Morgan Stanley
  • Thoughts on the Market Podcast
  • Jul 6, 2021

The Complex Outlook for U.S. Housing


Jay Bacow: Welcome to Thoughts on the Market. I'm Jay Bacow, Co-Head of U.S. Securitized Products Research for Morgan Stanley.

Jim Egan: And I'm James Egan, the other Co-Head of U.S. Securitized Products Research.

Jay Bacow: And on this edition of the podcast, we'll be talking about the red hot U.S. housing market. It's Tuesday, July 6th, at 10 a.m. in New York.

Jay Bacow: Now, Jim, wherever I look, I'm getting reports on the housing market and how strong it's going. I'm seeing reports of record home sale data, home price appreciation. What's the right report to look at and how strong is the housing market and where do we go from here?

Jim Egan: There are a number of different ways to look at home prices right now. And no matter how we look at them, we're really seeing record growth. The Case Shiller number that came out in late June-- it's a two month lag number so we're talking about April-- were at a 14.6% Year over year growth, non-seasonally adjusted. That is faster than at any point in the early 2000s. Our prior peak was low 14s in the 2004 2005 timeframe. So that repeat sales index really takes into account the mix of homes that are being sold and shows us that we've never been growing faster. Another way to look at this, is the median price of existing home sales. Those are up almost 25% year-over-year as of the most recent print, which is far and away the largest increases we've ever seen there. And this growth in home prices, this record growth in home prices is really starting to put pressure on the affordability of the U.S. housing market.

Jay Bacow: OK, but I get that that there's pressure and mortgage rates are a little bit higher than they were at the beginning of the year. But aren't they still pretty low? How does that play a role?

Jim Egan: As home prices really started climbing in earnest over the summer of 2020, mortgage rates were dropping precipitously and they would hit an all time low in January of 2021. And what that was doing was enabling affordability to remain at its current levels or to even improve. Now, they haven't increased dramatically. In fact, mortgage rates are lower today than they were in April, but they're still 35 basis points above where they were in January and they've really plateaued here. And what that means is that homebuyers are really feeling the pinch of these increased home prices. Mortgage rates are no longer bailing them out. To put that into context, because we've plateaued here with the growth in home prices, the monthly principal on interest payment on the median priced home is up almost $200 from January to May. That's a 19% increase in that payment over a four-month period. And that's really making itself felt in consumer attitudes. One of our favorite things to look at here, the University of Michigan Consumer Sentiment Survey asks consumers whether or not they think it's a good time to buy a home. That number just fell to 36% think it's a good time to buy a home. That's the lowest it's been since the early 1980s. To put it into context, at its at its trough during the great financial crisis, it was still above 50. So a very small percentage of consumers relative to history think now is a good time to buy a home. And then separately, they're asked why they have that opinion and 62% of them say it's because home prices are too high. That is literally off the historic charts. Its prior peaks is in the mid 30s. So this increase in home prices, combined with mortgage rates that are no longer decreasing, is really leading to affordability pressures that are manifesting themselves in consumer attitudes.

Jay Bacow: I guess I'm having a hard time thinking about how to look at these affordability metrics because, you know, on a big picture, yeah mortgage rates are, you know, as you said, about three eighths of a point higher than their all time lows. This is the all time lows. Mortgage rates are below 3%. My parents' first mortgage was in the teens. So given that mortgage rates are still historically low and when we look at the affordability metrics, homes seem on average affordable. Why are consumers so negative on the outlook?

Jim Egan: Traditional affordability metrics, what we publish in our monthly housing tracker when we compare these median monthly principal and interest payments to long run averages, they show a pretty affordable housing market. And what they really show is a housing market that's far more affordable than it was at its, what we'll call, 'peak unaffordability' in 2004 to 2006. However, there's one assumption that all of these metrics make that we like to call into question, and that's that all borrowers throughout the history of time have taken out a 30-year fixed-rate mortgage to finance the purchase of their house. And from 2004 to 2006, that really was not the case. Now, we've talked about this before, but from '04 to '06, what we saw was a proliferation of adjustable rate mortgages and really affordability products that brought down. That monthly payment and they made housing feel a whole lot more affordable to consumers. Now, in the past, we've mentioned this to talk about the higher default risk of those mortgages. The lack of them today means housing is on a much healthier foundation. But what we'd like to point out here is they also made housing feel a lot more affordable. And if you were to control for the mix of products that are available to consumers over time, we think that the affordability indices today would look a lot closer to where they were in '04/'06, and therefore make housing appear a lot more unaffordable on a historic basis and make the sentiment that we're seeing from consumers make a lot more sense there.

Jay Bacow: OK, so if we've got this shift in affordability products, so we're using less of those and therefore more types of products that have better credit underwriting, but homes are less affordable as a function of that. What does this mean for home sale activity going forward?

Jim Egan: So we've used this argument in the past to say why we're still constructive on home prices. That home price growth will have to slow from, again, record pace right now, but it will remain positive. We have it in the 7-8% range by the end of this year. We have it in the 3-4% percent range by the end of 2022. But that's still home price growth because of that healthy foundation. But there is more to the housing market than just home prices: housing activity, existing home sales, single unit starts, new home sales. We do think that these affordability pressures are very much going to weigh on existing home sales in the second half of 2021. Now, when we start to get these numbers, you're also going to see pretty stark year over year decreases not just because of affordability problems, but also because of really difficult year over year comps. The second half of 2020 was incredibly strong from a sales perspective. And when we take all of this into account and look at our models from an existing home sales perspective, we actually have them falling 16% year over year in the second half of 2021 versus 2020. Now we're out to a very big lead. And so that 16% decrease for the second half of the year means that we finished the year down about 1-2% versus 2020. Looking ahead to 2022, we see a further decrease in roughly the 2-3% range. But so we think that these affordability pressures are really going to lead to some weakness in the second half of the year, a bit of a plateauing into 2022. And one of the things that that we're looking at, one of the inputs there that's kind of muffling this impact just a little bit is credit availability. We've talked a little bit about credit availability easing as part of our base case for the housing market, for home prices. It plays a role in existing home sales, too. But recent decisions coming out of the Supreme Court in Washington, DC may actually be increasing the probability of these easing lending standards.

Jim Egan: So Jay, you've been paying a lot of attention to this. Can you walk us through what's been happening down in the Supreme Court and how it relates to the housing market?

Jay Bacow: So the Supreme Court ruled last week on a few different things, one of which was the separation of powers within FHFA. And effectively what happened is it gave the White House the ability to remove the director. And the same day as the ruling, the White House removed the old director, Mark Calabria, and replaced him with Sandra Thompson. And what's notable is in Sandra Thompson's acceptance remarks, which were only a few paragraphs long, you know, she said that there is a widespread lack of affordable housing and access to credit, particularly in communities of color. And therefore, based on those comments, we think you could see an expansion of access to credit, particularly on the lower end of the credit spectrum, which would therefore lead to more supply.

Jim Egan: All right. So we're keeping our eyes on the Fed, the housing market and domestic banks. Jay, it's always great speaking with you.

Jay Bacow: Jim, it's always a pleasure.

Jay Bacow: As a reminder, if you enjoy Thoughts on the Market, please take a moment to rate and review us on the Apple Podcasts app. It helps more people find the show. 

U.S. home price growth has been on a tear, but will affordability pressures begin weighing on home sales? The answer is a bit complicated.

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