The Investment Implications of the Housing Slump

The Investment Implications of the Housing Slump

Subscribe to the Notes on the Week Ahead newsletter to receive it directly in your inbox and access Market Insights on Amazon Alexa & Google Home.

For many people, I suspect, 2022 will be a year to forget. However, for millions of home-builders, home-sellers and home-buyers, it will be remembered for the speed with which a housing boom turned into a housing bust. The reason, of course, has been a surge in mortgage rates. These rates look likely to stay high, at least over the next year, contributing to sharp declines in housing starts and home sales and a negative impact on GDP. Eventually, this could motivate the Federal Reserve to reverse course and cut rates. However, mortgage rates are unlikely to fall to anything like the levels they maintained for the 14 years prior to 2022, while limited housing supply will probably prevent a collapse in prices. Given this, it appears we are now entering an era when the decision to buy a house should be focused more on the finding the right home in which to live than the right asset in which to invest.

The Sudden Housing Slump

The collapse in housing in recent months has been dramatic. Housing starts, which in April topped 1.8 million units annualized for the first time since 2006, slumped to 1.425 million units in October. Traffic of perspective buyers in November has fallen to its lowest level since 2011. Existing home sales for October, released last week, showed a further slump in sales, also to their lowest rate since 2011. October new home Sales, due out on Wednesday, should show a similar decline.

The reason for this sudden slump is easy to see. In the last week of 2021, the 30-year fixed-rate mortgage rate was 3.11%. In the week that ended last Wednesday, it was 6.61%, which, although down from a peak of 7.08% a week earlier, was still up by 3.50% from the end of last year.

It should be noted that over the same period of time, 10-year Treasury Yields rose by a more modest 2.29%, from 1.51% to 3.80%. So why the sharper increase in mortgage rates? 

The main reason is the usual problem with the mortgage market, which has to do with prepayments. When rates fall, mortgage holders are more likely to prepay their mortgages, shortening duration and causing mortgage rates to fall by more than Treasury rates. When rates rise, the opposite happens, with refinancing collapsing, duration extending and mortgage rates rising by more than Treasury rates.

However, on top of this, it should be noted that the spread between the 30-year fixed rate mortgage rate and the 10-year Treasury has averaged 1.78% over the past 25 years, so the spread of 1.60% at the end of last year was unusually tight. In addition, the Federal Reserve’s quantitative tightening program has begun to reduce their holdings of mortgage securities, although by much less than they seemed to intend when they announced the program last spring.

Regardless of the mechanics, the impact on borrowers has been dramatic. In October, the monthly mortgage payment on the median existing home sold was $1,997, (assuming 20% down and a 30-year fixed rate mortgage), up an astonishing 65% from the $1,210 of a year earlier. This has, of course, radically shrunk the pool of potential home buyers. 

The Macro Impact of Weak Housing – The Economy’s Handbrake

We now estimate that single-family housing starts will fall by 28% year-over-year in the fourth quarter of 2022. In addition, we estimate a 30% decline in sales of existing single-family homes over the same period. These impacts are being somewhat mitigated by strong demand for multi-family housing starts, which look set to rise by 10% year-over-year in the fourth quarter and continued strong demand for additions and repairs as many home-owners decide to renovate rather than relocate.   

However, even netting this out, we estimate that the decline in home sales and home building will directly reduce real GDP by 0.6% in the year ended in the fourth quarter of 2022 and 0.2% over the following year. Even with further knock-on impacts on consumer spending on furniture, appliances and home-moving expenses, this isn’t a big enough hit to trigger a recession on its own. However, combined with weakening net exports, continued fiscal drag and growing corporate caution, the housing slump could help tip the economy into recession in 2023. 

Slow Motion Recovery

One lesson from many past housing cycles is that it takes a long time for the market to return to equilibrium. While we believe that the Fed is nearing the end of its rate hike cycle, we still expect that it could raise the federal funds rate by 0.50% in December and 0.25% in early February. In addition, the Fed may contemplate the outright sale of mortgage-backed securities at some stage over the next few months, as allowing them to roll off their balance sheet clearly isn’t working in a world where mortgage refinancing has collapsed.

The first genuine relief on mortgage rates may have to wait for the end of 2023 when the Fed may begin to take back some of its rate hikes in response to both slower economic growth and lower inflation. Even then, we do not expect any return to the 4% average mortgage rate seen between 2009 and 2021. 

Meanwhile, home prices should only fall slowly. The demographics underlying housing demand continue to be weak, with the U.S. population likely growing by less than 0.3% in the year ended in June compared to roughly 0.7% per year in the middle of the last decade. However, vacancy rates remain at historically low levels due to weak building activity after the Great Financial Crisis and mortgage delinquency rates remain very low. Unless homeowners are forced to sell at a loss, they will likely hold houses off the market until mortgage rates subside. 

For the economy, housing will be more of a handbrake than a roadblock – slowing economic growth rather than preventing it. However, for prospective home-buyers the next few years are likely to be difficult, with homes remaining very expensive to buy while providing less potential for capital gains.

For generations of American families, buying a home has been a mark of personal achievement and a foundation upon which to build a fulfilling life. From time to time, it has also been seen as a quick path to financial success. 2022 is not one of those times and both today and likely for some years to come, investors might be well advised to buy a home for lifestyle but consider financial assets for investment returns. 

Read the On the Minds of Investors article, How does a softening housing market complicate the Federal Reserve’s quantitative tightening plan?, or listen to an Insights Now episode, Real Estate Booms, Busts and Structural Change, for more of insights on the housing market.

Disclaimers

Opinions and estimates offered constitute our judgment and are subject to change without notice, as are statements of financial market trends, which are based on current market conditions. The views and strategies described may not be suitable for all investors. Any forecasts contained herein are for illustrative purposes only and are not to be relied upon as advice or interpreted as a recommendation.

Content is intended for institutional/wholesale/professional clients and qualified investors only (not for retail investors) as defined by local laws and regulations. J.P. Morgan Asset Management is the brand for the asset management business of JPMorgan Chase & Co. and its affiliates worldwide (collectively “JPM”).

Opinions and comments may not reflect those of J.P. Morgan or its affiliates. Content is intended for US audience only, and should not be considered a recommendation or endorsement by JPM for any product, service or strategy specific to any individual investor’s needs. JPM is not responsible for third-party posted content. "Likes", "Favorites", shares, similar functionality or content appearing on third party websites should not be considered an endorsement of JPM products or services.”).

Nicholas Day, MBA, EIT

Sr. Specialist, Project Engineer at L3Harris Technologies

1y

“Regardless of the mechanics, the impact on borrowers has been dramatic. In October, the monthly mortgage payment on the median existing home sold was $1,997, (assuming 20% down and a 30-year fixed rate mortgage), up an astonishing 65% from the $1,210 of a year earlier. This has, of course, radically shrunk the pool of potential home buyers.” No Millennial I know who has actually been able to afford homeownership, was able to put down 20%…The tens of thousands of dollars that would have went to that, are going to our student loans instead. The older generations can only get so much blood from the Millennial stone, and if rent keeps increasing faster than pay raises, there won’t be a housing market to discuss in 15-20 years!

Margaret Little, CFP

Margaret V. Little is a Registered Representative offering securities through United Planners Financial Services of America - member FINRA & SIPC. Wealth Avenue and United Planners are not affiliated.

1y

Interesting piece - thanks for sharing, Susan. As was said below, buyers can always refinance in future - just maybe not to 3%!

Rick Stanley

NMLS # 277528 Residential Mortgage Originator @ Hallmark Home Mortgage NMLS# 53441 | FHA VA Conventional USDA

1y

Even when we come out theis inflationary period, we still won't have enough homes for the demand. Then we start the cycle over again with the paying over list and multiple offers. Until the inventory gets right, the housing market will not recover.

Dmitriy Yakubovich

Partner at Bridge National Capital

1y

We may see a repeat of the 90’s when housing was not considered an investment asset but a homestead and the price plateaued for some time.

Interesting perspective and I believe consistent with most estimates these days. I think the silver lining though might be realigning new homebuyer expectations and entry level costs to afordable levels. If the mortgage payments are up 65%, and out of reach for too many then possibly the home values should drop by roughly half to keep the segment buying with a large mortgage in homes. Not all house prices will drop that far but a lot likely will (my opinion)…. But great insights in the article, thank you!

To view or add a comment, sign in

Insights from the community

Explore topics