Should I Buy A House in Today’s Market?
There is a lot of bad news right now. Interest rates have risen. Inflation has reached 40-year highs. There is a war in Ukraine and record high gas prices. The Nasdaq, the S&P 500, and Bitcoin have fallen as much as 30%, 20%, and 70%, respectively, from their 2021 highs.
The 2008 housing crash left millions of consumers underwater on their homes, or worse, left them unable to pay their mortgages once their loans adjusted from their teaser rates.
Given current macroeconomic factors, many fear a similar housing price crash is imminent. I do not agree with this assessment and explain why below.
I am not a real estate investor, and this blog does not express the views of Alpine nor does it constitute investing advice. But recently, when we looked at investing in a company that had exposure to the residential housing market, I decided to dig in to try to learn more about the current state of the real estate market. In the past month, several people asked me, “Is now a good time to buy a house?” So I decided to share my research here.
What I found
Housing prices are determined by a complex set of factors: Interest rates, consumer sentiment, rental prices/inflation, terms of mortgages, housing supply, and housing inventory.
In 2008, nearly all of these factors pointed in the same negative direction, causing a historic nationwide crash in home prices. Today, however, the impact of these same factors is mixed. Two of the factors seem to point to a decline in housing prices and four factors seem to point to stable or increasing housing prices.
Factors pointing to a decline in home prices:
Higher interest rates: The 30-year fixed rate mortgage has doubled from a low of 2.7% to 5.5%. With the same monthly mortgage payment, at the higher rate a consumer could afford to purchase a home 25% less valuable than previously, creating downward pressure on home prices.
Historically low consumer sentiment: Consumer sentiment fell from 100 just prior to the COVID-19 pandemic to 50 in July 2022, which is the lowest reading on record since the University of Michigan began collecting data in 1978. While important, this factor can also change very quickly and is relatively volatile.
Factors pointing to stable or increasing home prices:
Shortage in housing supply: In the 13 years leading up to the 2008 housing crash, we significantly overbuilt homes relative to demand. However, in the 14 years since 2008, we have significantly underbuilt homes. According to Realtor.com, we now have a cumulative housing shortage of 5.8 million homes. Additionally, the gap between permits and completed housing is near historically high levels, indicating it is taking longer to build homes and also indicating this gap is not likely to close anytime soon.
Lack of housing inventory: In July 2016, there were 1.6 million housing units listed nationwide. But by February 2022, housing inventory was recorded at just 376,000 units, close to the lowest recorded inventory on record. While this factor is critical in determining home prices, the number of homes for sale at any time can change more quickly than overall housing supply.
High rental prices: Renting is a substitute for owning a home. Nationwide, median rents have risen from $1,600 to $2,016 over the past three years, and in many markets rents have risen over 30%, making renting a home a less attractive option than previously.
Low mortgage defaults: In the 13 years since the housing crash, banks have significantly tightened lending standards. In addition to stricter income verification, today only 4.35% of homes have adjustable-rate mortgages. These factors together reduce the chances of a large wave of defaults in the near future.
In the appendix below, I review each of the above factors and their impact on housing prices in today’s market.
Real estate is a regional market. The statistics above on each of these factors is for the nationwide housing market, but each of the factors differ by market. For example, in Naples Florida, there were recently 555 homes for sale per 10,000 homes, while in Modesto, California, there were only 53 homes for sale per 10,000 homes, according to Inspection Support Network. And rental prices for a one-bedroom apartment have increased much faster in New York City than in Columbus, Ohio, over the past year. If you’re curious, the price of a one-bedroom apartment increased 36% year over year in New York City (from $2,900 to $3,950) and 26% in Columbus (from $950 to $1,199), according to Zumper.com.
So back to the question, “Should I buy a house in today’s market?” Here are a few thoughts:
A nationwide crash is likely not imminent, and values will vary by location
Given the shortage of housing supply, increase in rents, and unlikely chances of high mortgage defaults, I do not believe that there will be a nationwide crash in home prices like in 2008. I believe the housing market will be more nuanced and that each region will behave differently based on its own market characteristics. Specifically, rental prices, housing supply, and housing inventory will vary significantly by market. There is not a single website which lists these factors for every market, but with a few Google clicks, you can find each of these variables for your specific market. They are typically listed by a local real estate agent. Do your homework and make sure you understand the market in which you are considering purchasing. Buying a home is not a decision you should rush.
Buy a house you love versus trying to time the market
We purchased our home in Marin County, California, in August 2008. This turned out to be less than ideal timing given Lehman Brothers declared bankruptcy one month later, setting off the Great Recession. Several years after we bought the house, I am sure we would have lost money if we had sold it, but because we were planning to live there for a long time, we didn’t need to worry about short-term fluctuations in value. Over a long enough period of time, owning a home is likely to be a reasonable investment decision, but even more importantly, you’ll get to enjoy living in a home you love.
While housing is typically one of the largest investments for individuals, it is not merely a financial decision. It is also an emotional purchase. Most people are better served not trying to time the exact bottom of the market, but instead considering where they want to live and how long they can see themselves there. If you know you’re going to be living in a place for a while (five years or more), and you fall in love with a house that makes you happy, then it may make sense to purchase it. Even if your local market prices fall for a few years and you didn’t buy right at the bottom, you’ll get tremendous joy and utility from the house and more likely than not, your home will appreciate over a long period of time.
In the appendix, I’ve shared many of the factors I consider important inputs in home prices, and if you’re serious about buying a home, make sure you understand how these factors impact your specific market.
Good luck!
Graham
Appendix: A look at factors determining home prices
I examined several factors that are likely to impact home prices in the U.S. Those factors include:
Interest rates
Consumer sentiment
Rental prices
Housing supply
Mortgage defaults
Housing inventory
Interest Rates
Perhaps the single largest negative factor impacting housing is the increase in interest rates. Roughly 65% of home buyers take out a mortgage when purchasing a home, and interest rates determine the monthly payment these buyers will need to make on their mortgage. The effective federal funds rate has risen from 0.07% in April 2021 to a most recent reading of 1.58% in July 2022. As a result, the 30-year fixed mortgage rate has also risen from 2.67% to 5.54% over the same period. In 2021 the median U.S. home sold for $385,312.
In June 2021, with a 20% down payment, a consumer would pay $1,283 per month to purchase the median home.
In June 2022, if that same consumer made the same down payment and monthly payment, they would only be able to purchase a home of $288,875 (a 25% decrease). The previous median price of $385,312, would require a monthly payment of $1,712 (a 33% increase).
Net impact of higher interest rates on home prices: Negative
Chart pulled from Harvard University’s Joint Center for Housing Studies, “The State of the Nation’s Housing, 2022” (https://www.jchs.harvard.edu/state-nations-housing-2022).
30-Year Fixed Rate Mortgage Average in the United States. Source: Freddie Mac (https://data.sca.isr.umich.edu/data-archive/mine.php)
Consumer sentiment
Consumer sentiment can impact the demand for housing. When consumers are fearful or when they feel negative about the state of the economy, they avoid making large investments like buying a home. They may think house prices will fall, be nervous about keeping their jobs, or just want to wait on the sidelines. Consumer sentiment fell from 100 just prior to the COVID-19 pandemic to 50 in July 2022, which is the lowest reading on record since the University of Michigan began collecting data in 1978.
Net impact of low consumer sentiment on home prices: Negative
Rental prices
For many considering purchasing a home, their alternative is to rent. Nationwide, median rents have risen from $1,600 to $2,016 over the past three years (though as indicated above, rents vary significantly by market). Rental prices are driven by many factors, but one of them is inflation, which recently reached 9.1%, a 40-year high. Given inflation and low unemployment nationwide, rents are likely to remain stable or keep rising nationwide. Because owning a home is a substitute for renting a home, and because home buyers can choose to rent out their homes, higher rents have an upward impact on housing prices.
Net impact of rising rents on home prices: Positive
Redfin’s analysis of rents over the past three years.
Housing supply
The supply of homes speaks to the number of homes in the market. While demand can change quickly, supply can take years to correct in either direction. For this reason, I generally believe that the factors impacting supply have a larger impact on home prices than the factors impacting demand.
Number of single family homes relative to household formation:
In the 13 years leading up to the 2008 housing crash, we significantly overbuilt homes relative to demand. In the four years prior to the housing crash, we built nearly twice as many homes as we needed. However, in the 13 years since 2008, we have significantly underbuilt homes.
Ratio of housing units to new households formed. Source: Madison Hoff/Business Insider, First American Financial Corporation: https://www.businessinsider.com/us-underbuilding-housing-over-the-past-decade-2020-9
According to realtor.com, we now have a cumulative shortage of nearly 5.8 million homes nationwide.
So even if we were to overbuild by one million homes a year, it would take six years to reach equilibrium.
Net impact of housing inventory shortage on home prices: Positive
Mortgage defaults
Mortgage defaults played a large part in the 2008 housing crash. Leading up to the 2008 crash, banks were relaxed in their lending standards. They made millions of loans without income verification, and nearly 45% of all mortgages were adjustable-rate mortgages. When the teaser rates adjusted to the higher, longer-term rates, millions of consumers could no longer afford their mortgages. As banks foreclosed and tried to shed these homes, a significant supply of homes was added to the market. The share of subprime mortgages that were seriously delinquent increased from about 5.6 percent in mid-2005 to over 21 percent in July 2008.
In the 13 years since the housing crash, banks have significantly tightened lending standards. In addition to stricter income verification, today only 4.35% of homes have adjustable-rate mortgages. These factors together reduce the chances of a large wave of defaults in the near future.
Net impact of tight historical underwriting on home prices: Positive
Inventory of homes on the market
The final factor impacting home prices is the number of homes for sale at any given time. The higher the inventory of homes on the market, the more likely there will be a downward pressure on home prices, and similarly low inventory will create upward pressure on home prices. In July 2016, housing inventory was 1.6 million housing units. But by February 2022, housing inventory was recorded at just 376K units.
While inventory has a significant impact on home prices, inventory can also change much more quickly than the total supply of homes, so this factor is shorter term in nature.
Housing Inventory: Active Listing Count in the United States. Source: U.S. Census Bureau Housing Inventory Estimate, from FRED (https://fred.stlouisfed.org/series/ETOTALUSQ176N)
Net impact of low inventory on home prices: Positive
Summary
Housing is a regional market and there are certainly areas in the U.S. in which housing prices have become overheated or in which building has outpaced demand; it is likely there will be select markets where housing prices cool. But I believe that nationwide, the overall lack of supply, increasing rents, and historically tight underwriting by banks over the past cycle will offset the short-term dampening of demand and will serve to keep housing prices from collapsing nationwide like they did in 2008. Many of the factors above—like rental prices and housing inventory—vary significantly for each individual market. Consider these factors in your specific market to understand their impact on housing prices.
Owning a home is not purely a financial decision. If you plan to live in your home for a long time, you will be less subjected to short-term changes in housing prices. Ultimately, owning a home can have utility beyond the financial impact.
Sources
FRED, Economic Data
Fed Funds: https://fred.stlouisfed.org/series/FEDFUNDS
4.5% of ARM in 2022: https://fred.stlouisfed.org/series/MORTGAGE5US
U.S. Total Inventory: https://fred.stlouisfed.org/series/ETOTALUSQ176N
Monthly Supply: https://fred.stlouisfed.org/series/MSACSR
Subprime ARMs: Popular Loans, Poor Performance. Federal Reserve Bank of St. Louis (2007): https://www.stlouisfed.org/publications/bridges/spring-2007/subprime-arms-popular-loans-poor-performance#figure1
Redfin News
Rents, May 2022: https://www.redfin.com/news/redfin-rental-report-may-2022/
Rents, June 2022: https://www.redfin.com/news/redfin-rental-report-june-2022/
The State of the Nation’s Housing 2022 (Joint Center for Housing Studies of Harvard University) Chart: https://www.jchs.harvard.edu/sites/default/files/reports/files/Harvard_JCHS_State_Nations_Housing_2022.pdf
The Rise in Mortgage Defaults, Finance and Economics Discussion Series Divisions of Research & Statistics and Monetary Affairs Federal Reserve Board, Washington, D.C. (Columbia University 2008): https://www.federalreserve.gov/pubs/feds/2008/200859/200859pap.pdf
Consumer Prices Jump Sharply Again in June. The Consumer Price Index Report, as published in The New York Times (2022): https://www.nytimes.com/live/2022/07/13/business/cpi-report-inflation
Average rent prices as analyzed in major cities, Zumper.com: https://www.zumper.com/rent-research/new-york-ny