INTRO: When the pandemic began
and stocks plunged, most people likely expected that the housing market was next in line. But,
with the fed lowering interest rates and printing loads of money, we’ve seen the
exact opposite unfold. The median sale price of a house in the US has skyrocketed from $322,000
to $428,000 within a matter of 2 years. This translates to an annual growth rate of 13.2%
which is literally higher than the S&P 500. This is of course unsustainable and it has
caused many to speculate that a housing crash like we’ve never seen is just around the corner.
You just have to make one search on YouTube to see how prevalent this theory really is.
And its popularity isn’t that surprising. The fed is finally starting to raise interest rates and
the housing market is finally starting to show the first signs of a potential slowdown. There
aren’t as many bids on each property and inventory is slowly starting to build up. Not to mention,
the stock market is teetering on bear market territory, so it only makes sense that this
pain extends to real estate right? Well, yes and no. While it is likely that we see a cool down in
real estate of 10-15% across the board and maybe 20-25% in some more heated areas, it’s not likely
that we see a 2008 style 40 to 50% collapse with loads of foreclosures and here’s why.
INFLATIONARY TIMES:
Starting off, the first thing to understnad is that a recession and a stock market crash are
not indicative of a housing market crash. In fact, there’s plenty of recessions during which housing
continued to go up even during a recession, and this is especially true during periods of high
inflation. Likely the best comparison that we have to today’s market environment is the 1970s
when there was also sky high inflation. We saw inflation peak above 10% on multiple occasions,
and it wasn’t till interest rates were raised to over 10% that we finally saw inflation cool
down. On top of this, there were multiple recessions during this time period that lasted for
multiple quarters each. For example, let’s take a look at the recession that took place between 1974
and 1975. During this time period, the S&P 500 got obliterated dropping a full 50%. But what do
you think happened to housing? Given this massive sell off in the stock market, you would atleast
expect a cool down in real estate right? Well, the median sale price actually increased from $34,000
to $39,000. In other words, housing grew by 14.7% while the country experienced a recession and the
S&P 500 dropped by 50%. And this isn’t a one off thing either. This happened on multiple occasions
during this time period. For instance, we saw another recession during the first half of 1980.
This recession was accompanied by a 20% sell off in the stock market,
but housing prices still went up. Similarly, in the 1981 to 1982 recession, the stock market
sold off 25%. This time, the housing market actually had a slight pull back coming in 5.7%,
but nonetheless, housing prices were still higher at the end of the recession than at the
beginning of the recession. As you can see, just because there’s a recession and the stock market
crashes doesn’t mean that the housing market must crash as well. Something else to note is that a
lot of people think that the rate of increase in housing prices are indicative of a housing crash,
but this is not really true either. Throughout the entire decade of the 1970s, we saw abnormally high
growth in real estate prices. When President Nixon dropped the gold standard in 1971,
the median sale price stood at $25,800. 10 years later, the median sale price stood
at $69,400. This means that housing prices grew 168% during these 10 years. That translates to an
annual return of 10.4% for an entire decade. While that might be hard to believe at first glance,
it makes perfect sense when you account for inflation. The average inflation rate
during these 10 years was a whopping 8.42%, so really, real estate only grew about 2% per year
this during time period which is very sustainable. The thing to keep in mind is that real estate is
one of the most trusted and reliable safe havens to protect against inflation. So, it only makes
sense that real estate would at the very least keep pace with inflation regardless of whether
there’s a recession or a stock market crash. So, don’t think that housing prices have to come down
just because they’ve gone up so fast. As long as inflation is high, that scenario remains unlikely.
RISING MORTGAGE RATES:
Another popular argument for a housing market crash is rising interest rates.
People argue that as interest rates go up, people will be able afford less meaning that sellers will
have to decrease prices. While this argument makes sense during normal periods, the thing to consider
is that supply is extraordinarily low. Housing inventory is literally at 40 year lows and the
trend has only been downwards. So, it’s not clear how much rising interest rates will even
affect housing prices. For example, let’s say that 30 year mortgage rates go all the way to
8% from their lows of about 3%. The general rule is that for every 1% increase in mortgage rates,
purchasing power decreases by roughly 10%. So, a 5% increase in mortgage rates would
decrease purchasing power by 50%. Now, that’s quite a decrease, but even if this results in
inventory doubling, we’d only be back to pre pandemic levels. In other words, the decrease in
purchasing power would more or less just wipe out the excess demand. So, while houses may no longer
be selling for crazy amounts above listing, I’m not sure this would drag down the listing prices
themselves all that much. Something else to note is that even with these massive hikes,
interest rates are still super low on a historical basis. And even more importantly, real mortgage
rates are still negative. While a 6% mortgage rate may sound high compared to 12 months ago,
6% is still lower than the 8% inflation that we’ve been seeing. So, from an investment perspective,
taking out a mortgage right now is still rather appealing. And the last thing to
consider regarding mortgage rates is that they’re completely irrelevant to a significant amount of
buyers because they’re buying with cash. Now, this isn’t to say that they don’t keep tabs on
mortgage rates, but in terms of purchasing power, it doesn’t affect them whatsoever. I’m sure these
guys would like for the real estate market to cool off as well so that they can buy lower.
But, most of them aren’t going to wait for a crash because they have excess cash reserves that need
protection from inflation. I mean these 13 companies alone hold a trillion in cash.
Now, Apple is likely not going to go out and pick up single family homes, but banks and financial
institutions will and that’s exactly what they’ve been doing. In q4 of 2021, for example,
almost 20% all US home sales were to institutional investors who were more than likely paying cash.
So, rising mortgage rates probably won’t cause a housing market collapse,
and if you don’t believe me, just take a look at the 1980s. After a decade of high inflation
in the 1970s, the fed decided to jack up interest rates to unprecedented amounts.
This caused 30 year mortgage rates to nearly reach 20%. Given that mortgage rates were at 8.5% just a
few years before this, this means that mortgage rates rose 10%. According to our rule of thumb,
purchasing power should have decreased 100%, and housing prices should have gotten flamed.
But in reality, real estate prices actually ended up rallying 100% over the next decade. So, if an
18% mortgage rate didn’t cause a crash, there’s no gaurantee that a 7 to 8% mortgage rate will.
NO FUNDAMENTAL CRISIS:
Yet another factor that is preventing a housing crash from taking place is that home buyers
are more qualified than ever before. Here’s the thing, for a 2008 style collapse to take place,
there needs to be a fundamental crisis. Secular variations in supply and demand due to mortgage
rates and inflation aren’t going to crash the housing market 40% within 12 months.
For that, you need a fundamental crisis like loads of unqualified buyers or threateningly
low cash reserves across financial instutions. But, we’re not seeing that,
we’re actually seeing the exact opposite. The average homebuyer is more qualified
than ever, and the reason for this is that the average person can no longer afford these homes.
So, it’s primarily just high income families that are buying homes. In Texas, for example,
the median homebuyer has a household income of $112,000. This puts the average homebuyer in
Texas in the 71th percentile in terms of household income. In other words, the majority of homes are
being sold to people who are well off. So, it’s quite unlikely that we’re gonna see a crisis were
people suddenly can’t pay their mortgages. Now, you might be saying that these people may lose
their jobs during a recession which could change their financial position. But, the truth is,
the vast majority of job losses are usually amongst everyday blue collar workers. These white
collar workers are generally some of the last to lose their jobs because of two reasons.
One, these employees are harder to replace so companies are more reluctant to let them go.
And two, most of these guys work at cash rich IT companies that can afford to weather a recession.
Also, even if the company can’t weather the recession, it’s more than likely that the
homebuyer can weather it themselves. The median bank account balance rises exponentially with
income. For example, the median bank account balance in the US is only $5,300. However,
the median bank account balance of someone earning between $90 to $100,000 is $70,000. The median
homebuyer in Texas actually makes even more than this, so it’s likely that they have nearly
$100,000 in savings. The median monthly payment on a new mortgage was $1,931 in February. Even if
we say that it’s $2,500, these median homebuyers could keep up their mortgage for two full years
before running into problems. Also, it’s not just homebuyers who are on top of their finances.
Bank are on top of their finances as well. JP Morgan Chase for example is hold $1.5 trillion in
cash and Bank of America has $895 billion in cash. Clearly, these institutions are more liquid than
ever before meaning that the odds of a fundamental crisis are also lower than ever before.
THE TRUTH ABOUT A HOUSING COLLAPSE:
In the end, there’s no question that housing is becoming increasingly unaffordable for the average
person. But, this doesn’t mean that housing market is going to collapse anytime soon. It appears that
many people are hoping for a massive plummet so that they can finally buy for a reasonable price,
but the truth is that 2008 was a one off thing. I mean, just take a look at the last 60 years
worth of pricing data. There are times were the market goes sideways or cools off 10-15%,
but 2008 was the only time that the housing market actually crashed.
Since then, regulation has tightened significantly and lenders have become extremely cautious.
So, it’s primarily just high income families and cash buyers who are driving the current market.
On top of this, from the 1970s, we’ve seen that real estate can continue skyrocketing despite
recessions, stock market crashes, and interest rate hikes. Now, this isn’t to say that we won’t
see a cool off like we’ve already been seeing. As mortgage rates rise and inventory builds up,
the real estate market will no doubt soften. But, to correlate that to a full on housing
crash is quite a leap in logic. To be honest, the vast majority of articles and videos that are
telling people that there’s gonna be a monumental housing crash are just preying on these people’s
desperateness to afford a house. But, that’s just what I think, and I’m just some random guy on the
internet and I could be completely wrong. Do you guys think there’s going to be a housing collapse?
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