August 8th, 2022
The US housing market is in a bit of a pickle. Following the start of the COVID pandemic in 2020, low government interest rates pulled down the mortgage rate for home buyers, supporting a historic rise in home values across the country. Now, however, the Federal Reserve is reversing course and is increasing benchmark rates. Consequently, many potential buyers are faced with more significant monthly mortgage payments than originally anticipated. This, in turn, has reduced current demand to the point where we may be seeing a ‘topping out’ of the housing market.
There are many well-regarded indicators of US housing values, but currently several seem to be at odds with each other. Take, for instance, the difference between national mortgage interest rates and the 10-year US Treasury rate. As this ‘spread’ increases, one would expect to find higher mortgage delinquencies as bank underwriters push up prices for the risks in issuing new mortgages. The difference between the mortgage rate and 10-year US Treasuries in June and July were in the top 3 of all monthly readings going back to 1990. This should eventually lead to an increasing delinquency rate, but so far, delinquencies have continued their post-COVID declines to near record lows. This could mean that banks are charging borrowers more due to interest rate uncertainty rather than the borrower’s ability to repay, further reducing retail demand for high home prices.
Another indicator to keep an eye on is the ‘price-to-rent ratio’ from the OECD, which takes the inflation-adjusted cost to buy a home and divides it by the cost to rent an equivalent apartment. The higher this ratio, the more relatively expensive it is to buy a home than to rent. This ratio has spiked from 110 at the start of the pandemic to 139 at the end of Q1 2022. That is the highest reading since this metric began. Though current multi-family rents look very expensive, when compared to purchasing a home, they seem downright cheap. While it is unlikely that many Americans will elect to sell their home and move into an apartment, those looking to purchase their first home will have a difficult time reconciling this large difference in relative value between buying and renting.
The supply of homes has been affected by the decreased rates of new home construction since the Great Recession. This has led to a shortfall of new housing stock, constraining the supply side of our equation and bolstering prices. Additionally, national homebuilders are as well-capitalized as they ever have been, meaning developers could continue to build new homes and wait for the market to absorb the new properties at higher prices rather than being forced to sell low.
All told, the US housing market is a dynamic and complex system that ebbs and flows based on the sentiment of the supply and demand drivers. No one knows what will come next, but prudent market observers would urge caution in such an uncertain market.
Carey S. Blakley, CFA