Can The Housing Recovery Continue?

The real estate sector has been one of the strongest pillars of the economic recovery. Low interest rates and major intervention from policymakers gave home buyers added incentives to purchase a home and sellers have benefited from rising prices and low housing inventories. Home sales have increased a cumulative 20 percent over the last two years and median home prices are up an average of 18 percent nationwide, according to recent data by the National Association of Realtors (NAR). 

However, there are some signs that the housing recovery may be faltering. Some analysts think that the sector has some significant headwinds in the form of weak jobs growth and rising interest rates. On the other hand, the pressure of low inventory and motivated home buyers may keep the pedal to the metal.  While there’s no way to predict the future of housing with any accuracy, let’s dig a little deeper into the economic data and discuss why some economists think that the housing market still has some steam.

PROS:

HOUSES ARE STILL AFFORDABLE

While rising prices may be pushing lower-income home buyers out of expensive urban real estate markets, housing affordability remains high in most of the rest of the country. In the second quarter, 69 percent of new and existing homes sold were considered affordable by families earning the U.S. median income of $64,000.  Moreover, there’s still plenty of room to go as housing affordability is still well below historic levels. Investor speculation and institutional sales have accounted for a significant portion of price increases in urban markets.  This trend is starting to fade away as prices rise (making it more difficult for investors to flip and profit,) meaning that primary home buyers now have greater opportunities and many Americans can still afford to purchase a house in many markets.

HOUSING INVENTORY STILL HISTORICALLY LOW

Inventories of homes for sale have been slow to bounce back since the recession, despite rising prices and buyer demand. Tight inventory means that many motivated buyers are being shut out, keeping demand up. According to the Federal Reserve, one of the major factors depressing the supply of homes for sale is that many owners still owe more on their houses (in the form of mortgages and loans) than their houses are currently worth on the market.   As housing prices rise, more homes will come on the market, increasing opportunities for buyers. However, if housing prices drop due to rising interest rates or decreased demand, fewer houses may go on the market, tightening up that supply again.

CONS:

RISING MORTGAGE RATES

Interest rates have risen in past months as the Federal Reserve prepares for tapering, leading to higher mortgage rates. The NAR expects mortgage interest rates to hit 5.3 percent by the end of 2014.  Rising interest rates could give the housing market some temporary steam as house hunters try to get in before rates go higher, but it will likely act as a headwind in the long term as buyers get pushed out of the market.

WEAK LABOR MARKET

A vibrant housing market thrives on a healthy jobs market and the current job market is weak, particularly among the 20-30-somethings who are critical to future housing demand. Higher unemployment means fewer people that are able to qualify for a mortgage.

Hand-in-hand with the stagnant labor market is a drop in household formation – when a person who lives with someone else (parents or roommates) moves out and creates a new household. Current levels of household formation are well below recent trends as low wages and tight credit conditions prevent young Americans from moving out on their own.

The simple truth is that it’s hard to predict what will happen in the housing sector in 2014.  As investors, it’s important to keep our eyes on these important macro economic trends while maintaining focus on long-term financial objectives. One of the benefits of an active management strategy is that we can take steps to try and leverage these macro trends while not allowing them to derail our long-term strategies. If you have any questions about how the housing recovery may affect your personal financial situation, please give us a call. We’d be happy to speak with you.

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