Market Insights | The US Housing Market: Supported by Tight Supply

By Cornelius Zeeman & Gavin van der Berg,
Fairtree Portfolio Manager & Equity Analyst

Rising interest rates, lower affordability.

 

Understanding the US residential real estate market provides valuable insight into the US consumer – the bedrock of the consumption-led US economy. One does not need to dig too deep into the history books to find a good example of the housing market driving the direction of the world’s largest economy. With an asset value of $45 trillion, US residential real estate accounts for roughly 30% of the overall US consumer’s balance sheet. Its size and relevance to a broad spectrum of Americans make it an important driver of US consumer psyche and confidence.

Given this relevance to the US economy, the US domestic housing market’s surprising resilience over the last 18 months warrants closer attention. The US has shifted away from the ultra-accommodative post-pandemic environment into an environment where US 30-year mortgage rates have increased to 7.3%, up from 4% levels pre-pandemic and pandemic lows of 2.7%. As a result, US home affordability has come under pressure. To place this change in mortgage rates into a dollar context, a $2,500 monthly payment with an 80% Loan-to-Value (LTV) allows potential home buyers to purchase a house worth $450,000 today. This is a $300,000 decline from the peak affordability of $750,000 when rates were at post-pandemic lows.

Graph 1: US Mortgage Rates & Home Affordability

Source: Fairtree, Bloomberg LP & Mortgage Bankers Association

Yet, according to the Case Shiller US National Home Price Index, US housing prices are only down 1% from pandemic highs. At first glance, it seems as if prices have been defying gravity, but in reality, it is another excellent example of supply and demand forces at work.

Graph 2: Case-Shiller Single Family Housing Index

Source: Fairtree, Bloomberg LP & S&P Global

Structure of the Mortgage Market.

 

While some nuanced factors in the US offset the pressing affordability crisis, the key factor supporting housing prices relates to the supply side of the equation: the fixed-rate nature of the US mortgage market. During the pandemic, home buyers purchased houses at record-low mortgage rates, and homeowners refinanced their existing mortgages. As shown in Graph 3 below, this has led to the current US residential mortgage stock being financed at attractive and, more importantly, fixed, long-term mortgage rates. Today, nearly 70% of outstanding US mortgages are financed below 4%. With mortgage rates currently above 7%, it is understandable that potential sellers prefer to stay on the sidelines to keep their preferential mortgage rates.

Graph 3: US Mortgage Rate Distribution

Source: Fairtree & Federal Housing Finance Agency

Low Inventory Levels.

 

As a result, existing homes for sale have decreased and are expected to remain low as long as mortgage rates remain elevated. Although traditionally a smaller component of annual supply, it is worth noting that an increase in new home inventories has partially offset this decrease. The aftermath of the Global Financial Crisis is another factor which has contributed to a tight US housing market. Over the last decade, new homes built have undershot housing formations since the Homebuilders have become more disciplined and land permitting has become harder to obtain. Initially, this was necessary to clear out excess inventory, but the US is now sitting with a shortage – this can be seen in Graph 4 below when looking at the total home supply in relation to demand (measured in months’ worth of demand held in inventory).

Graph 4: US Total Housing Inventory

Source: Fairtree, Bloomberg LP & National Association of Realtors

In Conclusion.

 

It is difficult to see how housing prices and rents, which make up ~33% of the CPI basket, will come under severe pressure given this supply shortage. Our next article will explore the healthy, longer-term housing demand dynamics.

Disclaimer:

Fairtree Asset Management (Pty) Ltd is an authorised financial services provider (FSP 25917). Collective Investment Schemes in Securities (CIS) should be considered as medium to long-term investments. The value may go up as well as down and past performance is not necessarily a guide to future performance. CISs are traded at the ruling price and can engage in scrip lending and borrowing. A schedule of fees, charges and maximum commissions is available on request from the Manager. A CIS may be closed to new investors in order for it to be managed more efficiently in accordance with its mandate. Performance has been calculated using net NAV to NAV numbers with income reinvested. There is no guarantee in respect of capital or returns in a portfolio. Prescient Management Company (RF) (Pty) Ltd is registered and approved under the Collective Investment Schemes Control Act (No.45 of 2002). For any additional information such as fund prices.

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