2022 Theme - Rising Rent & Resilient Housing
With US interest rates hikes in the pipeline and mortgage rates rising as a result, what will this mean for the always critical housing market?
As we covered the last few weeks, financial conditions are gradually tightening from record lows and a big driver has been the rise of US mortgage rates. They are now above where they were pre-Covid at around 3.70% for a 30 year fixed.
This is stoking expectations that perhaps house prices will struggle in the months ahead and the housing market will cool down as demand wanes.
We are not so sure.
Put very simply, housing was a big theme of ours in 2021 and unlike some others, we expect it to continue in 2022.
Here is is why:
Too much demand is still chasing too little supply.
The reason?
Supply is still very limited. And while demand may moderate in the months and quarters ahead there are still a lot of people very determined, if not desperate, to find a roof to put over their heads.
Here is a great graph that summarizes both these points from the National Association of Realtors:
I think it does a great job of putting the quarter by quarter swings to the side and showing the long term trend.
Over the last 20+ years, there has never been so much demand for so little supply.
EIther the US needs to build drastically more houses or rates need to rise far more than current expectations to really shift these current expectations.
There are two big takeaways from the interlinked trends of rising mortgages but scarce supply:
There is still a very strong incentive for builders to build more homes. The chief problem at present is a lack of labor - especially skilled labor - to do so.
A moderating housing market will be very helpful to cool inflation, if it is sustained and significant.
The second point is a to-be-decided situation and one of the reasons that prices may still elevated for a lot of buyers - especially first time buyers:
You may be competing with a (major) investing firm along with other regular home buyers in your neighborhood.
This is a very big shift. The retail housing market now has permanent capital (i.e.: a firm that has the benefit of offering all cash up front) chasing investing returns and out competing regular Americans for homes.
There are many implications from this shift. We will only focus on a couple and conclude with the most important, in our view.
The most basic is that this is one of the perverse downsides of ultra low interest and very few yielding assets.
The Federal Reserve has suppressed interest rates to encourage investors to buy other assets because government bond yields are so low.
It has taken a while but the gradual institutionalization of the real estate industry now means that there are very large companies looking to buy homes, to rent or flip.
This is, of course, very new for the US housing market.
It is also helping to keep house prices rising.
Other than the rising prices, the most critical part about the above breakdown are the words "to rent."
Because many of these firms are turning around and renting the very homes that buyers were trying to buy back to them.
They are also doing so at the markup, of course. So, people are being outbid and then charged more for renting the very property they thought they could afford.
This isn't academic for a lot of people either.
Average house prices rose 14% in the year to January 2022 with the median home price now fetching over $357,000 according to Redfin.
And guess what?! Median rents are also up 14% over the last year.
This has implications for US inflation as well. Rental inflation makes up around 1/3rd of the US CPI basket. We will return to this theme in future weeks.
You can get a terrible cycle here.
People are trying to buy a home but the prices are rising faster than BOTH their income or savings can keep up. Further, first time buyers are also facing rising rents which are also eating into their savings and ability to save.
It is a very tough situation.
It is also a very incendiary political one.
Building homes take time and, in many markets, is very difficult because of zoning restrictions and regulation. There are efforts to change both of these trends - there was some incredibly radical news out deeply difficult California recently - but will take time and it is very likely that any sort of meaningful shift will happen this year let alone this quarter.
It also divides generations, communities and even families. If you own a home, then you are not necessarily displeased. A rising market lifts all homes and keeps you deeply above water on your gradually diminishing mortgage which you likely refinanced during the Covid-19 doldrums.
If you do not you are in a very challenged situation. Caught between the need for a roof over your head and the twin pincer of higher rents and house costs.
Where does this leave us?
It leaves us liking homebuilders (a cheap homebuilder ETF is XHB but there are others). They outperformed the market last fall and were dragged down by the recent January correction.
