By Sari Zeineddine | Staff Writer
If you scroll through the business news daily, you undoubtedly encounter a bearish sentiment since the debut of the hiking cycle imposed by the Fed. Apparently, the housing market is not escaping the damage of high-interest rates like other asset classes. In the following article, the deviation of housing prices will be discussed, caused mainly by this cheap leverage of interest rates near 0. In addition to the general trend and where the housing sector is heading next with the current economic conditions.
The data is more telling than ever
As published by Bloomberg on 18th November, existing home sales shrunk by 5.9%, while the monthly supply of homes rose from 3.1% to 3.3%, indicating that sales are decreasing while the monthly supply is increasing. Evidently, prices can’t stay at their current levels, and a drop in sales is inevitable, as the data showcased it as the largest since 2008. The data available shows us that the whole housing market is slowing, and it can no longer sustain previous prices with current conditions. For instance, single-family building permits are down 31% from their peak, while multi-family permits are down by 11%, per EPB Research. It’s never counterintuitive to see that single-family building permits are more affected since they are usually provided to the end consumer and are not invested in. In addition to that, the homebuilder sentiment index (NAHB/Wells Fargo Index) plunged in November to a rough level of 33.
Back to the Fundamentals
A report published by DallasFed, the federal reserve bank of Dallas, made it clear how much the housing sector had expanded and how it contributed enough for the latest increase in inflation. A common measure of affordability is the mortgage borrowing cost which is now flirting with the 2008- level (The 30-year fixed mortgage rate is now at around 6.5%). A US homebuyer must earn 107,281$ to afford 2,682$ mortgage payment. A year ago, he should have earned only 73,668$, indicating a 45.6% increase. The price-to-income ratio is at 104.8, close to pre-2008 recession levels. The hiking cycle of the Fed and the bubble in the past 15 years completely demolished the affordability, the demand is subject to unprecedented destruction.
Besides what’s happening to affordability, rental yields are now around 4.1%. This number alone seems quite useless, but when you benchmark it with the real yields on US treasury bonds, which are standing at around 4%, it makes the picture more dangerous. A surprising chart published by FRED, shows that the CAP rate is now below the 6 Months Treasury Yield, which we haven’t seen in years. Risk-free rates are higher than they were before the housing recession of 2008, challenging rental yields and earning yields in general (earning yield of the S&P 500 is just around 5%). The spread between the number of homes in the US completed against those which are under construction is at a record low (deeply negative at -383), per Bloomberg. The sign is that a huge supply of homes will soon hit the market with low affordability levels. So, it’s obvious where we are heading, no?
To sum up, the whole issue is that 15 years of near-zero levels of interest rates fed nothing but asset bubbles and created an intellectual illusion that risks are zero as well, to the extent that pension funds started relying on Bonds-Stocks Correlation. The discount rate near zero approximately meant that everything’s present value looked interesting; bitcoin’s market cap exceeded $300 billion in 2021, way above Costco’s $250 billion market cap at the end of 2021. Risks were hardly priced in decision-making processes in investments, which helps understand the reason behind the huge size of the hedge fund industry in the US (around 1.2 trillion dollars in assets). As Professor Nasim Taleb once noted, “experience in finance with a discount rate near zero is like having studied physics except without gravity”, and now we are back to normal: A world with interest rates above zero, a level of uncertainty and risk that decision-makers should factor in, and with assets getting back to their intrinsic value. However, that doesn’t mean it won’t cause pain. It’s just the beginning for the market.