About the author: Ken Shinoda is a portfolio manager with Jeffrey Gundlach and Andrew Hsu of the DoubleLine Total Return Bond Fund.
As an investor in mortgage-backed securities, I keep my eye on the U.S. housing market. A few years after starting my career, I saw up-close this sector implode into the epicenter of the Global Financial Crisis, an episode of tremendous destruction but also of extraordinary opportunity. So early on, I learned to always stand watch for the next bubble or next crash. Home prices increased 19% year-over-year as of Oct. 31, after a record-breaking 20% 12-month gain through the end of August. Some market participants see another housing bubble. Perhaps in certain areas that’s true. Local markets that welcomed homebuyers from America’s most densely populated, epidemic-hobbled cities could cool as people realize Gotham is not dead and return to the office. However, I think prices will likely climb higher on a nationwide basis.
The same forces that supported home prices through the economic shock of the Covid-19 pandemic and in fact fueled the ongoing rally remain in place today. Demographic demand for single-family housing remains strong while supply is extremely low. Affordability, notwithstanding torrid home price appreciation, is still reasonable.
The pandemic has acted as a “Great Accelerator” in the corporate world, prompting sweeping digitization of internal operations, supply chains, and customer relations. The Great Accelerator also acted on the housing market. The effects of Covid-19 accelerated the move from renting to buying for many individuals who had been sitting on the sidelines. New household formation, including by parents of young children, had already embedded desire for more living space in an important segment of the population. Then along came Covid-19 and workplace shutdowns. Business managers quickly got religion on the benefits, to say nothing of the necessity, of hybrid work and work from home. WFH sped up the demographic demand of the millennials for single-family housing.
New household formation, the main engine of housing demand, is not going away any time soon. From 2019 through 2029, most millennials (people born between 1981 and 1996) will shift into the 35-44 age group. That is the prime age for first-time home buying. The largest generation since the baby boomers, U.S. millennials represent a population of 72.1 million. At today’s home ownership rate of 65.4%, that’s a lot of demand for housing.
The supply of single-family housing was at historical lows entering the pandemic and remains so. In January 2020, the inventory of both existing and new homes for sale stood at 1.6 million homes. By comparison, the peak in homes available for sale was 3.9 million homes in summer 2007. Since then, the U.S. population has grown by 31 million. Inventory currently totals 1.5 million. New home construction, while picking up, is being slowed by material and labor shortages.
Affordability is a function of incomes, mortgage rates, and home prices. From these, one can calculate the average monthly mortgage payment of the average household and that payment’s percentage of monthly household income.
At the peak in the housing bubble in 2006, the median home price in the U.S. reached $230,300 with 30-year fixed mortgage rates at 6.76%, assuming a 20% downpayment. The monthly payment for that mortgage was $1,196 or 29.8% of the $4,071 in monthly income that a household with two working persons generates at the median. Today housing prices are up over 53% with a median home price of $353,900, but household income is up 40% and mortgage rates are cut in half at 3.07%. That implies a $1,204 monthly payment, 21.4% of today’s median monthly income of $5,627. Mortgage rates would have to almost double to revert to 2006 affordability. Long story short, housing affordability is still higher than historical averages of the 1980s and 1990s (28.1% of monthly income), when mortgage rates were much higher.
Speculation on mortgage rates merits a digression on the Federal Reserve. Fed Chairman Jerome Powell has stepped-up tapering of the central bank’s purchases of U.S. Treasuries and Agency mortgage-backed securities. One might extrapolate rising interest rates, synonymous with falling bond prices from decreased asset purchases, but that would be naive. In reality, every time the Fed has begun tapering, long-term rates fell as the bond market priced in slowing growth due to less accommodative monetary policy. This time is no different. Note the decline in the 30-year U.S. Treasury yield from its March 16 intraday high yield of 2.5%.
None of this justifies complacency. Indeed, a number of indicators suggest long-term interest rates should be higher. But affordability is a long way from the averages of the 1980s and 1990s, about 28% of income, when mortgage rates were much higher. Housing prices as measured by the national indexes do not appear at risk to Fed tapering.
That said, not all geographies and metros are alike. Real estate has always been about “location, location, location.” Underneath the record price growth summarized in national averages, there remains dispersion among geographic markets. Metros like Phoenix, Tampa, and Miami are up over 25% year-over-year whereas Chicago and Minneapolis are up less than 13%.
The “Covid Metros” could be susceptible to slowdowns if not outright correction. Homebuyers flocked to magical vacation destinations such as Boise, Idaho; Cape Cod, Mass.; and Truckee, Calif. in the expectation of living close to nature, free from the office. Perhaps one day they’ll trade the drudgery of the daily commute for a pair of VR goggles and the metaverse, but today’s world is calling people back to the office, at least part-time. Covid Metros already show signs of softness. While those markets might or might not depreciate, in all likelihood the times of 20-30% appreciation are behind them.
To sum it up, home prices are up a lot, but affordability is still better than the historical average, and supply and demand dynamics point toward continued resilience for U.S. housing. Good luck to my fellow millennials who are searching for their first homes, and good health and happiness to everyone in the New Year.
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