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Record home price growth coupled with surging mortgage rates are eroding US housing affordability, placing the sector squarely under the microscope. Rumblings of a possible housing bubble akin to 2008 have been growing louder.
However, I do not see a catalyst for a major US housing market correction anytime soon. While home price growth is expected to decelerate going forward, there remain long-term tailwinds that I believe are likely to keep US housing relatively expensive, while still allowing affordability to recover over time through income growth.
In 2020/2021, US home sales reached their highest levels since before the 2008 global financial crisis (GFC), as many homebuyers “pulled forward” their purchases during the COVID pandemic.
Annual household formation drove much of that upward trend, peaking at around 3 million, but has since slowed significantly. As a result, home sales have moderated as well. Adding to housing-related concerns, US mortgage rates have risen by more than two percentage points in 2022 alone (as of 31 May). Meanwhile, the median US home price was recently the highest on record, making homes less affordable for many prospective buyers. I expect home sales to slow further amid continued declines in household formation, deteriorating affordability, and limited inventory (see below). In addition, other indicators that we track, such as consumer confidence and mortgage applications, suggest near-term weakness in homebuyer demand.
Even with these negatives, my longer-term outlook for home prices remains positive . Notably, US demographics look favorable for housing over the next decade. In 2020, there were 108.9 million Americans in the prime homebuying age group (25-49), which is projected to grow by 7.5 million by 2030 – a potentially powerful tailwind for housing demand in the coming years (Figure 1). So, while it may take some time for homebuyers to adjust to higher mortgage rates and less affordable housing, we believe that if they find the job market strong and mortgage credit readily available down the road, housing demand should rebound on the back of this demographic-driven tailwind.
Despite this tailwind for housing demand, US housing supply remains at historic lows as of this writing, and I don’t see a catalyst that might push inventory substantially higher in the near term. In recent years, demand for housing has far exceeded the supply of it, leading to negative excess supply when you also factor in the number of demolitions. The pandemic only amplified this trend: Essentially, the US housing market went from a supply surplus of 2.4 million during the GFC to a shortage of 3.0 million in 2021, which has clearly helped support home prices.
The tightness in supply is readily apparent in the number of available housing units, but it becomes even more pronounced when you factor in the increased number of US households. As of year-end 2021, for example, housing inventory as a percentage of total households was historically low at just under 1%, less than a third of the level seen during the GFC (Figure 2).
An undersupplied housing market should typically elicit a corresponding response from the supply side, but not this time around. Homebuilders simply haven’t been able to keep pace with the growing number of households that have been relentlessly depleting inventory. And tempting as it may be to sell one’s home to capitalize on record price growth, limited supply doesn’t give most existing homeowners a strong motivation to move. After all, there is no substitute for shelter. Therefore, it remains a seller's market, which has two important implications: 1) low supply is a stubborn deterrent to home sales; and 2) the lack of interest in selling can keep home prices from declining materially, even in the face of weaker demand.
While US housing activity is slowing, I believe favorable supply/demand dynamics should continue to underpin valuations in the absence of a more severe economic downturn, which is not our base case at this time. Importantly, home price growth is supportive of mortgage credit performance, and non-agency residential mortgage-backed securities (RMBS) may be a compelling way to express a constructive view on the US housing market.
Nevertheless, recent data on US housing activity hasn’t been very upbeat, so I think it’s important to acknowledge some of the possible risks to my outlook. This will be the topic of my next piece in July.