Federal Reserve Makes Large Policy Changes

The housing market is running hot! Driven by high demand, record-low interest rates and monthly federal reserve asset purchases ($120 Billion)… Yet no one seems to be worried about a housing bubble? In today’s newsletter, we critically assess the state of the current housing market. 
 
Current State of the Housing Market 

Housing prices are surging to new records with no end in sight. They are being fueled by millennials who seek housing for the first time at historically low interest rates and an unprecedented amount of quantitative easing. It is believed by economists and investors that the housing market has a unique ability to support these runaway prices.
 
These dramatic price increases eerily mirror the U.S. housing bubble that inflated from 2004 through early 2007, before prices crashed, wreaking havoc on the U.S. economy and the global financial system. The fallout from the crisis led to the Great Recession, the biggest setback that the U.S. economy has suffered since the Great Depression and it produced massive, prolonged unemployment along with the greatest destruction of household wealth in the nation's history.
 
Interestingly, most economists and investors are not focused on the state of the U.S. housing market right now. Their attention is on other factors burdening the economy, such as a labor shortage, decades-high inflation, supply chain disruptions, and of course, the ongoing pandemic, which has been, at least partly, the cause of all these problems.
 
The reason for this lack of focus is that prominent economists and investors do not believe that the current run-up in housing prices represents a bubble that could potentially burst and take the economy down with it.
 
As a cautionary tale though, practically no one was worried about the housing bubble in 2007 either.

Few Saw the Bubble Last time
 
The most prominent person who missed the housing bubble of 2007 was former Federal Reserve Chairman Alan Greenspan who famously insisted in 2005 that there was no bubble. Instead, he thought that America had a large number of smaller bubbles in some housing markets scattered around the country.
 
He was not alone in his assessment. Credit-rating agencies gave top scores on mortgage-backed securities (assets backed by the payments due on home loans with questionable underwriting rules).
 
At the time, economists and investors widely believed that these dubious lending practices would be covered by rising home values, effectively allowing borrowers to sell the homes at a profit and pay off the loan if they couldn't afford the payments. Wall Street, international firms and banks rushed to buy these securities.
 
Moreover, a building boom in the early 2000’s helped to feed swelling home inventories and high vacancy rates. Still, many believed the rising pace of homeownership meant that there was a nearly endless supply of buyers who would be able and willing to pay, despite surging home prices.
 
But, of course, the price increases came to an end. By June 2006 home prices started to decline, first slowly and then rapidly, losing 28% of their value before bottoming out in February 2012, according to the S&P Case-Shiller national home price index (Case Shiller). See chart “S&P Case-Shiller National Home Price Index (2004 – 2012)” for details.

Today Housing Prices Are Rising Faster Than During the Last Bubble
 
The previous record for rising home prices was a 14.5% year-over-year gain in September of 2005, according to Case-Shiller. The U.S. housing market blew past that mark in April of this year, with a new record set every month since. Year-over-year price increases now stand at 19.8%. Further, the median price of existing homes now stands at $352,800, according to the National Association of Realtors.
 
Home values stand at 45% more than the peak of the last bubble in mid-2006 and have doubled (+100%) since the last trough in early 2012. See chart “S&P Case-Shiller National Home Price Index (2012 – 2021)” for details.

Moreover, in just about every measure, housing affordability has plunged, even as record-low mortgage rates have kept home payments in check. And yet economists forecast even more price increases ahead. Zillow projects that national home price increases will slow, but not decline. Follow this link to Zillow for details https://www.zillow.com/home-values/.  Zillow predicts a 13.6% growth from September 2021 through September of 2022, a slightly faster pace of increase than its previous forecast. Also, Goldman Sachs forecast earlier this month that prices would rise another 16% by the end of 2022.
 
Overall, the consensus among economists and investors is that the U.S. housing market will continue this upward trend and remain stable throughout the next year. Have buyers and investors learned their lesson? Perhaps.
 
Factors Supporting Further Growth
 
Structural forces will continue to create positive tailwinds for the U.S. housing market. The millennial generation that has come into its own is now starting to participate in the first-time home buying market, suggesting pent-up demand for new housing formation. This is supported by the active house listing count, which dropped from 1.6M listings in January 2016 to just over 600K in September 2021. Demand is very high and outpacing supply. See chart “Housing Inventory: Active Listing Count (2016 – 2021)” for details.

The primary argument in favor of stability in the housing market, for the foreseeable future, is the combination of strong demand by millennials and the largely unavailable supply owned by boomers (around 60% of all housing stock is owned by the boomer generation). This should restrict the supply of homes for sale in the immediate future. 
 
Historically low mortgages rates have been fueling affordability in the housing market and therefore driving up prices with it. The rate on a 30-year fixed mortgage has been on a steady decline for the past two decades. At the turn of the century, the rate was 8.1%. In 2010, it declined to 4.7%, and in 2020 it declined to 3.1%, a record low. The year-to-date average for 2021 is currently 2.9% and it is likely that the annual average will remain below 3.0%, setting another record low. See chart “30-Year Fixed-Rate Mortgages (2000 – 2021)” for details.

Conclusion

The Federal Open Market Committee (FOMC) announced yesterday (November 4th) that it will start to cut back the current $120 billion per month asset purchase by $15 billion each month, starting in November and completely stopping the purchases by June of 2022.

As the fed continues to closely monitor inflation, they will have the hard job of walking this tight rope. Their actions will directly impact housing prices and the economy as a whole. Housing markets across the country that have seen the most significant appreciation, while market rental rate increases have not kept pace, have the highest risk for declining prices.

This price to rent ratio is a key factor for minimizing risk and maximizing returns in this current economic climate. It is the primary metric Safeguard uses before approving a loan. We like to see double (even triple!) the amount of rent coming in compared to the monthly loan payment being paid to our clients.  

If you currently own multiple rental properties, it may be time to diversify into first trust deed lending. 

The team at Safeguard is always happy to have a discussion regarding your existing real estate Investment activity and our first trust deed lending alternatives.