By Cornelius Zeeman & Gavin van der Berg,
Fairtree Portfolio Manager & Equity Analyst
Our previous article expanded on how tight housing inventory in the US is supporting prices despite a drastic change in the financing environment. As a result, US housing affordability has decreased to multi-decade lows. This is a prominent and rather obvious headwind to potential home buyers. The 31% decline in total home sales over the last year is evidence of that.
The increased economic burden of homeownership has reduced the number of potential buyers. Does that mean the actual underlying US housing demand has been dented? This was indeed the case in the mid-2000s. Fading primary and speculative demand contributed to the housing market weakness leading up to the Global Financial Crisis (GFC). Housing prices dropped, and affordability levels improved, yet sales remained lacklustre. The recent housing sales weakness has unfolded differently. Affordability levels have deteriorated, as a tight supply environment has constrained sales, and prices have held up well to date. This points to a more resilient demand picture.
Graph 1: US Total Home Sales & Affordability
Source: Fairtree, Bloomberg LP & National Association of Realtors
Vacancy rates across both homes owned and homes for rent are another indicator of a tight housing market and that underlying demand for housing is healthy. To better inform our view, we decided to look at two key drivers of housing demand.
Graph 2: US Vacancy Rates
Source: Fairtree, Bloomberg LP & US Census Bureau
A household is defined as a single group of people living under one roof – this makes the household formation statistic released by the US Census Bureau a good indicator of underlying housing demand. It is worth noting that a household can be a family, two families or a group of friends. Therefore, a range of demographic and economic factors play a role in household formation and cause it to deviate from population growth.
During times of economic stress and periods leading up to them, household formation tends to contract. To reduce living costs, people group together and younger individuals move in with their parents – this can be observed in Graph 3 below. The nature of the GFC contributed to a prolonged period of weak household formation.
Graph 3: US Household Formation
Source: Fairtree, Bloomberg LP & US Census Bureau
Together with demographic tailwinds, such as the ageing US population and strong growth in citizens aged between 30 and 40, a strong case can be made that there is pent-up household formation in the US. This has created a situation where, despite the affordability crisis, strong household formation can continue.
Life events are often delayed or postponed by economic conditions, but rarely permanently cancelled.
Graph 4: US Population Pyramid
Source: Populationpyramid.net & United Nations Department of Economic and Social Affairs
Resilient US Consumer Balance Sheets.
The typical consumer’s balance sheet has strengthened considerably over the last decade. Consumers have deleveraged, and strong asset performance has further contributed to a positive development in consumer’s net worth compared to disposable income. The asset-to-liability ratio is another indicator of the resilient US household balance sheet (see Graph 5 below).
Graph 5: US Asset-to-Liability Ratio & Household Net Worth
Source: Fairtree, Federal Reserve & Bureau of Economic Analysis
A closer look at mortgages reinforces this view. The share of unencumbered homeowners has increased to 42%, up from 34% in 2011. On top of that, the typical level of home equity has increased substantially. The share of homeowners with more than 20% home equity has risen from 60% in 2013 to nearly 90% today, providing legroom for potential buyers to manoeuvre the challenging environment.
Graph 6: Percent of First-Lien Mortgages by Current Loan-to-Value
Source: Fairtree & Federal Housing Agency
We see the current US housing market as resilient, evidenced by how well it has held up to date despite the rapid pace of rate hikes undertaken by the US Federal Reserve Bank since the beginning of 2022. The pillars of medium to longer-term demand for housing remain intact. Existing housing supply is constrained, and Homebuilders are more rational with new supply. While affordability is a pressing headwind, we suspect the US residential housing market will be hard to ‘break’. Our next article will explore the US Homebuilders, a sector which has delivered a return of 40% year-to-date.
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