The Bifurcated Housing Narrative

The residential housing market continues to face limited inventory, low affordability and high mortgage rates, but the worst may have passed.

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Michelle Weaver: Welcome to Thoughts on the Market. I'm Michelle Weaver from the Morgan Stanley U.S. Equity Strategy Team. 

Jim Egan: And I'm Jim Egan, Co-Head of U.S. Securities Products Research. 

Michelle Weaver: On this special episode of the podcast, we'll discuss the state of the housing market. It's Monday, August 7th at 10 a.m. in New York. 

Michelle Weaver: We recently did a deep dive into the global housing market and found that cyclical housing headwinds are significant but approaching a peak globally. And there are a few important things to keep in mind when thinking about this housing cycle. First is that higher interest rates and high home prices have kept affordability low. Second, housing is undersupplied in most economies. And third, there is a big gap between new and existing mortgages. Jim, can you start by talking us through how the structure of U.S. mortgages are different from what's common in other parts of the world? 

Jim Egan: Absolutely. So the structure of various mortgage markets has important implications for the pass through of monetary policy changes. And average mortgage terms vary significantly across the globe, from roughly 70% adjustable rate in Australia on one end to nearly all 30 year fixed rate mortgages here in the United States. Though we would say the duration has generally lengthened post the great financial crisis for most economies. Longer duration mortgages lower the sensitivity of housing markets to the policy rate, both in terms of timing and cyclicality. But for the U.S., that 30 year fixed rate, fully amortizing mortgage that's freely repayable at any point in time with no penalty to the borrower, that's a unique feature for our mortgage market. And it's something that's made possible by the fact that roughly 2/3 of that $13 trillion mortgage market is guaranteed by the U.S. government. And that in turn contributes to the sizable and relatively liquid securitization market, which effectively democratizes the risk across a much broader range of investors than just the lenders themselves. 

Michelle Weaver: And how have high mortgage rates impacted home sales in the U.S.? If someone's looking to buy a home, are they able to even find listings? 

Jim Egan: I think that's an important question, and that's really contributed to our bifurcated housing narrative that we've discussed on this podcast in the past. Mortgage rates go up, affordability deteriorates, but not for current homeowners. They become very locked in at that lower rate and disincentivized to really list their home for sale, and that's why we've seen existing listings fall to 40 year lows. We say 40 year lows because that's just as far back as the data goes, this is the lowest we've seen that. If they're not listing their homes for sale, that means that they're also not buying homes on the follow, and that really brings sales volumes down. That's why in the cycle, existing home sales have fallen twice as fast as they did during the great financial crisis, despite the fact that home prices have remained incredibly protected at near those peaks. Now, let me turn it to you, Michelle. You cover U.S. equities and the housing market has many different links to the equity market. When someone buys a new home, they make a lot of associative purchases, like buying new furniture or making improvements around the house. How have home improvement companies fared? 

Michelle Weaver: Sure, so a lot of people made improvements to their houses during COVID to make staying indoors a little bit more comfortable. And post-COVID demand reversion has been a really important driver for the past few years. If you make home improvements one year, you're not going to need to make them again for, you know, several years. And so we think that the reversion of COVID driven overconsumption is largely complete now. Housing prices and housing turnover, these fundamental metrics governing the housing market are likely to resume being the core drivers for the home improvement space from here. 

Jim Egan: Now, banks also have a relationship with the housing market through mortgage lending. What've these higher mortgage rates meant for banks? 

Michelle Weaver: Interest rates are very high and consequently mortgage rates are also very high. And this has put a damper on demand for new mortgages at banks. There's also a large gap between existing mortgage rates and new mortgage rates, like we were discussing earlier. And in the U.S., homeowners refinanced and masked during COVID when mortgage rates were extremely, extremely low and locked in these rates. Now, less than 1% of American mortgages would be considered in the money to refinance or essentially make sense to refinance. So mortgage originations are expected to continue to stay very low. And this means that banks won't be getting this source of revenue from mortgages. 

Jim Egan: Now, that all makes sense on the homeownership side, the mortgage side, but let's think about the reciprocal here a little bit, the rental space. How have high mortgage rates and the lack of supply that we're describing impacted the rental market? 

Michelle Weaver: Definitely, high home prices and lack of availability have made it really tough for first time homebuyers. So people that are on the margin between buying their first house or staying in a rental have had to remain renters. And this has increased rents and been a big tailwind for rentership rates that are the owners of these rental properties. Jim, what do you think is going to happen with affordability in the United States, it's been very poor, are you expecting that to improve and what's going to go on with home prices? 

Jim Egan: Sure. So affordability remains very challenged, but it's not getting worse. On the margin that's probably going to improve a little bit from here, but remain challenged. Supply remains incredibly tight, but it's not getting tighter. We think that we're in a range bound environment here now, Case-Shiller just turned negative on a year-over-year basis for the first time since 2012. And while we expect that to persist for another couple of months, we expect home prices to basically be unchanged from these levels over the coming year. 

Michelle Weaver: Jim, thank you for taking the time to talk. 

Jim Egan: Great speaking with you, Michelle. 

Michelle Weaver: And thanks for listening. If you enjoy Thoughts on the Market, please leave us a review on Apple Podcasts, and share the podcast with a friend or colleague today.