Notwithstanding what one has to believe is an internal plan at the Fed to cool a US housing market turbocharged by monetary largesse, nominal home price declines aren’t likely. Or at least not at the national level.
That’s according to Goldman, whose Ronnie Walker addressed one of the most pressing questions facing the world’s largest economy as Jerome Powell embarks on an ambitious quest to tame an inflation dragon dormant for a generation.
Mortgage rates are up nearly two full percentage points in 2022, and, as discussed at length here, the velocity of the move is remarkable (figure below). 5% is a milestone of sorts.
Would-be buyers are being priced down, or out of, the market, in something close to real time.
On Goldman’s estimates, a 100bps increase in mortgage rates reduces residential investment by 6% over a year, on average. “That estimate, taken at face value, implies that the YTD increase in mortgage rates should weigh on residential fixed investment by over 10%!”, Walker exclaimed on Monday.
Thankfully, market tightness should mitigate the impact. The drag on existing home sales from a 100bps jump in mortgage rates depends, in part anyway, on the vacancy rate during the prior year. The same is true of homebuilding. In short, the lower the vacancy rate, the tighter the market and the smaller the sensitivity to rising rates.
Specifically, a record low housing vacancy rate like that which persists currently, implies just a 2.5% hit to demand for every 100bps higher in rates, versus a 6.5% hit when the vacancy rate is 2% or higher. Similarly, there’s virtually no impact on housing starts from a 100bps rise in mortgage rates when the vacancy rate is below 1% versus a 13% reduction when the prior year’s vacancy rate exceeds 2%.
“When housing markets are tight, like they are today, homebuilders are likely to keep building because they should have little fear that homes will sit vacant after completion,” Walker wrote.
Still, Goldman was compelled to cut its estimates for real residential fixed investment growth to -3%/0%/+1% in 2022Q2-Q4 versus +3%/+3%/+2.5% previously. Those aren’t trivial reductions, and they’re predicated on the bank’s forecasts for existing home sales and housing starts. Although the latter are expected to rise 5%, the former will likely fall 6% and end the year at a pace that’s 7.5% lower.
“When viewed in combination with weakening purchasing intentions and the broader reduction in affordability driven by higher home prices, sales are likely to decline substantially this year,” Goldman said, noting that “the average monthly mortgage payment has increased by over 40% in the last year,” driving the banks’ Housing Affordability Index to levels last witnessed in 2007.
Coming full circle, Goldman doesn’t expect nominal price declines at the national level. That’s “a historical rarity,” the bank reminded investors.
Still, model-implied price growth is seen decelerating “significantly” by the end of 2023 (figure above).
Importantly, Goldman assumes mortgage rates will be “roughly unchanged” through the end of 2023. If that assumption doesn’t hold, the bank may need to reassess their price projections, something Walker alluded to.
“Additional increases in mortgage rates could materialize if tighter-than-expected monetary policy is required to contain inflation, which would also raise the likelihood of negative home price growth,” he cautioned.
I’d gently note that at least one well-known analyst has suggested the best way to slow inflation is for the Fed to deliberately push home prices lower. The familiar figure (below) suggests it’s too late, though.
Seen through that lens, the die is probably cast.
Walker was keen to emphasize that housing is “the most interest rate-sensitive segment of the economy and the textbook channel of monetary policy transmission.” Given that, a Committee that really is serious about leaning into inflation may well adopt some version of the Zoltan Pozsar plan. In February, Pozsar said mortgage rates “need to get higher.” Home prices, he insisted, need to be flat or “outright lower.”
If policymakers were to embrace a controlled demolition approach to the housing bubble they helped inflate, buying a home at any point during this tightening cycle would be tantamount to fighting the Fed. Historically, that’s a losing proposition.
Price of housing is not solely dependent on mortgage rates. Demographics and income play a very signifcant role. Also supply was suppresed for a long time post GFC. So a scenario where prices are flat for 3-5 years, even though nominal income grows seems reasonable. Supply will catch up to demand over the next few years and the positive demographics should also decline as millenials age. The last crash was largely a lax lending situation. Right now we are not seeing that play out. The FOMC will succeed in slowing things down, probably all too well. Right now the market is tightening up conditions more than the FOMC. Watch out for credit spreads- if you see high/medium grade bond spreads widen vs. UST bonds that is likely to be the Wiley Coyote moment…..
Yeah, they mention other factors. To wit, from Walker: “While there could be outright price declines in some regions under our current economic baseline, our expectations for elevated inflation, still-restrained homebuilding, and a continued demographic tailwind from millennials passing through their prime home-buying years make nominal price declines at the national level, a historical rarity, seem unlikely over the next couple years.”
Yes, their analysis is fair. I would expect that the housing markets won’t have a correlation of 1 either. I saw a story about the Boise, Idaho market – one of the hot spots cooling off rapidly. Some of those moonshot local markets like Boise, Austin, etc. will probably come off the boil. My understanding is that NYC prices have improved lately- so some of the laggards like NYC and SF may still have some room to run. The fact that the correlations are not 1 is actually a sign of a healthy nationwide housing market. It is when markets are hyper correlated that you have a scary situation- either on the upside or the downside- just like financial markets. As I live in NYC it is becoming increasingly evident that activity is picking up in the commercial areas here. I can see it when I take the subway during rush hour to Manhattan- not like it was pre-covid but the bounce back is picking up and becoming more apparent. Perhaps we will get more covid waves, but it looks like successive waves are not as scary as previous ones and that folks are adjusting to the new reality. The kids (recent grads especially) are comng back- as more entertainment venues open up, the draw of the city will become more apparent.