was $ 1,196 or 29.8% of the $ 4,071 monthly income that a two-member household generates at the median. Today, house prices are up over 53% with a median price of $ 353,900, but household income is up 40% and mortgage rates are halved to 3.07%. This involves a monthly payment of $ 1,204, or 21.4% of the current median monthly income of $ 5,627. Mortgage rates are expected to nearly double to return to 2006 affordability. In short, housing affordability is still higher than the historical averages of the 1980s and 1990s (28.1% of monthly income), when rates mortgages were much higher.
Mortgage rate speculation deserves a digression on the Federal Reserve. Fed Chairman Jerome Powell has stepped up a reduction in central bank purchases of U.S. Treasuries and the agency’s mortgage-backed securities. We could extrapolate a rise in interest rates, synonymous with a fall in bond prices due to the fall in asset purchases, but that would be naive. In fact, every time the Fed started to cut, long-term rates fell as the bond market anticipated slower growth due to less accommodative monetary policy. This time is no different. Note the decline in the 30-year US Treasury yield from its 2.5% intraday high yield on March 16.
None of this justifies complacency. Indeed, several indicators suggest that long-term interest rates should be higher. But affordability is a far cry from the averages of the 1980s and 1990s, at about 28% of income, when mortgage rates were much higher. Real estate prices as measured by national indices do not seem threatened by a Fed cut.
That being said, not all geographies and all subways are the same. Real estate has always been about ‘location, location, location’. Beneath the record price growth summarized in national averages, there remains a dispersion between geographic markets. Subways like Phoenix, Tampa and Miami are up more than 25% year over year, while Chicago and Minneapolis are up less than 13%.
The “Covid Metros” could be subject to slowdowns, even to an outright correction. Home buyers have flocked to magical vacation destinations such as Boise, Idaho; Cape Cod, Massachusetts; and Truckee, Calif. with the expectation of living close to nature, without having to work. Maybe someday they’ll trade in the chore of the daily commute for a pair of VR glasses and the metaverse, but today’s world reminds people of the office, at least part-time. Covid subways are already showing signs of softness. While these markets may or may not depreciate, in all likelihood, the 20-30% appreciation times are behind them.
To sum up, house prices have risen significantly, but affordability is still better than the historical average, and supply and demand dynamics point to continued resilience for housing in the United States. Good luck to my Millennials looking for their first home, and good health and happiness to all of you in the New Year.
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