Housing Sector Has Firm Foundation

The modern debt heavy housing industry exists due to the centuries old concept of the mortgage. A “mort gage” is an Old French or Latin term meaning Dead Pledge, which is a debt obligation that dies when the loan is repaid or foreclosed upon. While the US adopted mortgages as early as 1781, it wasn’t until the Great Depression of the 1930’s and WWII before Federal Insurance and 30-year loans transformed home ownership. With the US Government essentially subsidizing the real estate market through insurance backing of most loans, home ownership jumped from a steady 45% before the Great Depression to 65% over the ensuing generations. The Governments social justice effort to boost investor use of leverage. As the Covid stimulus encouraged a new wave of home buying and rapid inflation in 2020-2022, concerns have risen again that the secular Housing Bubble would lead to massive loan defaults. With 40-year high mortgage rates, the worst home affordability in modern history and negative wage growth of homeowners, it sounds like a recipe for a housing market crash. To the chagrin of Bear market prognosticators, housing stocks bottomed last summer after a brief scare and low builder inventories continue to support lofty listing prices. However, with mortgage rates more than doubling in less than a year, the housing sector will deteriorate at least modestly until interest rates fall closer to pre-Covid 4 to 5% range. The good news is that a deep housing recession will be avoided as long as unemployment is low and borrowing rates are trending lower. 

It’s a testament to the strong consumer that home buyers remain as active as they are given that home affordability has never been worse. Nationally, prices are still rising year over year and the National Association of Realtors estimates the housing shortage has only been reduced to 4 million homes. Building permits and housing starts are in the doldrums, but we see pent up demand by Millennials salivating to snap up homes at faster rates once the 30-year mortgage rate tests 5% or lower. With 80% of mortgages financed at rates below 4%, there is no chance the inventory of homes will suddenly balloon, as in 2008. 

Some of the smaller homebuilders are feeling the pain of buyers and sellers stepping back this past year, but the major builders continue to hire workers and expect an improving marketplace when borrowing rates decline this year. While significant optimism may be premature with an economic cycle low due in early 2024, it’s noteworthy that sentiment is improving.

For the last 10 months in a row employment in the construction industry has reached record highs and yet the extremely high-level of job openings indicates that builders remain optimistic about demand. Back when the 2008 housing bubble burst, construction employment peaked 19 months before the Great Financial Crisis recession began. We expect the current need for labor to move lower by year end, but there are no signs yet of builders pulling back on payrolls.

With home sales, especially in Florida, near one-year highs, realtors across the nation are once again experiencing multiple bidders for their inflated homes despite a 6.5% 30-year mortgage rate.

The Bloomberg real estate and housing surprise index continues to surprise to the upside with mortgage rates stuck near 40-year highs. Challenging times may still arrive late this year, if the economy fades into a normal economic cycle low that we project, but how much will housing sector sentiment improve if inflation and mortgage rates fall substantially while the labor force stays near full employment?

When the Covid stimulus reached record heights last year, triggering a major spike in inflation and mortgage rates, it was assumed the real estate sector would be among the worst affected. Housing giants like DR Horton and Lennar are finally seeing their idle inventories rising sharply, but their stocks have erased most of their Bear market declines, which augurs well for at least a well-supported market. The overall home builder stock index never tested its pre-Covid peak and sits at levels today that indicate little concern in the sector at this time. It’s too early to expect a long-term Bull market in housing stocks, but the downside risk also appears limited until late 2023. A wide trading range is the most likely outcome this year with a new Bull market potential building when mortgage rates move closer to 4%.

 

 

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