Is another housing bust coming?


Gargi Pal Chaudhuri Aug 30, 2022

KEY TAKEAWAYS

KEY TAKEAWAYS

  • Home prices will slow from the double-digit gains of recent years, but a housing “crisis” is highly unlikely.
  • U.S. banks are much better positioned today for a housing slowdown vs. the period prior to the Global Financial Crisis.
  • U.S. demographics support strong household formation and the inventory of homes for sale is at a record low.
  • Housing’s influence should keep upward pressure on inflation data, supporting our preference for shorter-dated inflation-linked bonds.

HOUSING: WHERE ARE WE NOW?

HOUSING: WHERE ARE WE NOW?

Mortgage rates jumped this year — with the average 30-year fixed rate rising to over 6% vs. under 3% a year ago1 — while consumer confidence fell to its lowest level in over a decade2, putting the U.S. housing market in the crosshairs. Is America facing another housing bust?

Indeed, many measures of real estate activity have softened after a remarkable run, including pending and new home sales (both down 8% from prepandemic levels). Existing home sales have fallen for six consecutive months and are down 20% on a year-over-year basis.3

In addition, mortgage refinancing activity is down 82% vs. a year ago and applications to buy a home are 19% lower.4

Yet home prices remain high, with the latest data showing median home prices climbed approximately 11% vs. a year ago to a record $404,000.5

Home prices keep rising as sales fall: something’s gotta give

Line chart showing that even while home prices keep rising, other measures of housing activity – like home sales – have fallen sharply from their pandemic-era peaks.

Source: National Association of Realtors as of June 30, 2022.

Chart description: Line chart showing that even while home prices keep rising, other measures of housing activity — like home sales — have fallen sharply from their pandemic-era peaks. This will likely lead to a slowdown in home prices, but not necessarily another crash.


ARE WE IN ANOTHER HOUSING BUBBLE THAT MAY BURST?

ARE WE IN ANOTHER HOUSING BUBBLE THAT MAY BURST?

Given the growing disconnect between prices and other measures of housing activity, some worry we’re heading for a repeat of the Global Financial Crisis (GFC), which followed the bursting of the housing bubble circa 2003-2007.

We believe a slowdown in both appreciating home prices and sales volumes is likely to continue given the rise in mortgage rates and decline in home builder sentiment, which has fallen for eight straight months to its lowest level since May 2020.6 

However, there are major differences between the housing market today vs. 2008. Some highlights:

  • 68% of new mortgages went to borrowers with credit scores over 760 in the first quarter of 2022 vs. only around 25% pre-GFC.7
  • Just 2% of newly originated mortgages were subprime in the first quarter vs. an average of 12% between 2003-2007.8
  • The share of mortgage payments over 90 days past due is at 0.5%, a historic low.9
  • Adjustable-rate mortgages are less than 10% of total mortgages now vs. 50% in the 2005-2007 period.10
  • Subprime mortgage originations (FICO scores < 620) are now running at about $20 billion per quarter vs. close to $100 billion per quarter before the GFC.11
  • Household debt service payments as a share of disposable personal income was just 9.5% in Q1 2022 vs. over 13% before the GFC.12

Critically, the U.S. banking system is also far-less vulnerable to a downturn in residential real estate compared to the prior era.

U.S. banks are much better capitalized today vs. 2008, thanks in part to legislation that emerged in the wake of the Global Financial Crisis. The common equity tier 1 capital ratio for American banks — a key measure of the financial sector’s ability to withstand large losses — is now 12.6%, up from less-than 7% before the crisis, according to the 2022 Federal Reserve Stress Test Results.13

In addition, banks’ direct exposure to residential real estate has shrunk steadily to 21% now vs. the low 30% range pre-crisis. (Mortgage-backed securities held on banks’ balance sheets are often nonconforming loans, meaning they don’t qualify for inclusion in MBS backed by Fannie Mae and Freddie Mac because of size, credit quality or terms.)

Commercial bank direct residential mortgage exposure
(as % of total assets)

Line chart showing how U.S. bank holdings of mortgage-backed securities have fallen sharply since the financial crisis.

Source: Federal Reserve as of June 30, 2022.

Chart description: Line chart showing how U.S. bank holdings of mortgage-backed securities have fallen sharply since the financial crisis, meaning they are less vulnerable to a housing slowdown. Source: Federal Reserve as of June 30, 2022.


HOUSING WILL KEEP INFLATION ELEVATED: HOW CAN INVESTORS CAN NAVIGATE IT?

HOUSING WILL KEEP INFLATION ELEVATED: HOW CAN INVESTORS CAN NAVIGATE IT?

Our view is home prices will slow from the double-digit gains we have seen but will certainly not crater like we saw in 2008. We believe a slowdown would make home buying more affordable to the growing demographic that has historically been a key driver of housing formation; the approximately four million people becoming 30 years old from 2021-2026, which is 18% higher than the 1998-2005 period.14 That age group has historically been critical to new housing construction and coincides with record-low levels of existing home inventory for sale. (At current levels it would take 2.6 months to sell all homes on the market.)15

While we believe the risk of a housing-induced crisis is very low, our iShares Midyear 2022 Investor Guide outlook predicts a rising likelihood of recession amid sustained inflationary pressures. Housing and especially rental inflation will continue to be a driver of elevated inflation readings as total shelter inflation comprises 42% of core CPI inflation. Affordability at all-time lows means rental markets will remain lofty for some time. We believe fixed-income investors can hedge for this with shorter-dated inflation-linked bonds.

Equity investors, meanwhile, could consider staying invested but play for lower volatility through minimum volatility strategies. And as a potential hedge against inflation and further weakness in housing, investors can also consider broad U.S. real estate ETFs, which aim to offer diversified exposure to the sector beyond just the residential market.

Gargi Pal Chaudhuri

Gargi Pal Chaudhuri

Head of iShares Investment Strategy Americas at BlackRock

David Jones

Investment Strategist

Contributor

Aaron Task

Content Specialist

Contributor

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