About the Author: Ken Shinoda Jeffrey is a portfolio manager with Gundlach and Andrew Hsu of DoubleLine Total Return Bond Fund.
As an investor in mortgage-backed securities, I keep my eye on the US housing market. A few years after starting my career, I watched as the sector fell into the epicenter of the global financial crisis, an episode of tremendous destruction, but also of extraordinary opportunity. So quickly, I learned to always stand up for the next bubble or the next crash. After a record-breaking 20% 12-month gain by the end of August, home prices rose 19% year-on-year through October 31. Some market participants see another housing bubble. Perhaps this is true in some areas. Local markets that welcome homebuyers from America’s most densely populated, pandemic-ridden cities may calm down as people learn that Gotham is not dead and back in the office. However, I think prices are likely to go up across the country.
The same forces that supported home prices through the economic shock of the COVID-19 pandemic and in fact fueled the ongoing rally, persist today. Demographic demand for single family housing continues to be strong, while supply remains tepid. Affordability, despite the steep home prices, is still reasonable.
The pandemic has acted as a “great accelerator” in the corporate world, leading to widespread digitization of internal operations, supply chains and customer relationships. The Great Accelerator also worked on the housing market. The impact of Covid-19 hastened the move from renting to shopping for many people who were sitting on the sidelines. The desire for more living space was already embedded in a significant portion of the population, including the parents of young children, in the new household formation. Then came Covid-19 and workplace closures. Business managers soon found the dharma to be hybrid work and work from home, to say nothing of the necessity, on profit. WFH accelerated Millennials’ demographic demand for single family housing.
New home construction, the main engine of housing demand, is not going to end anytime soon. From 2019 to 2029, most millennials (those born between 1981 and 1996) will move into the 35-44 age group. This is the prime age to buy a home for the first time. The largest generation since the Baby Boomers, US Millennials represent a population of 72.1 million. At today’s home ownership rate of 65.4%, this is a very high demand for housing.
The supply of single-family housing was and remains at historic lows entering the pandemic. In January 2020, there were 1.6 million homes in inventory, both existing and new, for sale. By comparison, the peak in homes available for sale was 3.9 million homes in the summer of 2007. Since then, the US population has increased by 31 million. Inventory currently totals 1.5 million. The pace of new house construction is slowing down due to shortage of material and labour.
Affordability is a function of income, mortgage rates and home prices. From these, the average family’s average monthly mortgage payment and the percentage of that payment to the monthly household income can be calculated.
At the height of the housing bubble in 2006, the median home value in the US reached $230,300 with 30-year fixed mortgage rates at 6.76%, assuming a 20% downpayment. The monthly payment for that mortgage was $1,196, or 29.8% of the $4,071 in monthly income that a family with two working individuals generates on the median. Today housing prices are up more than 53% with a median home value of $353,900, but household income is up 40% and mortgage rates have been cut in half by 3.07%. This means $1,204 monthly payments, 21.4% of today’s average monthly income of $5,627. Mortgage rates would have to nearly double to get back to 2006 affordability. Long story short, housing affordability is still higher than the historical average (28.1% of monthly income) in the 1980s and 1990s, when mortgage rates were very high.
Speculation on mortgage rates merits a digression on the Federal Reserve. Fed Chairman Jerome Powell has accelerated central bank purchases of US Treasury and agency mortgage-backed securities. Rising interest rates can be extrapolated from decreased asset purchases as synonymous with declining bond prices, but this would be naive. In fact, whenever the Fed begins lowering, long-term rates have declined as the bond market prices fell in slow growth due to less liberal monetary policy. This time is no different. Note the decline in the 30-year US Treasury yield from the March 16 intraday high yield of 2.5%.
None of this justifies complacency. Indeed, several indicators suggest that long-term interest rates should be higher. But affordability is a long way from the average of the 1980s and 1990s, about 28% of income, when mortgage rates were much higher. Housing prices as measured by national indices do not appear to be at risk of a Fed shortfall.
That said, not all geographies and metropolises are the same. Real estate has always been about “location, location, location”. The spread across geographic markets remains below the record price increase summarized in the national average. Metros like Phoenix, Tampa and Miami are up more than 25% year-over-year while Chicago and Minneapolis are down less than 13%.
“Covid Metros” may go into recession if one-time reforms are not done. home buyers keep coming to magical vacation destinations like Boise, Idaho; Cape Cod, Mass.; and Truckee, Calif. Freed from office, hoping to be closer to nature. Maybe one day they’ll trade the hard work of a daily commute for a pair of VR glasses and the Metaverse, but today’s world is calling people back to the office, at least part-time. The Kovid Metros are already showing signs of softening. While those markets may or may not depreciate, in all likelihood a 20-30% appreciation time is behind them.
In short, home prices are high, but affordability is still better than historical averages, and supply-and-demand dynamics point to continued resilience for American housing. Best wishes to my fellow millennials who are looking for their first homes, and good health and happiness to everyone in the new year.
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