US Housing Affordability: What Is Driving Prices Higher

It is becoming an openly debated and important question as to whether, at these levels, lower US interest rates are still a good thing for stocks.

Regardless of the answer, there is clearly a sector of the economy still boosted by lower long term interest rates: real estate.

A few weeks ago we published a piece in Pebble 6 on why we expect US housing market to continue to do really well. We have put that piece up on our sparkling new blog and the link can be found here if you want to revisit.

We had a lot of interest on this topic and wanted to expand our argument a bit further. Last time, we focused a lot on the underbuilding over the last decade plus and how the US needs 2-3 million+ homes or more. See Chart 1 for a different and longer term look at this housing deficit.

We do not see a change there (it has also been two weeks....) but we also wanted to make mention of a second and equally important theme that is helping to support the housing market: record affordability.

The reason? Exceptionally low interest rates that feed through to record low mortgage yield (see Chart 2 for US 30 year fixed yield). As we discussed at great length last week, US interest rates have been low and heading lower.

Real estate prices rocketing upwards put a dent in affordability but house prices are more manageable for your average American than they were at any point in the decade before the crisis.

One of the consequences of the recent decline in US interest bond yields has been a simultaneous decline in mortgage rates as well.

After a brief jump this spring mortgages are stunningly back below 3.00%. Historically this is really something (see Chart 3) and underlines a key difference between today and, say, 2007.

So, low interest rates, a lot of demand and limited building should keep housing very hot. What could change this trend?

The US Federal Reserve. Nothing will dampen a hot housing market like higher interest rates. Higher borrowing costs rapidly makes buying a house more expensive for the vast majority of buyers which throttles back on demand.

So, as we have covered before, watching the Fed and how they are analyzing the data around their dual mandate of employment and inflation is critical. The central bank's interpretation of that data and whether to opt for higher interest rates is super important.

One last point, sooner or later, if housing continues to appreciate at this rate, it will feed into rents (see Chart 4). That is at least one source of non-pandemic (and non transitory) inflation that is not getting a lot of attention right now....

Chart 1:

The long slow road to very little available housing supply. This is no longer purely a coastal, big city phenomenon. This also underlines how long the road back to greater supply may be.

Chart 2:

Anything below 3.00% is not just cheap but incredibly so, even by pandemic standards.