The Crisis In Housing, Part 1: A Lopsided Market

Zinger Key Points
  • A four-part Benzinga special report on the U.S. housing market
  • Demand drowns supply while construction stagnates

The Japanese novelist Kobo Abe once wrote, “There is always order in the distant view. No matter how strange the happening, it can never project from the frame, from the order which this distant view possesses.”

For the past several years, the U.S. housing market has been seen through the spectrum of a distant view, where all appeared to be copacetic. This vibrant and seemingly healthy market was hailed for not only rebounding with unprecedented vigor from the wreckage of the Great Recession, but also for its ability to bring positive energy during the pandemic when other sectors of the U.S. economy were paralyzed.

But when one abandons the distant view and moves closer to the subject, the picture becomes very different. The factors that gave the housing market the appearance of strength seem warped and off-kilter upon deeper examination while the fissures snaking through its foundations begin to appear with harsher clarity. There is no regimented order, but rather a sense of quiet yet growing chaos that many within the market have chosen to downplay or ignore — but which cannot be ignored as the wider economy — which many economists fear is tumbling into a recession by year’s end — undergoes a slow-motion convulsion fueled by policy shifts that could easily make a bad situation worse.

To call this situation a “crisis” might seem melodramatic to some, but the current situation is not sustainable and all evidence is pointing to an upcoming detour into a problematic direction. And when one realizes what is going on — and going wrong — it's impossible to retreat back to the distant view and reconnect with the false sense of serenity.

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Swelling To An XXL-Price: In February 2020, the month before the COVID-19 pandemic took root in the U.S., the National Association of Realtors (NAR) reported the national median existing-home price for all housing types was $270,100, up 8% from the $250,100 recorded one year earlier. February 2020 also marked the 96th consecutive month of year-over-year gains for the median existing-home price, which many pointed to as the housing market having swept the nightmare of the Housing Bubble’s collapse into the history books.

But fast-forward to February 2022 and the median existing-home price for all housing types in February was $357,300, up 15% from the $310,600 level recorded in February 2021. This also marked the 120th consecutive month of year-over-year increases, the longest-running streak on record.

On the surface, this might look like the ultimate success — no one wants to see home prices tumbling and properties sitting empty, and sellers were clearly reaping success. However, this sales price growth turned into too much of a good thing.

Also in February, Zillow Group Z reported the U.S. totaled 481 housing markets during 2021 that qualified as “million dollar cities,” which means the typical home values were at least $1 million. Last year saw a record 146 markets becoming defined by the “million dollar cities” designation, with three states — Idaho, Montana and Tennessee — joining that pricey club for the first time with localities where home values started in the seven-digit range.

Part of this situation can be attributed to the pandemic — with so many people forced to self-quarantine and work from home, a new consideration of one’s surroundings began to arise. Thanks to technology, a remote worker didn't have to be anchored in a home within commuting distance to a workplace — thus, people began looking into purchasing a new residence, often in another state where the cost of living was more favorable.

While this was happening, the federal government worked overtime to ensure Americans would not be financially decimated by the pandemic. According to Dr. Anthony B. Sanders, distinguished professor of real estate finance at George Mason University and former director and former head of asset-backed and mortgage-backed securities research at Deutsche Bank AG DB, this is where things became thorny.

“After the COVID breakout in early 2020, the Federal Reserve went nuts and just dumped trillions of dollars into the market,” Sanders told Benzinga. “And then the Biden administration and Congress dumped tons of money in terms of fiscal stimulus — which, by the way, most of it did not go to the intended people. So, in other words, he took a quiet economy and dumped trillions of dollars of stimulus into it. And rates were too low for too long when Washington intervened with stimulus — it just triggered a nightmare.”

The nightmare scenario was allowed to metastasize because housing supply was ridiculously distant from buyer demand. NAR reported that at the end of February, U.S. housing inventory totaled 870,000 units, down 15.5% from the 1.03 level of one year earlier. Unsold inventory was at a 1.7-month supply at the current sales pace — a mini-triumph of sorts, as the supply recorded in January was 1.6 months, a record-breaking low.

According to Jeff Tucker, senior economist at Zillow Group Inc. ZG, this situation was more than a dozen years in the making.

“Homebuilding cratered beginning with the Great Recession and it took a very long time for the rate of new home construction to get back to kind of normal levels,” Tucker said. “We really didn't build enough homes from about 2007 through 2019, and homebuilding was really just getting back up to where it needed to be on the eve of the pandemic.”

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When Demand Drowns Supply: But Tucker also observed that the housing industry knew demand was going to overwhelm supply sooner rather than later.

“On the demand side, we've known for several years that there would be a bumper crop of households who wanted to buy their first homes right around the early 2020s because there was a second baby boom right around 1990, when an unusually large number of people were born,” he continued. “So, we have an unusually large number of people turning 30 in 2020, and a trailing edge of folks in their late 20s at that time. We knew that this big wave of demand would be coming to buy homes, especially to start moving from apartments into single-family homes, and we weren't really building in anticipation of that.”

Not only was there a larger-than-normal quantity of potential buyers, Tucker added, but record-low mortgage rates increased the purchasing power of would-be homeowners. Although the lack of supply sparked increased pricing for the elusive residential commodities being sought, Tucker noted the record low mortgage rates “helped a lot of people persevere past the rapidly rising prices of the last couple years.”

But if younger buyers were eager to get into a home, older homeowners were not necessarily eager to sell and move out. Data released earlier this month by the brokerage Redfin RDFN found the typical American homeowner in 2021 had spent 13.2 years in their home, which was slightly lower from the peak of 13.5 years in 2020 but much higher than the 10.1 years recorded in 2012.

John Glassock, professor of finance and director of the University of Connecticut Center for Real Estate and Urban Economic Studies, offered his own example of what he called the “difference between the old days and the new days.” Glassock noted that when he graduated from college in 1970, it was common for people to be married either in their senior year or during their first two years out of school, with children following afterward. He recalled becoming a homeowner at 26, which he renovated and sold at a profit four years later.

“I bought a house for $65,000,” Glassock stated. “And then four or five years later, we sold that house and I bought a house for $150. So, by the time I was 50, I'd probably had seven different houses. Now, that's not happening as much today to college grads who are making good money. They’re not getting married until maybe about 33.

“Recently with one of my students,” he added, “he and his wife were 36 when they had their first baby. And then about four years later, they moved out to New Jersey, bought a beautiful 3,200-square-foot house, and they're hoping to be in that house for the rest of their life. So, there's a new trend — these young people don't go up the ladder the way they used to.”

But Zillow’s Tucker pointed out this trend created a logjam for the younger homebuyers trying to get their feet in the proverbial door.

“The baby boomer generation is mostly settled into getting around retirement age,” he said. “That’s an age when people just don't move as much as younger folks do. So, a lot of the baby boomers are staying put. And ultimately, what that means is we kind of have these two biggest generations ever, the baby boomers and the millennials, all trying to be homeowners at the same time.”

Wither Construction? Perhaps the most obvious strategy for solving this situation would be the construction of more homes. But that opens another set of problems: the cost of building homes has become significantly more expensive in a relatively short period of time. The prices of goods used in residential construction (not counting energy) were up by 1.6% in February, according to the latest Producer Price Index report released by the U.S. Bureau of Labor Statistics. Building material prices increased 20.4% year-over-year and have risen 31.3% since pre-pandemic January 2020.

“Builders are reporting growing concerns that increasing construction costs and expected higher interest rates connected to tightening monetary policy will price prospective home buyers out of the market,” warned Robert Dietz, chief economist of the National Association of Home Builders (NAHB). “While low existing inventory and favorable demographics are supporting demand, the impact of elevated inflation and expected higher interest rates suggests caution for the second half of 2022.”

“Inflation has been draining households of accumulated savings and could trigger rapid slowing in consumer outlays,” added Anirban Basu, chief economist with Associated Builders and Contractors. “Elevated oil prices are likely already doing damage to the economy, damage that is not yet apparent in key macroeconomic indicators. Elevated oil and other prices are also driving the cost of delivering construction services higher, which could result in the postponement or cancellation of some projects.”

Complicating matters is finding the people to build these new homes.

“We are still seeing drastic shortages in labor on the construction side of things,” said Jonathan Kanarek, managing director at Verisk Analytics Inc. VRSK. “When you look back pre-pandemic to the amount of labor that was available for construction, it was significantly higher than it is today. And we are seeing some amount of lengthening time between a permit being issued and the actual housing start happening.”

NAHB’s Dietz agreed, pointing that “on the single-family front, the count of homes permitted but not started construction reached a four-month high in February, rising to 152,000. This is an indication of the ongoing supply-chain delays and cost issues that are limiting the pace of home building in many markets.”

Kanarek highlighted that this situation is creating a deficit of starter homes, which traditionally were the smaller and less expensive residences for first-time younger homebuyers.

“The labor shortage and material costs deriving the general cost of building those starter homes are up, which may be redefining what a starter home is,” he said.

But even if starter homes are available, too many people can't afford them. The NAHB issued data that determined, the minimum income required to purchase a $150,000 home is $36,074. However, about 36 million U.S. households are estimated to have incomes at or below that threshold, while another 24.4 million can only afford a home priced between $150,000 and $250,000.

George Mason University’s Dr. Sanders warned that new buyers seeking starter homes might want to consider looking at another arrangement.

“The alternative for those people is renting,” he said. “It's very difficult to create starter homes — I don't know how they can make housing more affordable. For first-time homebuyers, we have all these mortgage financing programs in place from Fannie Mae FNMA, Freddie Mac FMCC and the FHA, but the problem is with housing prices, it's very difficult for anyone to afford a home anymore.”

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Looking Ahead: Will housing prices plateau or even begin to decline into 2022? The general consensus within the housing industry is that today’s rising prices will not ascend at breakneck speed but will also not go into reverse.

“We expect price growth to decelerate but, overall, there's still really strong demand out there,” said Redfin’s Marr. “Supply has not quite picked up, so there's a lot of momentum that's been causing prices to accelerate lately, and even reaching record highs week after week.”

“Supply constrained with continued demographically drives strong demand,” said First American Financial Corp. FAF Chief Economist Mark Fleming. “As mortgage rates rise, demand is likely to moderate, but not enough to regain balance in the housing market relative to the shortage of homes. Because there are so few homes for sale and demand is expected to remain strong for buyers even amid rising mortgages rates, strong house price appreciation is expected through this spring, albeit possibly not quite the record-breaking pace of appreciation we saw last year.”

Fleming added that the rising level of inflation will not have a negative impact on homebuyers.

“Recent mortgage application data suggests little decline in the desire for homeownership amongst millennials, even with higher inflation,” he said. “In fact, there has been a rush of demand due to the fear of missing out in recent months, as home buyers move to lock in a low mortgage rate before mortgage rates rise further.”

Fleming also saw no reason to believe the Federal Reserve’s new mania for rate hikes will not impact housing, observing that “federal funds rate hikes don’t directly impact housing. However, raising the Fed funds rate is an indication of tighter monetary policy to cool inflation, which causes longer term rates (bond yields) to adjust. So, mortgage rates respond to investor expectations about the long-term pace of inflation and monetary policy.

“How does the housing market fare?” Fleming added. “Higher rates reduce buying power and reduce demand, but the early indication from already higher rates is that the demand response to less buying power is not particularly strong.”

Tomorrow: Part 2 of this series will look at the multifamily housing market and the challenges facing renters in this volatile environment.

Photo courtesy of StockVault

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