US housing supply deficit pushed housing prices to record highs at a rapid pace, affecting affordability especially of first-time home buyers. This in turn has slowed down sales activity with new home sales down to a year low in May. This, however, does not imply a crash in prices. Despite some risks, prices should settle at levels higher than during the pre-pandemic period for some time to come.
Housing has been a key source of strength during the post-pandemic recovery phase. As early as May 2020, we highlighted the jump in mortgage applications as an initial sign of a V-shaped recovery in the United States (US). Soaring demand subsequently prompted a substantial supply response so much so that residential investment made nearly as large a contribution to GDP growth in Q4 2020 as household consumption!
Yet, despite the notable acceleration in housing starts, the supply deficit worsened. Consequently, US house prices are not only at record highs, but they have also been rising at a near record pace (Figure 1). In May 2021, the median price of an existing single family home was 24.4% higher than a year ago. Compare that with previous peaks of 16.9% YoY in October 2005 and 17.2% YoY in 1979!
Figure 1: US Housing Faces a Growing Affordability Problem
We believe that deteriorating affordability will slow – but not doom – the US housing boom. Affordability has undeniably deteriorated over the past year. Price appreciation appears most intense at the lower end of the market, as evidenced by the record high ratio of the median to the average house price. This is a particular disadvantage for first time home buyers, an increasing number of whom are being priced out and forced to delay purchases.
We have seen a notable slowdown in sales activity in the past couple of months, with new home sales down to a year low in May. The message seems to be clear: the recent pace of price appreciation is not sustainable. Indeed, some price moderation could be on the horizon, especially in the new house segment, as input costs normalize somewhat from recent spikes. For instance, although lumber prices more than doubled from the start of the year to mid-May, they have since retreated by about 45% (Figure 2).
Figure 2: Lumber Plunges From Record Highs But Still Pricey
This, however, does not imply a crash. Demand for housing remains impressively strong. According to the National Association of Realtors (NAR), existing homes stayed on the market for a mere 17 days in April and May (record lows and down from 26 days in May 2020) and nine out of ten homes sell in under 30 days. The COVID-19 crisis and ensuing work from home arrangements appear to have had a two-fold positive impact on housing demand: an enhanced preference for home ownership and surging demand for vacation homes.
The NAR recently reported that during the first four months of 2021, vacation homes accounted for 6.7% of all existing home sales, up from 5.5% in 2020 and 5.0% in 2019. These trends, in conjunction with the housing construction deficit of the post- global financial crisis (GFC) period, will likely support housing activity in the coming quarters. Moreover, the credit quality of current buyers is strong, offering a far more reassuring picture than in the years preceding the GFC (Figure 3).
Figure 3: Borrowers With High Credit Scores Drive Mortgage Originations
We suspect we are past the explosive growth phase of the post-pandemic housing cycle and are shifting into a slower but still robust period. In our view, these supply constraints and high prices will not kill demand as much as impose a degree of self-regulating discipline on the market. Demand would just get pushed out into the future to allow supply to catch up. At the same time, solid pent-up demand for housing should put a floor under prices, preventing outright reversals.
Admittedly, risks to prices may increase down the line when the US Fed begins to normalize interest rates and mortgage rates rise as a result. Albeit this possible decline from their peak, housing prices should settle at levels higher than during the pre-pandemic period.
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