Housing, the American Dream, captures headlines during good economic times and bad. This of course is for good reason. For most Americans their home is their single largest asset and the biggest purchase they will make in their lives. It’s also the easiest asset to borrow against and most buyers use a lot of leverage to make the purchase. There are entire government programs designed to increase home ownership, funneling billions of dollars into housing ever year. With the exception of US government debt, mortgage debt is the largest debt market at over $15 trillion.
With the financial crisis still so fresh in the minds of both consumers and market observers it’s natural for the focus to turn to housing any time interest rates creep higher. However, the housing market moves more like an aircraft carrier than it does a fighter jet. It usually takes years for a housing market to turn up or down once it is headed in a particular direction. While we always track economic indicators closely, we thought we would share some of our observations more regularly with clients.
Where are we now?
First, a note on housing data. As will be evidenced in the charts, housing data can be incredibly messy. In normal years it follows very predictable sales patterns, but in a year like 2020 where a pandemic shut the world down for a few months and delayed and condensed the sales cycle we witnessed wild swings in the data. In March of 2022 the US registered 5.77M home sales (annualized). That’s down nearly a million homes from the post pandemic highs in early 2021. While that pace is the lowest in nearly two years it’s still above even the highest levels of the last decade and a half.
It’s always hard to isolate historical periods of time and compare them to the present but we think an interesting period to look at is the period from 2017-2018.
The Fed was on the move during that period as well. The Fed Funds rate went from 0.66% to 2.40% at the end of 2018. The 10-year rose 70bps from 2.45% to 3.15% before topping out. The economy was on solid footing with low unemployment and moderate inflation. US home price appreciation was brisk at more than 5% annually during the two-year period ending 2018 (Case-Shiller). Existing home sales fell more than 12% from the 2017 highs to the start of 2019 before the Fed pumped the brakes on the hiking cycle and rates moved lower.
What’s different this time is the Fed is expected to raise rates more aggressively that the last hiking cycle and the 10-year started at a much lower level and moved much more quickly than it has historically. So, we have a market that moves like an aircraft carrier but a key input to the market that just moved like a fighter jet. We had to double check our math but the monthly mortgage payment on the median existing home sale today versus one year ago is up 45% or an extra $500 a month.
Mortgage purchase applications act as close to a real-time gauge as we have. As the name implies this measure tracks current demand for mortgages in purchasing residential real estate. The purchase index specifically excludes refinance applications. Recently the purchase index has started to soften albeit still inline with where demand was pre-pandemic.
In addition to existing home sales (discussed above), new home sales are at reasonably strong levels when compared to the last 15 years. After the initial pandemic drop and pop, new home sales have settled in just a touch higher than pre pandemic levels. Nowhere near the bubble years of the mid-2000s. Household formation, a key driver of housing demand, grew by more than 1.5M during 2021. While not all of those household formations will buy a brand-new home, it does suggest new home sales are not running at an unsustainable level.
Housing starts are running a bit above household formation at nearly 1.8M and would suggest the market should be adequately supplied with new housing stock matching new demand. Again, according to this metric, assuming unchanged demand, the housing market looks to be on reasonably sound footing. In contrast, during the mid-2000s new home starts ran well above household formation for years and then demand collapsed.
Foreclosures were all but suspended in the aftermath of the pandemic. Many of the COVID era protections expired at the end of 2021. The Federal Reserve Bank of Philadelphia estimates there are more than 2.7M homes in forbearance or past due. Not all of these homes will hit the market in the form of a bank sales. Fortunately for homeowners, the market has appreciated tremendously through COVID and many of the homeowners behind on payments should be able to sell their homes in the market. That being said, whether a home hits the market through the foreclosure process or a traditional sale it’s still additional housing supply not currently available to the market. It’s hard to ballpark how many foreclosures might happen in 2022, but to give us a frame of reference we said what if 2020 and 2021 had seen the same number of foreclosures as the last pre-pandemic calendar year (2019)? In 2019, 493K foreclosure filings occurred which would imply nearly 1M foreclosure filings potentially could have occurred during 2020 and 2021. Only 365K filings happened during said period. In this scenario we could see 1M foreclosure filings this year which would account for a backlog and a normal level of annual filings. Admittedly, this is a very rough estimate but it would account for a little less than 20% of existing home sales at the current pace or about two months of supply.
At Custos, our biggest concern right now is affordability. The median home price of an existing home in the US rose over 30% from the start of 2020 through January of this year. The meteoric rise in prices was fueled by incredibly cheap money and a historic lack of supply. Supply is still tight but 2022 should see that start to change. We will update this information throughout the year.
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