“The frenetic pace of the housing market over the past few years is starting to return toward a more normal trend.” - Aaron Terrazas, Zillow
It’s hard to overstate the importance of consumer, investor and business confidence to the health of the overall economy. While growth is expressed in and measured by cold, hard statistics, those statistics are merely the byproduct of countless small decisions and behaviors exhibited by individuals over a period of time. All of this, in large part, is an aggregate reflection of how people feel. And judging by economic numbers as a whole, people have been feeling pretty good over the past few years.
Housing has been an important tailwind to this positive sentiment. Rising home prices create positive equity and household wealth that encourages higher levels of consumption – at least for those of us who are fortunate enough to own property. As the chart below shows, since bottoming out in early 2012 the national home price index has grown at an annualized pace of 7% (well above its long term average) for over six years.
This rate of growth is obviously unsustainable, so common sense dictates that at some point the trend has to slow. We are starting to see a plethora of signs suggesting we’re at that point. First, the combination of higher prices and higher mortgage rates is putting homeownership out of reach for more and more American households. The Department of Housing and Urban Development calculates an index that depicts the change in “homeownership affordability” over time, taking into account prices and mortgage rates relative to household income. As seen in the chart below, although we’re not at record low affordability by any stretch we’re certainly much lower than we were at the trough in housing prices and interest rates.
Lower affordability, combined with a frenetic housing market characterized by tight supply and competitive bidding wars is starting to foster disenfranchisement amongst home buyers. This was referenced in Redfin’s most recent earnings call…
Homebuyers in today's market are frustrated by how few homes there are to buy, and how few of those are affordable. … What's striking about this change is that it seems to have been driven by dissident demand from homebuyers. As U.S. home prices have increased faster than wages for 70 straight months, buyers in markets like these have finally had enough, at least for now. There are still plenty of markets where homebuyer demand is strong. But for the first time in years, we are getting reports from managers of some market that homebuyer demand is waning, especially in some of Redfin's largest markets.
Have buyers really “had enough?” Apparently so, according to the University of Michigan’s Buying Conditions for Houses survey. Based on this index potential buyers have been feeling that the overall conditions for buying a house have been deteriorating steadily in the face of rising prices, limited supply and lower affordability. This is another scenario where the absolute value of the index wouldn’t be considered historically abnormal or extreme, but there’s no question about the trend.
In summary, prices are way up, financing costs are on the rise, affordability is plummeting and buyer attitudes seem to be deteriorating…but what does that mean for the market itself? After all, the same observations could have been made a year ago (or even two!). While it’s certainly a possibility that the strong uptrend could continue for the foreseeable future, it does appear to us that the dynamics described above are beginning to bleed through and be seen in actual housing activity.
As just a couple of examples of this the median price of new homes has already fallen 10% this year*, and new and existing home sales declined dramatically in June (the July numbers are due out later this week). Meanwhile, the quarterly growth rate in new orders amongst publicly-traded homebuilders was dismal as of the last reporting period, and Zillow is reporting an increase in price cuts and a decline in growth rates in many of the major markets they track. These data points are little more than anecdotes at this point, but they (and a long list of other data points) may very well represent early warnings signs of a downshift in the market.
And a downshift might be exactly what we need at this point.
As stated above, it would be unreasonable to expect that the recent rate of growth in the nation’s housing market could be sustained over the long-term. To hope for continued white-hot growth is to hope for an eventual bubble and all the market dysfunctions that come along with it. Ideally, the market will remain firm, but growth will decelerate to a more stable, measured pace. Things that would aid in this type of controlled downshift would be increased supply (ideally at the lower end of the market), stabilization in lumber and other commodity prices, a gradual pace to the upward trend in interest rates and most importantly continued job and wage growth in all other sectors of the economy.
We don’t see any reason why the housing market cannot continue to be a strong and stable contributor to economic growth, but all signs point to the strong tailwind beginning to lose some of its gusto. Homeowners might want to adjust expectations for the future after more than 6 years of exceptional price appreciation.
*It’s interesting to note that the median price for existing homes has not followed suit. We believe this is because existing homes tend to be in the lower price ranges, and much of the demand right now is being pushed out of the “new” home market and into the “existing” home market due to affordability constraints. Any realtor you talk to will tell you that the bulk of the pricing strength is in the lower price ranges right now.
Author David Houle, CFA is a founding member of Season Investments. He serves as the firm's Chief Compliance Officer as well as sitting on the investment committee overseeing the management of client assets. David spent nearly ten years in various roles primarily managing individual client assets prior to co-founding Season Investments. David graduated with a degree in Finance from Colorado University in Colorado Springs in 2003 and earned the Chartered Financial Analyst (CFA) designation in 2006. David and his wife Mandy have three children and spend most of their free time with friends and family.
Transparency is one of the defining characteristics of our firm. As such, it is our goal to communicate with our clients frequently and in a straightforward way about what we are doing in their portfolios and why. This information is not to be construed as an offer to sell or the solicitation of an offer to buy any securities. It represents only the opinions of Season Investments. Any views expressed are provided for informational purposes only and should not be construed as an offer, an endorsement, or inducement to invest.