Morgan Stanley
  • Thoughts on the Market Podcast
  • May 23, 2023

Is There Still Strength in the U.S. Housing Market?


Jim Egan: Welcome to Thoughts on the Market. I'm Jim Egan, Co-Head of U.S. Securitized Products Research here at Morgan Stanley.

Jay Bacow: And I'm Jay Bacow, the other Co-Head of U.S. Securitized Products Research.

Jim Egan: And on this episode of the podcast, we'll be discussing the U.S. housing and mortgage markets. It's Tuesday, May 23rd at 2 p.m. in New York.

Jay Bacow: It's been a while since we talked about the state of the U.S. housing market. And it seems like if I look at least some portions of the data, things are getting better. In particular, the NAHB confidence just showed for the fifth consecutive month that homebuilders are feeling better about building a house, and we're now finally at the point where they say it is a good time to build a house. When you take a step back and just look at the state of the housing market, do you agree?

Jim Egan: I think it's a great question. Housing statistics are going in a whole number of different directions right now. So, yeah, let me take a step back. We've talked a lot about affordability on this podcast and it's still challenging. We've talked a lot about supply and it remains very tight, and all of this has really fueled that bifurcation narrative that we've talked about, protected home prices, weaker activity. But if we think about how the lock in effect and that's the fact that all of these current homeowners who have mortgages well below the prevailing mortgage rate just are not going to be incentivized to list their home for sale, then kind of a logical next step from a housing statistics perspective is that new home sales are probably going to increase as a percentage of total home sales. And that's exactly what we're seeing, new home sales in the first quarter of this year, they were roughly 20% of the total single unit sales volumes. That's the largest share of transactions in any quarter since 2006. And this dynamic was actually quoted by the National Association of Homebuilders when describing the increase in homebuilder confidence that you quoted Jay.   

Jay Bacow: Okay, but when I think about that percentage, aren't building volumes in aggregate coming down?

Jim Egan: They are, though, as a caveat, I would say that if we look at that seasonally adjusted annualized rate, it did increase sequentially a little bit, month-over-month in April. What I would point to here is that from the peak in single unit housing starts, and we think the peak in the cycle was April of 2022, those starts are down 22%. Now, that's finally started to make a dent in the backlog of homes under construction. Now, as a reminder, again, this is something we've talked about here, there are a number of factors from supply chain issues to labor shortages, that we're really serving to elongate, build timelines in the months and years after the onset of COVID. And all of those things caused a real backlog in the number of homes under construction, so homes were getting started, but they weren't really getting finished. We see the number of single unit homes under construction is now down 130,000 units from that peak. Now, don't get me wrong, that number is still elevated versus where we'd expected to be, given the sheer number of housing starts that we've seen over the past year. But this is a first step towards turning more positive on housing starts. And again, homebuilder confidence Jay, as you said, it's climbed higher every single month this year.

Jay Bacow: Okay, but you said this is a first step in turning more positive on housing starts. We get the start, we get the unit under construction, we get a completion and then eventually we get a home sale, so what does this mean for sales volumes?

Jim Egan: We would think that it's probably likely for new home sales to continue making up a larger than normal share of monthly volumes, but we don't think that sales are about to really inflect materially higher here. Purchase applications so far in May, they're still down 26% year-over-year versus the same month in 2022. Now, that's the best year-over-year number since August of last year, but it's not exactly something that screams sales are about to inflect higher. Similarly, pending home sales just printed their weakest March in the history of the index, and it's the sixth consecutive month that they've printed their weakest month in index history. So it was their weakest February, their weakest January, and so on and so forth, so we think all of this is kind of emblematic of a housing market, specifically housing sales that are finding a bottom, but not necessarily about to move much higher.

Jay Bacow: Okay. Now, Jim, in the past, when you've talked about your outlook for home prices, you mentioned your four pillars. There is supply, demand, affordability and credit availability. We've talked about the first three of these, we haven't really talked about credit availability yet.

Jim Egan: Right. And that's another one of the reasons why we don't necessarily see a real move higher in sales volumes because of the whole new regime for bank assets that we've talked about a lot. Jay, you've talked about how much it's going to impact things like the mortgage market, so what do we mean when we talk about a new regime for bank assets?

Jay Bacow: Fundamentally, when you think about the business model of a bank, if you're going to simplify it, it's they get deposits in and then they either make loans or buy securities with those deposits and they try to match up their assets to liabilities. Now, in a world where there's a lot more deposit outflows and happening more frequently, banks are going to have to have shorter assets to match that. And as they have shorter assets, that means they're going to have tighter lending conditions, and that tighter lending conditions is presumably going to play into the credit availability that you're looking for in your space.

Jim Egan: And when we combine that with affordability that's no longer deteriorating, but still challenged, supply that's no longer setting record lows each month, but still very tight. All of that is a world in which we don't think you're going to see significant increases in transaction volumes. I will say one thing on the home price front month-over-month increases are back. We've seen some seasonality from a home price perspective, but we still think that that year over year number is going to soften going forward. It remains positive in the cycle, but we think it will turn negative  in the next few months for the first time since the first quarter of 2012. We don't think those year-over-year drops will be too substantial. Our base case forecast for the end of the year is down 4%, we think it will be a little bit stronger than that down 4% number, but we think it will be negative.

Jay Bacow: Okay. But I like things to be a little bit stronger. And with that, Jim, always great talking to you.

Jim Egan: Great talking to you, too, Jay.

Jay Bacow: And thank you for listening. If you enjoy Thoughts on the Market, please leave us a review on the Apple Podcasts app and share the podcast with a friend or colleague today.

As homebuilders’ confidence in new construction increases, will home sales follow? Jay Bacow and Jim Egan, Co-Heads of U.S. Securitized Products Research, discuss.