Brad Houle, CFA
Executive Vice President, Fixed Income Research and Portfolio Management
The residential housing market can be characterized as frenzied in many parts of the country, which begs the question — is it in a bubble? Housing price appreciation as measured by the S&P CoreLogic Case-Logic 20 city composite was up almost 17% from May 2020 to May 2021. Our view is that several factors are causing a massive increase in the demand for single-family housing and that this is not a speculative bubble.
The COVID pandemic has caused a tremendous increase in demand for single-family homes. Working from home has made having the greater space afforded in a single-family home more desirable as opposed to more compact living in the urban core. For many knowledge workers, the permanent ability to work remotely has allowed people to flee high priced coastal cities for less expensive desirable secondary cities. According to Goldman Sachs research, historically less dense cities like Boise, Idaho or Austin, Texas have seen price appreciation of 25% in the last year. This increase is notable when compared to the densest 1 percent of zip codes like San Francisco or New York having appreciation of only about 5 percent. This change in preference for single-family home living has also manifested in the rent increases for single-family homes. According to CoreLogic, single family rents have increased 7% year-over-year as of the month of May.
In addition to the change in consumer preferences for housing type, low mortgage rates have fueled the demand for housing. Mortgage rates for a 30-year fixed rate loan are hovering around 3%, making home ownership more affordable to more borrowers. The housing crisis in 2008 was also fueled by strong demand for housing and low interest rates. At that time, mortgage underwriting was sloppy to nonexistent, with many exotic mortgage products fueling crazy speculation. At this time, getting a mortgage or refinancing is accompanied by more stringent underwriting by lenders which should lead to more robust credit quality going forward. In addition, consumer balance sheets are in good shape due to strong personal income and a high savings rate.
Strong demand for housing and inexpensive financing has collided with a discernible lack of new supply. Since the financial crisis, there has been an underinvestment in residential housing resulting in inventory shortages. According to Zillow, there is less than a month’s worth of unsold homes on the market in Portland, Oregon, the lowest in 30 years. Nationwide, new supply has been slow to be built as is depicted in the chart of housing starts below. Building materials have been in short supply due to the disruption in manufacturing from COVID and have seen tremendous short-term price spikes. In addition, there has been a labor shortage in the building trades along with many related service industries.
Source: Federal Reserve of St. Louis
Any material increase in mortgage rates will cool the housing market as home price affordability will become a challenge for more borrowers. Our forecast is for interest rates to gently rise in the second half of this year and next year which would in turn push mortgage interest rates higher. This calming of the market would certainly slow activity and allow inventories of homes for sale to rise. The issue of underinvestment in housing nationwide will take longer to resolve as there is a lag in new supply catching up to housing demand. Our view is that the housing market will cool off with prices softening in many markets, but we do not believe there will be a sharp correction in prices like we saw during the financial crisis.
On Friday, the July jobs report was released with employers adding 943,000 jobs, a number well ahead of the consensus estimate. In addition, the jobs number for June was revised higher and the unemployment rate dropped from 5.9 percent to 5.4 percent. This was a robust employment report, proving the economy continues to heal from the disruption of the COVID recession last year. For the week, the stock market as measured by the S&P 500 was up almost 1 percent with the index bouncing around all-time highs. Interest rates increased during the week with the 10-year U.S. Treasury yielding 1.28%.
Takeaways for the Week
A shift in housing preference to single-family homes and low interest rates are causing a surge in demand
Underwriting diligence from lenders should prevent another housing crisis like we experienced in the 2008 financial crisis