PMC Weekly Review - March 31, 2017

A Macro View: Homing in on the Housing Market

Home prices in the US are continuing to climb, as reported earlier this week by the S&P Corelogic Case-Shiller Home Price Index (“Case-Shiller HPI”). The most-recent data represents the strongest increase in housing costs in nearly four years, as year-over-year prices increased 5.7%, raising the median house price across the U.S. to more than $230,000. What’s behind these numbers? Is it (a) low inventories, (b) changing demographics, (c) labor constraints, or (d) mortgage rates? Trick question. It’s (e) all of the above.

For the purpose of this Weekly Review, let’s separate the aforementioned housing dynamics into supply or demand, and begin with supply. Supply, or home inventory, in the housing market is composed of existing (previously owned) homes for sale, as well as new homes for purchase. The latter is often influenced by lot availability, which has decreased, as has the number of skilled workers, who build the homes. According to Bloomberg, although new homes for sale are at their highest level in eight years, there are still fewer new homes available for sale today than in 2007 (roughly 870,000 now vs 1.2 million in 2007). Historically lower new home inventory, coupled with lot and labor constraints, has pushed up prices for new homes for purchase. Augmenting a lack of total home inventory is the shortage of existing homes for sale. According to the National Association of Realtors, existing home sales declined 3.7% in February (roughly 400,000 now vs 1.0 million in 2007). Overall, home inventory is at its lowest level since 1999, when the National Association of Realtors began tracking the data.

On the other hand, the main determinant of the demand for housing is demographics, but also it can be influenced by cost, availability of credit, income, prices, et al. Currently, demographics and mortgage rates are the main drivers of housing demand. Regarding demographics, many studies have shown that home ownership by millennials (roughly defined as those currently between the ages of 18 and 35) is considered low at 35%, as compared to 41% of baby boomers who owned their homes in 1982 (when they were the same age). Recent data suggests that while millennials had been delaying home ownership, they finally may be ready to purchase their first home, which has stimulated current demand. A Morningstar report quantified these numbers, stating that housing demand should be strongly supported by the “80-million-strong generation of millennials” as they age into their 30s. As said generation looks to purchase their first homes, they will find historically low interest rates, with a current 30-year fixed mortgage rate averaging 4.20%, which pales in comparison to the average mortgage rate of 16% that baby boomers paid in 1982.

In summary, supply is currently low, as existing- and new-home inventory lags, and is exacerbated by a decline in lot and labor availability, whereas demand is increasing, as millennials enter the home ownership market, which is amplified by attractive mortgage rates. Recalling Economics 101 lectures reminds us that, generally speaking, low supply + high demand = higher prices, and that, in turn, helps explain the most recent Case-Shiller HPI data, and is the answer to our pop-quiz.

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