Renter Nation Says 'Goodbye' To The American Dream!
Real estate is not like the stock market, yet many people who analyze housing act as if they are the same.
When investing in stocks and you fear a market correction, you can sell your stocks and sit on cash. But unless you are ready to accept homelessness, you have to make a different type of choice in real estate.
Choose to be a property owner, taking on the risks and benefits of ownership, or choose to be a tenant, reducing risks and forgoing the potential of the historical returns to your landlord.
We have seen the end of an era for the 30-year fixed rate mortgage, where for fifty years homeowners have enjoyed generally falling rates. In just the past year, we've seen mortgage interest rates grow by more than double.
This has pushed home affordability to a 30-year low and has many people waiting for something that seldom occurs, home prices falling. While they wait, investment banks are entering the single-family homes market, scooping up properties from the historically low inventory of homes for sale, making both home prices and rents rise at well-above historically normal rates.
I believe we are seeing a generational shift in the housing market that will greatly reduce homeownership and push the US towards becoming a renter nation, one in which Wall Street is in control of both home prices and rents. Needless to say, this is not good for the majority of families who need the benefits of homeownership.
Understanding Supply & Demand Today (Versus 2006)
There are a lot of people who share opinions on the US housing market today, but most miss or omit the key driver of home prices.
Too many people who analyze housing suffer from recency bias and await a housing market crash like the one in 2006. But a study of the supply and demand for homes makes it evident that today's market is nothing like the one observed 15 years ago.
The graph above plots the supply and demand for homes in the US. The blue bars measure the number of homes for sale in the US (reported on the left vertical axis), while the red line reports the months of supply of homes for sale on the right vertical axis. The gray dashed line displays the one-year average of the months of supply.
It is commonly considered a balanced market when there are six months of supply. When we see the supply drop below six months, it is deemed a seller's market, as there are more buyers than sellers. The opposite is called a buyers market when the months of supply push above six months.
Today's 2.5 months of supply average is barely above an all-time low, making today's housing market very strongly in the control of home sellers and having home prices moving higher at rates more than double the historical average. Additionally, the 1.2M homes on the market today are roughly 75% fewer than the 4M+ homes that were available in 2006.
So how does today's market compare with 2006? 75% fewer homes and low months of supply of homes (versus 6 months in 2006, which was accelerating rapidly). When people analyze the market, they see homes far less affordable than what has been enjoyed for the past 30 years, so they assume home prices must come down. But supply and demand control home prices and today's historically low supply has caused both home prices and rents to soar, so a collapse in home prices is hard to imagine.
How The New Construction Premium Has Changed
With the market needing more homes, you might think that homebuilder production will come to save the day. That has not been the case, the US has been deficit building for the past fifteen years, leaving the US short as many as 5 million homes. So why aren't builders delivering more homes?
The short answer is that buyers cannot afford what builders can build.
The graph above was created from data pulled from the Tallahassee Board of Realtors MLS, but it mirrors what you will find in most US housing markets. It calculates the "premium" that buyers must spend to purchase a new home versus an existing home. The red line plots the five-year average new home cost (measured in price per square foot of heated and cooled space) while the blue line does the same for existing homes.
In the 1990s and up through 2010, the premium for new construction was typically near 10%. But inflation kept pushing the cost of building new homes higher while the housing bubble and recession brought down the value of existing homes. By 2016, the new construction premium had soared above 50%, and even as the market stabilized and new homes were needed, builders could not compete with the existing homes market.
With inventories tight, existing home values surged higher at alarming rates, and we have seen the premium drop to just above 32%, still far higher than what we had seen in the past. Today's soaring inflation, coupled with supply chain disruptions related to the COVID pandemic, have pushed the cost of building so high that the premium is only slowly falling.
Every year that we produce too few homes only adds to the deficit of available shelter for both buyers and tenants alike, and this has drawn the interest of large investment funds and investment banks who seek the stable cash flows that rental properties provide. They can borrow relatively cheap money and invest it into homes delivering great rental rates plus value appreciation driven by inflation and the lack of available shelter for our growing US population.
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Slow Pace Of New Construction
While there are some reports of high levels of new construction, they are not supported by facts in the overall US housing market.
This graph plots the number of new homes completed each month with a blue dot. The blue line shows the one-year average of monthly new homes completed, while the red line plots the 10-year average of monthly new homes completed.
This is one of those times when a picture is worth 10,000 words. The ten-year average monthly homes completed line shows that even with the recent rise in new construction, the US is producing homes at a rate LOWER than what we saw in the 1960s through 2005. The reduced inventory of homes in both the for-sale and the for-rent markets has caused prices and rental rates to soar, and Wall Street has noticed and has taken action.
Imagine a future where only large investment banks can afford to buy homes, happy to lease them to people with great credit who can no longer afford to buy homes. We'll see people forced to pay a higher percentage of their income to have a nice place to live, and the profits from landlording will be shared with a much smaller segment of our population than what has occurred for the past 80 years.
Mortgage Interest Rates Today (Versus 2006)
When we study mortgage interest rates for the past fifty-plus years, we find that a long-term trend appears to have ended.
The blue bars in the graph above plot the average monthly 30-year fixed mortgage interest rate since the beginning of 1971. The solid yellow line plots the fifty-year average rate, and you can see that roughly 1/2 of the months were above that line while 1/2 of the months were below the line.
Perhaps the most intriguing trend is plotted as an orange-dashed line showing how since 1980, rates generally declined until hitting a market low in December of 2020. Let me tell you what this means and why we're now facing a multi-generational change in the housing market.
Anybody who purchased a home in the late 1970s or later, all the way through recent years, generally found lower mortgage interest rates when it was time to sell their home and buy another. If they applied their equity from the sale of their home to the subsequent purchase of the next one, the lower rates allowed them to "move up" to a better home while keeping their monthly mortgage obligation pretty close to where their last payment had been.
For more than forty years, move-up buyers have been supported by falling mortgage interest rates, but I fear that those days are over. Interest rates are cyclical, and there is plenty of reason to believe that we're now heading into an era of generally rising mortgage interest rates. Rising mortgage interest rates mean that while move-up buyers will have the equity from the sale of their homes, they might be priced out of buying a nicer home because the cost of the home (and, more importantly, the rising cost of money) will price them out of the move.
Home Equity Has Fueled The US Economy
Another unfortunate outcome of rising mortgage interest rates will be untappable equity for young homeowners. Just as rising rates will squash many move-up buyers, so will homeowners who want to pull equity from their homes. Tenants have never enjoyed the luxury of spending their equity (as they do not create equity for themselves), but now homeowners will sit on a pile of equity, much of it beyond their reach due to the cost of borrowing money.
How much of the US economy has been buoyed by spending from homeowners tapping their equity, I couldn't say, but I cannot imagine things remaining the same when the cost of refinancing becomes greater than a homeowner can afford.
How much of the US economy has been carried by cheap money? That's another question I cannot answer, but again, I cannot imagine things remaining the same when the cost of refinancing becomes greater than a homeowner can afford.
US Annual Home Sales
With the shock of exploding mortgage interest rates impacting the housing market, we find sales falling as many of the discretionary buyers have left the market.
This graph plots annual home sales. The blue bars count the number of existing home sales, while the red bars count the number of new home sales.
The significant decline in 2022 is hidden because first-quarter sales were very strong. The decline in sales that commenced with April's rising mortgage interest rates will be far more obvious when we start reporting 2023 home sales.
The number of sales today remains lower than in the bubble formation years, suggesting that fewer buyers were purchasing for flips (investors) than what was observed in 2003-2006. Last year's sales were the most recorded in 15 years, but still fewer than each of the years from 2003 through 2006 when "irrational exuberance" was a term used to describe investment activity in the housing market.
Expect to see fewer buyers in the market next year, unless the big investment banks accelerate their acquisitions in the single-family homes market.
Goodbye To The American Dream?
Homeownership has been a major tenet of the American Dream since the end of World War II, but home affordability declines coupled with the aggressive acquisition of homes by large investment banks could make homeownership too difficult for most American families.
Homeownership has allowed families to build wealth and develop a measure of financial security for over eighty years, but without sweeping changes in how local governments perceive their roles in facilitating "the dream," I have little faith in its future. It will take strong leadership from elected officials and constant reminders to the NIMBY crowd that homeownership is an important element in personal wealth and a major factor in the overall health of the US economy.
When you take away the ability to own and afford a home, you reduce a family's chances of improving its financial wherewithal, and you strengthen the ability of a handful of large funds to control home prices and rents. The US housing market remains one of the last local Mom and Pop industries not yet conquered by Big Business. You can do your part by being a vocal advocate of property rights and smart development in your local community. I hope to hear your voice ring loud and clear, supporting the American Dream!
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