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By New_Deal_democrat August 29, 2017 12:02 pm
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A tale of two housing slowdowns
Last year after interest rates spiked in the wake of the Presidential election, I forecast a slowdown in the housing market, which duly arrived beginning this spring.

We had a similar slowdown in early 2014 after the "taper tantrum:"

That resolved positively. Should we expect the same this time? What's the same and what's different?

To recapitulate the order in which housing metrics typically react:

  • first, interest rates turn
  • second, sales turn
  • third, prices turn
  • last, inventory turns

It's true that prices that are too high, or bargains, will affect sales. But it is the turn in sales that give buyers and sellers the "signal" to raise or lower their price expectations. This is turn causes sellers to add or remove inventory from the market, if they think it is a "good" or "poor" time to sell.

Let's start by comparing the first 12 months after the beginning of the "taper tantrum" with the last 12 months, only 9 of which are after the latest interest rate spike.  Below are YoY quarterly averages of the volatile starts (blue) and new home sales (green) vs. monthly less volatile single family permits (red):

The 2014 data broadly traces a flattening through midyear, but not a meaningful downturn, in new housing. This year the YoY comparisons, except for starts, have not even turned flat (yet), but then again, in 2014 the maximum YoY effect was 12 months after the spike.

This year, as in 2014, housing demand is helped out by demographics, in the form of the large number of Millennials reaching prime age to purchase houses.

One important difference is the affordability of houses. Here is the National Association of Realtors' "housing affordability index:"

This is calculated by taking the median monthly mortgage payment, determined by the median price of houses times the prevailing mortgage rate, divided by median household income. As you can see, while housing isn't as unaffordable as it was at the time of the peak of the housing bubble, it has deteriorated in the last several years.

One thing I did want to decompose is household income, since the last "official" measure only goes through 2015.  But Sentier Research's data is up to date through June:

This is up only about 8% from its 2015 average of a little over $55,000.

Meanwhile house prices by several measures are up about 15%:

House price increases slowed down a little during the 2014 sales slowdown. They saem to be slowing down more now.

Another difference with 2014 is the second half of that year also saw the beginning of the big decline in gas prices that boosted disposable income, unlike this year, when gas prices YoY have generally been higher:

At best, I would expect gas prices to go sideways from here.

A wild card is whether we finally start to see a decline in rents. In 2014, rising rents meant the "substitute good" of apartments and condos were getting more expensive also.  With the vacancy rate now rising slowly, rent increases might ease or stop. If so, single family housing will become a less worthwhile competitor.

My best guess for now is that, after November, when the YoY interest rate comparisons improve, housing will improve as well, but because of decreased affordability, it will be a much more muted rise. If other factors intervene, it could still be the case that we have seen the peak for housing in this economic cycle.

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