Facts & Trends: U.S. Housing A House Of Cards?

Not that long ago, housing seemed to be a hopeless basket case. Yet, the combination of limited supply with abysmal mortgage rates brought such a revival that housing is now considered the only reliable support of the U.S. economy. Apparently, housing is so affordable in the U.S. that even a doubling in mortgage rates would not derail the uptrend.

This recent note from BMO Capital echoes the current conventional wisdom:

Referring to the recent move up in rates, Chairman Bernanke said  Wednesday that “the change in mortgage rates that we’ve seen so far is not all that dramatic”. Note that prices got so depressed during the downturn that affordability is still miles better than pre-bubble norms. In fact, even if mortgage rates rise to 6% over the next 3 years (about 200 bps), and income grows a moderate 3.5% per year, home price growth can still run at 7% per year without stretching affordability. So, the positive spinoffs from housing (confidence, construction, consumer spending, etc.) should continue even as rates rise.


Why, then, didn’t we get a housing recovery much earlier? After all, mortgage rates have been well below 6% since 2010.

Partly because house prices were still falling, but also for many other mundane reasons, including weak income and tight credit conditions.

Click to View(Doug Short)

The truth is that nominal median income is not even back to its 2008 level and real median income remains 10% below its 2008 peak. Meanwhile, the median sales price for new houses jumped 23% during the last 12 months to an all-time high (!). Median existing house prices are up 10% YoY. Median prices can be influenced by many variables including a changing mix but these nonetheless reflect actual transactions, i.e. real demand.



Even though income has declined, historically low mortgage rates have increased mortgage affordability through reduced monthly payments. This was Bernanke’s bet and it is precisely why mortgage rates are so crucial, since housing affordability has actually not improved all that much. This chart from Zerohedge should be considered by house builders who have aggressively raised prices lately.

We are bombarded with national statistics but real estate is, in reality, a very local business. National averages are virtually meaningless in that industry. House prices, income levels and other economic and demographic factors are very different in San Francisco, Detroit and Houston. Demographia, a consultancy, rates national affordability by measuring individual metropolitan markets, a much more sensible and precise way to assess affordability. Its most recent analysis found that affordability of existing houses has actually not improved much in recent years.

From the Demographia International housing Survey:

The Demographia International Housing Affordability Survey employs the “Median Multiple” (median house price divided by gross before tax annual median household income) to rate housing affordability. The Median Multiple is widely used for evaluating urban markets, and has been recommended by the World Bank and the United Nations and is used by the Harvard University Joint Center on Housing.

Historically, the Median Multiple has been remarkably similar in Australia, Canada, Ireland, New Zealand, the United Kingdom and the United States, with median house prices having generally been from 2.0 to 3.0 times median household incomes (historical data has not been identified for Hong Kong), with 3.0 being the outer bound of affordability.

Based on Q3’12 data,

Overall, the US Median Multiple was 3.1 (moderately unaffordable), up slightly from 3.0 last year. The United States had 100 affordable markets, 87 moderately unaffordable markets, 13 seriously unaffordable markets and 16 severely unaffordable markets.

These details will help you understand the dynamics (my emphasis):

Housing affordability deteriorated in the 51 major markets of the United States from a Median Multiple of 3.1 to 3.2. This year, 20 major markets are rated as affordable, down from 24 last year.

Severely depressed Detroit remains the most affordable major US housing market, with a Median Multiple of 1.5. The second most affordable major market is Atlanta, with Median Multiple of 2.0. At the peak of the housing bubble, affordability deteriorated to a moderately unaffordable 3.1 in Atlanta. Atlanta had been among the high income world’s fastest-growing metropolitan areas for at least three decades, but slowed briefly during the Great Financial Crisis. Growth has returned, with Atlanta ranking third in net domestic migration among US metropolitan areas with more than 5 million population. (…)

As was the situation last year, six major markets are rated severely unaffordable. Four of these markets are in coastal California, where housing affordability deteriorated markedly over the past year, especially in San Francisco (7.8) and San Jose (7.9), where the Median Multiple rose by one point or more — the median price of houses rose the equivalent of a year’s median household income. The Median Multiple has now risen in both San Francisco and San Jose to 30% or more higher than at any point before the California housing bubble. The Median multiple also rose 0.5 points in Los Angeles.

Pointing up Affordability could continue to deteriorate as regional planning agencies implementing new state regulations under Senate Bill 375 that virtually outlaws new housing on the urban fringe. Even in the face of heavy net outward migration to other states, this could lead to a new housing bubble. (…)


The scores at the end of 2012:


While U.S. affordability is better than for the other markets measured, it remains high relative to its own history.


In brief, U.S. housing is not as extraordinarily affordable as some national statistics suggest. In fact, given that house prices have increased further since Demographia compiled the Q3’12 data, housing affordability has been getting worse in 2013.

This is why mortgage interest rates are so crucial.

This is like when we are considering buying a new car. We first determine what kind and size of car is affordable given our income level. Then we consider financing options to assess loan affordability. Even at zero interest rates, there is a limit on what we can afford, especially when we factor in other costs such as insurance, maintenance and repairs.

Coming back to the income side of the ledger, the Washington Post blog had an interesting post last February that helps explain the stagnation in median income: How the recession turned middle-class jobs into low-wage jobs

(… ) The vast majority of job losses during the recession were in middle-income occupations, and they’ve largely been replaced by low-wage jobs since 2010:

job losses gains

Mid-wage occupations, paying between $13.83 and $21.13 per hour, made up about 60 percent of the job losses during the recession. But those mid-wage jobs have made up just 27 percent of the jobs gained during the recovery.

By contrast, low-wage occupations paying less than $13.83 per hour have utterly dominated the recovery, with 58 percent of the job gains since 2010.

That’s put downward pressure on wages: “[M]any middle-class workers have lost their jobs and, if they have been able to secure new employment at all, find themselves earning far lower wages post-recession,” the San Francisco Fed notes. ”[O]n average over the next 25 years, these workers will earn 11% less than similar workers who retained their jobs through the recession.”

That means that nearly 2 million of the 6.2 million re-employed workers since the spring of 2010 earn substantially less than before the recession. This is 2 million families that moved from the approximate median income level to a low income level, dragging the median down in the process. No doubt that their sensitivity to both house prices and mortgage interest rates has increased significantly.

The Royal Bank of Scotland adds in a more recent report that

Another concern raised about the “type of jobs” being created concerns the elevated number of part-time workers. The percentage of workers who are working part-time is indeed higher now than it was prior to the recession – 18.6% of total non-agricultural employment in April 2013 versus 16.5% in December 2007. However, this is down from its recessionary peak of 19.9%.

That’s nearly 1 million new part time workers also further away from affordable housing.

Taking into account the number of people with lower paying jobs, with new part time jobs, those who moved out of the labor force, those who joined the food stamps or other such social security programs, etc. the economic reality of the median American has worsened very significantly in recent years.

Remember that 50% of Americans reside below this lower median! Rising median house prices may look positive to economists and strategists who generally live well above the median, but not to the folks below and even those 10-20% above it. Income inequality has some downside!

This chart from Doug Short clearly illustrates the significant, enduring, downshift in retail sales since the financial crisis, a direct result of the significant, enduring, downshift in income. By Doug’s calculations, retail sales are 18% below their pre-2008 trendline. Really nothing to write home about!


As a matter of fact, first-time buyers accounted for only 28% of purchases in May, down from 34% one year ago and well below the historical norm of 40%. This is not a sign of a healthy market.

Let’s not lose sight of the fact that 30-35% of the houses purchased in recent years have been bought by investors. This one third of the demand, which will eventually become one third of the supply, potentially even more, is highly sensitive to house prices and to interest rates. One, professional investors buy with set return objectives which are highly sensitive to cost and the cost of carry. Two, they must have an exit strategy that takes into account the eventual end buyers’ ability to buy and finance, as well as their assessment of when other investors will begin unloading. It is often much easier to invest than to disinvest.

Raymond James & Associates housing market analyst writes that investor interest in the very popular (read depressed) Phoenix market seems to be waning:

According to Arizona State University, identified investors purchased 27% of all homes in April, the lowest percentage in several years and down from 35% a year ago. Home purchases financed with cash comprised 39% of all sales in May (down from 42% in April and 46% a year ago). Notably, according to ASU, the institutional buying spree peaked in the summer of 2012 and has now subsided. In total institutional investors now own 10,000-11,000 homes (or ~1% of the housing stock) in Greater Phoenix.

Now, 1% of the housing stock may not seem high, until you realize that 10-11k homes is, in fact, equal to half the current listings in Phoenix. The exit door can get pretty narrow…

The RJ analyst also notes that even though Phoenix existing home sales rose 12% YoY in May, pending sales declined 14% YoY after being down 8% in April. Interestingly, his comments on the Phoenix rental market, where most of the institutional stock is parked, are also not very positive:

Very importantly, though, we believe a large percentage of these newly acquired rental homes are being “warehoused” off-market until rehab
work can be completed (or other vacancies are leased up). Anecdotally, we found that a quick search on craigslist.org screening Phoenix
homes for rent with 3+ bedrooms turned up more than 4,000 links posted in just the past 24 hours (June 18-19).

There is thus a real possibility that housing demand stops rising pretty soon unless basic fundamentals improve meaningfully. Once again, the tendency of investors and economists to simplistically straight line recent trends will likely prove wrong.

Rising interest rates will also cool investors’ appetite for exotic yield plays, many of which have been artificially stimulating housing demand recently. I feel compelled to reprint an excerpt of my Feb. 25, 2013 post Housing Stocks: Buy Low, Sell High because it is so illuminating!

(…) “They didn’t ask us to fix anything, either,” said Creswell, 35, a pastor at a Wake Forest church who has flipped six houses since the market crashed in 2008. “They just bought it. It was the easiest housing closing I’ve ever been a part of. … They were a dream buyer.”

The dream buyer is American Homes 4 Rent, a Malibu, Calif., company that since late December has paid nearly $13.3 million in cash for 81 houses in Wake County, according to property records. The company, which formed last year, is one of several firms hoping to profit from rising home prices by amassing thousands of single-family homes across the country and converting them into rentals. (…)

What’s noteworthy about American Homes 4 Rent’s buying binge in Wake County is that it isn’t just targeting distressed properties, or even existing homes. About a third of its purchases have been new homes acquired directly from homebuilders.

“Very reasonable offers, they’re not trying to low-ball us,” said Dan Cunningham, of Brandywine Homes, which sold a house in the Braemar subdivision in Zebulon to American Homes 4 Rent for $152,000. “I mean,I don’t understand why they’re buying new homes to rent, but that’s their business model, I guess.” (…)

Institutional investors have invested at least $5.4 billion for purchase of single-family rentals nationwide during the past 18 months, according to Barclays, and an additional $8 billion is expected to be invested within the next couple of years. American Homes 4 Rent’s buying spree is being financed in part by a $600 million investment from the Alaska Permanent Fund, a $45 billion fund that invests royalties the state collects from oil companies. (…)

“Usually an investor will come in just at some ridiculous number you can’t deal with,” said Jeff Murdock of Murdock & Gannon Construction, which sold three new homes to American Homes 4 Rent in the Carlton Park subdivision in northeast Raleigh. “But these guys weren’t that way, bless their hearts.”

Bless their hearts! I would not bet much on whether much of the “additional $8 billion” will eventually be invested, at least wisely…

What about supply?

Believe it or not, supply has been increasing along with prices. Redfin, an online realtor, wrote on June 17 that

Inventory is finally beginning to recover! Active listings grew 6.4% between March and April and another 4.2% on top of that between April and May. Last year inventory peaked in January and fell almost all year. If the current trend keeps up, we may hit positive year-over-year inventory before the end of the year.

The growth in new listings has also been explosive over the same period. New listings have turned around completely in just four months, from a 10% year-over-year decline in January to a 15% year-over-year increase in May.

Redfin CEO Glenn Kelman:

People who bought near the peak in 2006 and 2007 — only to get buried in the downturn under a mountain of debt — can now, for the first time in years, see daylight. And they’re running for it.


This is obviously good news, especially for realtors and buyers. More listings may result in more transactions. It should also have an impact on prices which might surprise some people:


Note that only 2% of respondents expected prices to rise a lot in early 2012!

The big unknown is how professional investors will react to stalling price momentum and rising supply. It would be challenging to replace 30% of the demand on short notice.

The number of Redfin customers touring homes and making offers both dipped a bit more in May this year than over the same period last year, pointing toward a slight softening of sales volumes in June and July. This despite the fact that inventory improved in April, and will have improved again in May. Months of bidding wars and record-low inventory earlier this year has finally taken a toll on some buyers. Rising interest rates are likely discouraging some buyers as well. (Redfin)

While 23% of respondents are currently bullish on prices, 67% believe that now is a good time to sell in their neighborhood, up from 13% in Q1’12:


And here’s the wrap-up chart, one that Bernanke and friends should study carefully:


Low prices are no longer a major incentive. Positive price momentum has moved the fence sitters but this may be about to stop. The one major remaining incentive is low interest rates.

This is why mortgage rates do matter.

This is why the Fed is playing with fire trying to be “good at communications”. Bernanke may say that the FOMC has no intention of raising interest rates anytime soon, how can he forget that the only reason mortgage rates are so low is QE3? He, himself, closed the debate between flows and stocks, thankfully winning his bet. He is now risking losing it all playing Russian roulette. He may be better at communications but he is still an amateur on investor psychology.

Bernanke may say that all he will do is gradually take his foot off the gas pedal, the market knows too well that he is Driving Blind. Just consider that the May FOMC statement said that the panel “continued to see downside risks to the economic outlook.” One month later, it declared that “downside risks to the outlook for the economy and the labor market have diminished since the fall”.

No wonder some people now suspect that Bernanke is actually DUI. After all the “financial heroin” (h/t Don Coxe) he has injected in the economy…

Let’s be clear, housing is in a cyclical recovery, supported by rising household formations and relatively limited supply. But contrary to what many believe, its fundamentals remain very fragile, the road ain’t gone be straight up and policy mistakes are precisely what can totally derail it.


One thought on “Facts & Trends: U.S. Housing A House Of Cards?

  1. Excellent critique on US housing. Thank you for all the effort and hard work that you put into writing this blog.

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