This morning we received some data that support the narrative of a rapidly recovering housing market. Housing starts and building permits surged 22.6% and 18.8%, respectively, in July compared to June. Both metrics are now much closer to the recent highs reported in January of this year prior to the COVID outbreak. With this fresh data, we thought we’d take a more comprehensive look at where things stand in the housing market.
I should first mention that with the exception of building permits, housing starts, mortgage rates and homebuilder sentiment, the housing data we discuss below is only available through June.We should be getting July readings for a lot of these metrics over the next couple of weeks.
The first thing to note is that despite a 29% plunge in home sales (new and existing) from February to May of this year, the median sales price continued on an upward trajectory. In the chart below we used the sum of new and existing home sales and the weighted average median sales price for new and existing home sales. It’s fairly clear that the drop in transactions did not affect the growth in prices.
One of the big reasons for the resilience in housing prices has been a shortage of supply. The following chart shows that the supply of homes for sale had been falling precipitously over the five years leading up the the COVID crisis. More recently, there was a spike in supply corresponding to the drop in sales from February to May. However, as the pace of sales rebounded in June, so did the supply shortage. Based on the most recent reading (June), there were only 3.7 months of housing supply on the market – very low compared to historical averages. The limited amount of supply is helping to keep prices elevated.
Another major factor supporting housing prices has been the huge drop in mortgage rates. In the chart below we show the drop in mortgage rates along with another gauge of home prices, the S&P Case Shiller 20-City Home Price Index. Keeping mortgage rates low (and therefore housing prices elevated) has been one of the Fed’s main objectives in suppressing interest rates for the past many years.
In the next chart we show that housing price increases started to accelerate (on a year-over-year basis) in mid-2019. Interestingly, the price increases continued unabated through the first few months of the COVID crisis. One factor that could be contributing to the continued strength might be the big spike in personal income, which was driven by massive government stimulus payments and expanded unemployment benefits. You can see in the chart below that personal income spiked beginning in April as a result of the government’s initiatives. Without those stimulus payments, it’s hard to imagine that the housing market would have been so resilient.
Putting it all together, housing affordability has actually improved in recent months. Affordability is determined by three factors: 1) mortgage rates, which have plummeted to below 3% in recent weeks; 2) housing prices, which have continued on an upward trend despite the recession; and 3) family incomes, which received a big boost owing to government transfer payments. Housing prices have received additional support from a very low level of supply, which has been an ongoing issue for years.
The last evidence worth mentioning is that Home Depot, the largest home improvement retailer, reported a 25% increase in same-store sales (SSS) this morning for its fiscal second quarter (ending July 31). The growth in SSS was nearly double the consensus estimate, and the strong results clearly show that homeowners, builders and professional home-improvement contractors have been spending increasing amounts on projects designed to make home life more appealing during the COVID-19 lockdown. Over time, it would seem that these massive investments in the home would be supportive of housing prices as well.
Will the housing strength continue? In my opinion, we are at a critical watershed moment for housing. In order for prices to continue climbing at recent rates, we need to have a couple of things happen. First, and most importantly, the federal government must pass legislation that continues to provide income to the unemployed until such a time when COVID is no longer inhibiting job creation (or exacerbating job loss). If homeowners are unable to make their mortgage payments, a surge in foreclosures could cause supply to spike and prices to fall. Second, mortgage rates must stay low. If borrowing costs rise meaningfully from current lows, there is no reason why housing prices couldn’t drop again (although not to the extent they fell during the Financial Crisis).
The uncertainty surrounding the housing market is one reason that bank stocks have been underperforming in recent months. It is true that the government’s response to the COVID crisis included a moratorium on mortgage foreclosures while also providing unemployed folks with stimulus payments so they can pay their mortgages. However, if these initiatives are allowed to expire, nobody (including me) knows what the fallout for the housing market might look like. If more and more Americans are unable to make their mortgage payments, credit losses and housing inventory could easily spike, darkening the prospects for continued housing price gains and impairing bank earnings. The stakes for government action are quite high on a number of fronts, but the housing market is front and center.
It always makes me uneasy when the health of a large sector of the economy is so dependent on government involvement. Some might argue that the housing sector has been dependent on the Fed’s suppression of interest rates for decades now. This is true, but it also strikes me as more dire that such a large percentage of homeowners would be unable to make their monthly mortgage payments without a check from the federal government. For the time being, we are being very cautious and defensive with the stocks we own in the banking sector.