“Housing Crisis?”
Is the Fed Trying to Cool Down a Hot Housing Market?
Federal Reserve Governor Christopher Waller has stated “The housing market is definitely out of whack,” and even shared a personal story about how he recently sold his St. Louis home to an all-cash buyer with no inspection. He was further quoted as saying, “We’ll see how the interest rates start cooling things off going forward.”
Low borrowing costs introduced to insulate the economy from COVID brought about a reported 35% rise in home prices over the past two years. While home prices are not part of the inflation indexes tracked by the Fed, they do feed into other factors, such as rents, and this is an influential component to inflation.
Rising interest rates mean that borrowing for a house is suddenly more expensive. The 10-year Treasury note yield, a benchmark for mortgage rates, has risen due to expectations that the Fed is going to quickly increase rates. The average 30-year-fixed rate for a mortgage loan is now 5.42% as of May 19th, over a 2% increase since the year began.
The last time mortgage rates rose this fast was in 1994. At that time, there was a 20% decline in home sales as the Fed increased rates and based on that, home price appreciation slowed.
While many of the economists and Wall Street research teams predict a decrease in home sales again, they are much more conservative and have projected this at approximately 5% annualized by the end of the year.
A Market Comparison
The market however is very different than in 1994. Today, record-low housing stock, higher household savings, and a job market where there are approximately 1.5 jobs available for every person looking, not to mention the additional “mobile” or “remote” nature of today’s worker, are creating fundamentals that could materially impact many forecasts. The sale of homes that have been previously owned are at a two year low as of March, and mortgage applications were down as well.
For the first time in a while, we have begun to see list price reductions on homes for sale with an average days on market of 17 and mortgage applications remain above pre-COVID levels. A review of housing data shows that the correlation between home price appreciation and mortgage rates, while still strongly correlated, has been decreasing the past 20 years.
Record low inventory over the past couple of years also means there has been, and is, plenty of pent-up demand, particularly among Millennials ready to set up a home, whose share of purchases has been growing. Today, the average age of the first-time home buyer is 33 years old, and I believe we will see household formation numbers increase dramatically, as my opinion is that they have been under reported due to the pandemic and quarantine. Due to the rising cost of alternative housing, Baby Boomers have not downsized as quickly as anticipated and this is keeping, at times, larger homes from coming onto the market and these are generally the homes that are sought by the younger home buyer.
In addition, too few new homes are being built. Pre-pandemic, we were already seeing millennials, who were renting in urban areas, moving out of those areas to more suburban locations and purchasing homes. However, the pandemic really accelerated those moves and we saw a lot of other people moving out of the cities and even moving to different states where, for example, the cost of living was/is better.
The other thing that is very different now versus during the housing crisis, is that at that time there was over a 12-month supply of homes available for sale. In a healthy market, you will generally see a 6-to-7-month housing supply, and right now, we are generally seeing a 2-to-3-month supply.
During the housing crisis, there was always the option of buying a home at foreclosure auction as many of the homes were underwater. But that is not the situation today. Approximately 90% of borrowers in foreclosure have positive equity, and over 20% of them sit in a 50% equity position. According to realtor research data, the share of all-cash sales was the largest in nearly eight years in March, a sign that much of the supply will be purchased by both investors and second home buyers.
Another important note is that rent prices have gone up 14% year over year and we are seeing really strong housing permit numbers right now from builders. While this is positive, they have been under-building for approximately 10 years, so it will take them another four to five years to catch up.
Foreclosure Activity
Foreclosure activity dropped from March to April, but it was still up 160% year-over-year. One interesting data point is that while foreclosure starts were pretty much flat, foreclosure completions were much lower, as 90% of borrowers in foreclosure have positive equity. Based on this, many foreclosures will result in home sales rather than foreclosure auctions leading to less “distressed” real estate for purchase.
According to ATTOM Data’s most recent Foreclosure report, “Lenders repossessed 2,830 U.S. properties through completed foreclosures (REOs) in April 2022, down 36% from last month but up 82% from last year. The states that had the greatest number of REOs in April 2022, included:
» Illinois (417 REOs)
» Pennsylvania (266 REOs)
» Michigan (187 REOs)
» Ohio (150 REOs)
» California (148 REOs)
The major metropolitan statistical areas (MSAs) with a population greater than 1 million that saw the greatest number of REOs in April 2022 included:
» Chicago, IL (347 REOs)
» Philadelphia, PA (149 REOs)
» New York, NY (128 REOs)
» Detroit, MI (64 REOs)
» St. Louis, MO (53 REOs).”
An interesting fact is that the homes we are seeing in active foreclosure were generally 120 days delinquent pre-pandemic and should have been foreclosed approximately two years ago. Also, the foreclosure rate today is still at about half of the normal level.
What’s Next
The Fed has the tools to continue tightening. Rate hikes have managed to coax rates higher. Balance sheet reduction should also put some pressure on longer-term rates and active selling of mortgage-backed securities remains a potential tool for them beginning in June of this year. The Fed will now miss its inflation target in 2021, 2022, and most likely 2023. Rate hikes only affect the housing market with a lag, and shelter inflation follows further behind. The Fed must continue to raise real borrowing costs if they hope to slow inflation back towards 2%. It will be interesting to see what they do in the next few months but at least for today, another housing crisis is not in the near term based upon the factors we have discussed herein.
