Housing Market Puzzles - May 1, 2018
Here at MI2 Partners, we focus our attention on industry sectors that lead the broad economy. For example, manufacturing where we parse everything from Fed, small business to ISM data looking for trend changes. Another sector that garners our attention is housing. Economists also spend a great deal of time thinking about this too. But, as you’d expect from this crowd, there is no paucity of hind-sight based pabulum. For instance, the St Louis Fed in 2008 found that “homeownership is not necessarily the best housing option for highly leveraged households more prone to foreclosure”. Really, you think so? However, by way of redemption, the same institution just produced an excellent 3-part series focusing on “The Housing Supply Puzzle” in which they built on an article they published in 2009, “Examining the Housing Crisis by Home Price Tier” and went on to look at the differing dynamics between housing segments. i.e. new vs existing, high-price vs lower-priced, etc.
In the original piece, they found house prices grew at approximately the same rate across the board before the boom. During the bubble years, prices for the lower tier increased at a much steeper rate. Conversely, as home prices fell, it was this lowest tier that bore the brunt of the drop as mortgage innovations turned out to be less than the miraculous tools they were touted to be. Interestingly, the new Housing Supply Puzzle series, they discovered that this dynamic still casts a shadow over today’s market as homebuilders have chosen to focus on higher-end housing market where profit margins are best. The result is the supply of new “expensive” homes has outpaced the broad supply of existing homes. The second installment of the series highlights rental demand as another contributing factor, slowing turnover as landlords hold on to property while the tenants shift, and encouraging homebuilders to opt for multifamily construction.
In the final installment of the series, the St Louis Fed examines the price gaps that have emerged between different housing tiers. Echoing the findings from part one, they write that as homebuilders have focused on the upper-tier, the whole new home sector has shifted to larger more expensive homes, “making it relatively more expensive for owners to trade up”. They conclude that:
“Rising prices of lower-tier and middle tier homes should draw homebuilders to product more of those units over time, while a smaller price gap will incentivize owners to trade up, yielding additional inventory.”
However, they also caution that,
“In the near-term, however, it is likely that low- and middle-income homebuyers will suffer as affordability worsens in those market segments.”
For us, given the importance of housing and especially new construction to the broad economy, this is a red flag. We are concerned that these dynamics could combine with rising 30-year mortgage rates to undermine affordability, with clear implications for GDP growth. We will be watching this sector even more closely.