Since 2012, almost every economist has predicted that the housing recovery would continue into each coming year and would be a key driver of economic growth. That was again the plan for 2014, but with the housing recovery now on the ropes those same economists are perplexed as to why. Yet, “hope” remains that the recent slowdown is just a “weather related” casualty.
For me, I now get to say “I told you so.” The slowdown in housing is not due to the “weather.” It began prior to the onset of the recent winter blasts. Nor will reduced distressed sales, delinquencies, negative equity or rising inventories salvage the predictions. These are all indicators “OF” the housing market, but not what “DRIVES” the housing market. The real answer to the slowdown in housing is not so difficult to comprehend and is something I have argued heavily in past missives as listed below:
The housing market is driven by what happens at the margins. At any given point, there are a finite number of people wanting to “buy” a home and those that have a “for sale” sign in their yard. As with all markets, changes in the housing market are driven by the “supply/demand” equation. There is notably five important points that should be considered.
1) What is forgotten by the majority of economists and analysts is that individuals buy “payments,” not “houses.” Incremental increases in interest rates have a direct effect on a buyer’s “willingness” and “ability” to make certain monthly payments. Since, the majority of American’s are already primarily living paycheck-to-paycheck, any increase in the monthly payment may change both affordability and qualification for a loan.
2) Since individuals are “backward looking,” increases in interest rates may put a hold on activity as they “hope” that the payment, mortgage rate or home price they just missed out on will be available again soon. While individuals will eventually adjust upward, it will take some time for them to become “convinced” that a change has permanently occurred.
3) Many of the homes that have been purchased to date were by “all cash” buyers and institutions for conversions to rental properties. Now, with “price-to-rent” ratios reach levels of low profitability – the demand for that activity is decreasing. As I stated last year: “We are likely witnessing the beginning of that slowdown.” Furthermore, with institutions now moving to liquidate their rental investments either through direct sale or IPO – the increase in supply without an increasing pool of available and willing buyers could intensify downward pressure.
4) In order to continue to drive the housing recovery forward you need fresh entrants into the housing market in the form of household formations. As discussed by Walter Kurtz recently:
“The biggest issue, however, remains household formation. As of the end of last year, for example, the number of American households was not growing at all. This is likely due to record low marriage rates as well as a slew of other factors (lack of employment, wage growth, etc.). Whatever the reason, household formation needs to stabilize before we see stronger results in the US housing market.”
5) Lastly, with the Federal Reserve now tapering it ongoing stimulative activities and the government support programs either ended (cash for houses) or losing effectiveness (HAMP, HARP) the support for housing activity is fading.
The chart below shows the Total Real Estate Sales Activity Index (TRESAI), which is a composite of the seasonally adjusted new and existing home sales data. For the purpose of this article, which is focusing on the actual buy and sell of homes, this is the most appropriate index.
This index clearly shows that the downturn began in August of 2013 well before the “polar vortexes” made their appearance at the end of the year. However, the real culprit to the decline in housing activity, as discussed above, is shown clearly in the next chart.
The shaded areas show when 30-year mortgage rates have risen. As you can see it only takes small adjustments in interest rate levels to cause either stagnation or declines in home buying activities.
The point here is that while the housing market has recovered from the financial crisis lows, it has primarily been a function of speculation, historically low interest rates and massive amounts of government support. However, it is in this nascent recovery that we should recognize the true state of the average American family.
Without such massive interventions, it is unlikely the housing market would be showing much of a recovery considering the decline in real wages, and household incomes, over the last five years. Furthermore, while there has been much written about the deleveraging of the household balance sheet – the latest quarterly report shows that the only real decline in debt occurred in the mortgage segment. What wasn’t discussed by the Fed is HOW the deleveraging was accomplished which was done though serial refinancing (I am a prime example of 4 times in the last 3 years), foreclosures, short sells, and write downs. Not exactly a bullish commentary of the strength of the average American household.
Lastly, while residential construction only makes up slightly more than 2.5% of GDP, there is a limit to how much further the current recovery will go. The decline in housing reached extreme levels during the crisis and was due for a bounce back to normal activity levels. We are rapidly approaching an equilibrium of current supply and demand in the market. According to David Rosenberg:
“We estimate that the builders have caught up about 90% of the way with the recent improvement we have seen in the underlying demographic demand. There may be more upside in terms of pricing ahead. But it is going to be limited and we are not far off seeing some plateau until we start to see the demand indicators improve more forcefully, especially from the first-time buyer, who has been quite dormant during this nascent turnaround in the housing sector.”
It is important to understand that housing will recover – eventually. However, the reality of that recovery could be far different than what the current media and analysts predict. In an economy that is expected, according to the Federal Reserve, to have a long term economic growth trend of 2.1% – a recovery to historical norms, much less the pre-crisis peak, is highly unlikely.
The current decline in housing is not a “weather related” anomaly but a function of “real” affordability. I say “real” affordability, because buying a house is not just about the price, but the ability for a family to qualify for and pay the mortgage. Unfortunately, despite the ever ebullient hopes of mainstream analysis, the core requirements of rising wage growth, full-time employment, loan qualification and the ability to save a downpayment keeps home ownership elusive for many. That is unlikely to change anytime soon. Of course, I have already told you that previously.