US Housing Bubble Tested As Mortgage Rates Go Vertical

A few days ago, one regular reader ventured a quip about my (admittedly repetitive) characterization of the US housing market as an unsustainable mini-bubble.

Note I used the qualifier “mini.” Scarred by the subprime meltdown, lenders are still cautious. Generally speaking, housing market participants can’t get away with anything like the laughably cavalier behavior immortalized by Michael Lewis in “The Big Short.” The leverage isn’t there, and in that respect, at least, mentioning the current froth in the same breath as 2008 is almost a total non sequitur.

My critique of the pandemic-era housing boom relies heavily on common sense. Q4 2021 marked the fifth consecutive quarter during which the value of US real estate rose by $1 trillion or more (figure below).

I doubt that’s sustainable. The trajectory is simply too daunting.

There are, of course, myriad back-of-the-envelope ways one can calculate Americans’ capacity to keep buying homes given prevailing prices, mortgage rates and income trends. I’ve eschewed such metrics over the past two years in favor of a simpler, more qualitative assessment: The median American family doesn’t buy things that cost half a million dollars.

The good news is, they don’t have to — yet. In February, the median existing-home price for all housing types in the country was $357,300, according to the NAR. The median new home price last month was $408,000. Neither of those figures are half a million, and $100,000 makes a big different when it comes to monthly payments. Still, those prices are a heavy lift for families, if for no other reason than conjuring a decent downpayment means coming up with at least $75,000 in cash.

For a family of four making under $100,000 per year, saving that much in cash (and I emphasize “cash” because that’s separate and distinct from retirement contributions, emergency savings buffers and other sorts of cushions families need) is a tall order. To doubt that is to suggest the median American family has $75,000 in totally unencumbered cash sitting in a savings account, ready to be deployed. Forgive me, but that doesn’t seem realistic.

A September 2021 study from real estate startup Tomo suggested the average American would need to save 10% of monthly income for eight years to afford a downpayment. In Los Angeles and San Francisco, the figures were 19 and 18 years, respectively. In New York, would-be buyers would need to save 10% every month for a dozen years.

As usual, I’ve buried the lede. The purpose of this short piece was to point out yet another large weekly jump in mortgage rates. With last week’s increase, rates are now the highest since December of 2018 (figure below).

If you’re keeping track at home, first of all, congratulations: You’re reading this article from the comfort of a rapidly appreciating asset. Second of all, note that the four-week increase illustrated in the visual is nearly one full percentage point.

You don’t need to be a mortgage banker to know that if rates continue to rise on that kind of trajectory and prices don’t adjust lower, the pool of eligible buyers for a given price point will shrink rapidly. Those buying at the low-end will be priced out of the market. It’s a mathematical certainty, unless lenders relax their standards.

Already, demand for vacation homes is plummeting. According to Redfin, rate locks for second homes abruptly dropped to a two-year low in February (figure on the left, below). Although demand was still up 35% from pre-COVID levels, the prior month’s figures represented a near 90% increase.

“Rising mortgage rates, combined with rising home prices, are hitting the second-home market much harder than the primary-home market,” Redfin Chief Economist Daryl Fairweather said. “That’s largely because vacation homes are optional. People don’t need a second home, but they do need a place to live.”

Yes, they do need a place to live. But, again, I’d argue that the combination of record prices, surging rates, imminent Fed MBS runoff (and eventual active selling) and constrained household budgets amid the highest inflation in 40 years, is a recipe for a slowdown. You can’t buy what you can’t afford, no matter how much you need it.

A separate Redfin study released this month showed a record 8.2% of US homes are worth $1 million or more (figure on the right, above). That figure was 4.8% in February 2020.

Redfin Deputy Chief Economist Taylor Marr summed it up. “The surge in housing values has turned many homeowners into millionaires, but has pushed homeownership out of reach for a lot of other Americans,” he said, noting that although incomes have increased, they haven’t risen as fast as home prices. That, Marr remarked, “means many people are stuck renting or have to move somewhere more affordable if they want to buy a home.”

A third of New York homes were seven figures or more in February. In San Francisco, nearly 90% were worth at least $1 million last month.

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12 thoughts on “US Housing Bubble Tested As Mortgage Rates Go Vertical

  1. Housing is due for a breather. There has been a pattern post WW2 with US housing. Often you get relatively short periods of sharply escalating prices, followed by a shallower correction, and then slow appreciation. The overhang of inventory gets worked off and then the cycle renews. The great housing crash of 06-09, was exceptional due to leverage and its depth. That is why the recovery cycle took 10 years to see another rapid take off. While interest rates are important, so are demographics. And demographics are a tailwind. The average age for a first time buyer is about 30 and we are in the window when the millenial population echo is right in the middle of the first time buying sweetspot. Don’t be surprised for housing prices to appreciate slowly for the next 5 years. We may not see much of a correction due to demographics. But second homes- yeah they are vulnerable. There was a giant run up, and now incomes have to catch up to prices.

  2. And then there’s the real estate insurance and taxes. I assume that in most places these are based on the home’s value. If the home value increases exponentially, the taxes and insurance should too. So much for a nation of home owners.

  3. The Fed devoured about 50% of MBS out there. With that source of demand gone, for the first time since the financial crisis the market will have to determine the premium required to lend to a household as opposed to the US government. Currently that premium stands at about 2 percentage points. I for one would rather own a 30 year US bond than bet on a median US household paying me back $408,000 with interest.

    1. I’m not convinced it’s an issue of intent (or even ability necessarily) to pay. Unlike 2006/2007, I think the vast majority of households fully intend to pay the mortgage and probably “can” with the scare quotes there to indicate that “can” is becoming a very relative term. I guess what I’d say is that a couple who, between them, makes, say, $100,000 and currently pays $2,000 in rent with no kids yet, probably looks ok on paper for a $450,000 home, assuming they’ve got $90,000 down. But once you start adding kids, cars and, you know, real life, to the equation, what was a sizable monthly cushion could get eroded pretty fast. And, again, that’s assuming $100,000 household income and 20% down. I doubt such a family would ever have real trouble coming up with the monthly payment, but it shouldn’t be the case that a couple with a six-figure income and 20% down should have to even think about struggling. The fact that we’ve reached a point where there’s even a question about those kind of buyers/borrowers is unfortunate. As for a family making less than $100,000 and/or who doesn’t have something close to 20% to put down, they’ll need to resign themselves to the wholly ridiculous fate of paying a quarter of million for something that looks like it cost $80,000 because, three years ago, it probably did.

      1. My family almost exactly fits the bill you described, and we bought just prior to the pandemic

        500k with 110 down (4.25 rate when purchased), combined income around 120. New Jersey taxes. Kids.

        What was tough for us would now be impossible. Our neighbor’s house is currently selling for 750 and it’s in worse shape.

  4. H-Man, a bubble is a bubble and the housing market is a bubble. The number of buyers who can afford the cost (down payment + mortgage rate) for the “average” home will be decimated as rates continue to rise. So as cost demand buyers decrease, supply will increase and the bid/ask will simply get wider. Eventually the bid will prevail. For the last couple of years, the ask has owned the game and that is coming to an end.

  5. As an oldbird, I see the possibility of a housing bubble as being chicken feed that’s related to the old fashioned concept of time and appreciation reward, versus the concept that some kid wanting to cash in on a quick thing to flip.

    Owning a house in my case was about a long challenging battle to save for a down payment and live in ugly apartments for many years. That process of not being instantly gratified by fast money wasn’t fun, it was dreadful.

    The house I have is in a decent area and after years of smart choices, it’s done well, but in a way, it’s chicken feed. As an investment, it’s now up almost 12% on an annual basis, after 20 years, but, without the pandemic booster, it probably would have grown closer to 9%.

    After taxes and costs, it’s nice to have a little rat age, but, I don’t feel like I’m sitting on an expanding bubble that’s unrealistic. Even though inflation has been relatively mild over 20 years it’s a factor that’s as real as the increase in value.

    People used to invest in homes for appreciation and they used to be less speculative and obviously we’ve seen a unique trend in the last 5years, but let’s not be too quick in forgetting when selling a house was almost impossible around the GFC, that period where there was ten years of distress.

    Ok, let’s forget that concept of being patient and return to this huge bubble that’s making me rich. I’d love to sell but my massive profit won’t but crap and rent is insane. There’s no leverage, but there is risk …

  6. I am somewhat surprised that appraisals can support the values for the homes. The institutional (all cash) buyers are creating havoc in the marketplace.

  7. There is a buyer that didn’t exist in 2008, which is all the institutional investment funds accumulating portfolios of 30,000 or 60,000 rental SFR (houses). In some areas these funds were as much as a quarter of sales last year. With rents rising at least as much as inflation, the AFFO is still buyable.

    There is another buyer, which is people flipping
    part of the last two years of stock market gains into real estate. They are somewhat price sensitive – hence the softening second home market – but they aren’t as affected by mortgage rates.

    The traditional mortgage-dependent owner-occupant will certainly be set back by rising rates.

    Even for them, local conditions may trump rates. In my city, the influx of people who moved from more expensive cities in the last year with big RE gains in their pockets is still supporting a hot (sellers) market.

    As always, the lower income will lose the musical chairs game. But lower income families have become almost irrelevant to the house market by now, just like they are to the Mercedes market. It’s a game for the 200% of MFI (median family income) and up crowd.

    Overall, I think house prices will flatten and soften, but not reprise the GFC.

  8. Cycles will always be with us- the length and extremity will vary. A great investment since the summer of 2020 – short the 10 year treasury. Next best investment- the flattener. Third- coal.

  9. Argument by Anecdote time: For the last year-and-a-half, houses available for sale in my neighborhood have sold in 5 days or less while prices have appreciated 50%. Right now though, there’s a home that has been on sale for an entire month. Their listing is definitely ambitious: it’s one of the oldest homes in the neighborhood, looks a little run-down, and their asking price reaches for the full 50% of recent appreciation. Still, its failure to sell definitely has the feel of a keeled-over canary.

    (OK, just looked it up on Zillow. Listing is 28 days old, and according to Z, there’s a pending offer. It last sold in 2007 for $88k, now going for $355k).

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