Investment Strategy Brief:
Housing Market in Paradise

Below is a transcript of this week’s video.

Hi, this is Ilona Vovk with Investment Strategy at Glenmede. Watching the real estate market isn’t just important for people looking to buy. With concerns rising that a recession may be on the horizon, housing activity has traditionally been a relatively good leading indicator for the direction of the economy.

By multiple measures, home prices have reached historically extended levels. The chart on the left is probably the simplest expression of this, which graphs the median home price as a ratio of the median household income in the U.S. This multiple sits at 4.5, which is above the 4.1 figure observed during the housing crisis in 2007 through 2009. But another dimension to this has been rising mortgage rates, which are accounted for in the chart on the right. It’s essentially the same concept, but instead of home values, it calculates the total cost of a mortgage, assuming a 20% down payment and 30yr fixed term for purchasing the median home. Rising mortgage rates have offset slightly declining home prices over the past few months and continue to keep the total financing cost of new homeownership at multi-decade highs. Another way to think about this, is for a median household income purchasing a median cost home, it will take that household 10 years of income to pay off 80% of the financing for the home. 

Now the other element of this is that the difference between the effective interest rate of mortgages outstanding compared to the current 30-year fixed mortgage rate. That difference is at an all-time high. What does this mean? Well, the last time we saw this was in the early 1980’s and that wasn’t when home prices were at an all-time high like they are now, and secondly current homeowners who were able to lock in historically low rates are unlikely to leave their homes, putting further pressure on prices with lack of additional supply entering the market. 

We can see how high mortgage rates, have impacted borrowing. The total amount of borrowing has been high over the past few years, but has gradually declined over the last several quarters. The credit quality of those borrowers appears much different this time around than during the Great Financial Crisis. The chart shown here is U.S. mortgage originations by credit score, with the gray shaded region representing prime borrowers with scores of 760 or above. High credit worthy borrowers made up the majority of mortgage originations throughout 2020 - 2022. This, coupled with the majority of U.S. mortgage debt outstanding sitting at roughly ~3.5%, has made the housing market somewhat immune to the rise in rates that’s transpired over the past 24 months. Higher credit quality borrowers suggests that a late-2000’s-like housing collapse may not necessarily be in the cards this time around. And the supply issue isn’t likely to go away immediately. 

One of the other culprits of the supply-demand imbalance observed today has been more than a decade of underinvestment in housing shown by the percentage of U.S. gross domestic product attributable to the construction of fixed investment in single-family residences. Before the Great Financial Crisis, this averaged out around 2.5%, but fell closer to 1.3% in the aftermath of the crisis.

That underinvestment has contributed to a notable decline in the available housing stock relative to those who demand it. The total number of housing units in the U.S., including those that are occupied or vacant, divided by the number of households in the U.S. peaked in the middle of the housing crisis, when housing was arguably too plentiful, the pendulum has since flipped to the other extreme where housing supply appears too low. 

The National Association of Homebuilder’s Housing Market Index is a monthly survey of homebuilders designed to gauge the health of the single-family housing market in the U.S. The index has been in a free fall through the end of 2022, where it sat at its lowest level since 2012, aside from the brief decline at the onset of the COVID-19 pandemic. But it has bounced back more recently. The housing market is typically very interest rate sensitive, in this particular environment higher mortgage rates reduce demand for potential new homeowners, but because of limited supply, builders are poised to fill the supply gap, while existing owners are not very affected by this rise in mortgage rates.

So, to summarize, as one of the most interest-rate sensitive sectors of the economy, home ownership costs are extended relative to household income. Current homeowners who have locked in historically low rates are unlikely to leave their homes with 30-year mortgage rates at over 7%. This time around, borrower's credit quality has been strong this cycle, but the volume of borrowing has declined significantly. Because of this, home builders are selling into this undersupplied market but still face a headwind from rising rates; While a difficult environment for new home buyers, the undersupply of homes is likely to keep home prices and building activity from collapsing.

And with that, thank you for listening! And please don’t hesitate to reach out with any questions.

This material is intended to review matters of possible interest to Glenmede Trust Company clients and friends and is not intended as personalized investment advice. When provided to a client, advice is based on the client’s unique circumstances and may differ substantially from any general recommendations, suggestions or other considerations included in this material. Any opinions, recommendations, expectations or projections herein are based on information available at the time of publication and may change thereafter. Information obtained from third-party sources is assumed to be reliable but may not be independently verified, and the accuracy thereof is not guaranteed. Outcomes (including performance) may differ materially from any expectations and projections noted herein due to various risks and uncertainties. Any reference to risk management or risk control does not imply that risk can be eliminated. All investments have risk. Clients are encouraged to discuss any matter discussed herein with their Glenmede representative.