A brief explanation of the current market-

Since 2010 there has been record underinvestment from builders in residential properties which has caused a tremendous supply – demand imbalance (Homebuilder sentiment did not recover from the Great Financial Crisis until 2017!). On any given year, on average, U.S. homebuilders need to build around 1.3 million new units to keep up with household formation and replacement cycles.

To give you an idea of how bad it got, in 2008 housing starts hovered around the half million mark, and stayed there for the next 3+ years! Depending on where you get your information, we didn’t get back to normal until 2017. That’s 9 years of underbuilding! It is currently estimated that the country is short around 4 million units. Doing that math, U.S. homebuilders would have to build an extra 800,000 homes a year, a 61.5% increase from what’s normal, for the next 5 years to cover the shortage.

Another angle to consider is a whopping 82% of current mortgage holders have an interest rate below 5%. Even worse, 62% of mortgage holders have a rate that’s less than 4% and just under 24% of mortgage holders have rates below 3%! Most sane people that I know would not sell their home, unless they had to, to buy a more expensive one, at an interest rate that’s around double of what they currently have. This is going to keep a significant amount of housing supply off of the market – until rates come down.

With the current inflationary environment of geopolitical turmoil and U.S. fiscal policy, I don’t see rates coming down below 5% in the foreseeable future. That combined with labor markets being very tight and a general shift away from construction type jobs by younger generations, the outlook for getting back to par doesn’t look good anytime soon.This should put a floor under housing prices.

On the demand side, it’s coming from all directions, Baby Boomers downsizing, Gen Xer’s wanting to trade up, people of all sorts getting second homes because they can work remotely, a huge group (~ 72 million) of millennials hitting their home buying years along with Gen Zer’s (~68 million) right on their heels. With such an imbalance in the market it appears to me that we are reliving the late 1970’s to early 1980’s. Housing during that time performed well even though interest rates were well into the double digits with the 30 year fixed reaching 18.63% in 1981. No, that’s not a typo!

If you look back at historical interest rates we appear to be close to normal. The 30 year fixed mortgage is loosely tied to the 10 year treasury note plus a spread. The 10 year treasury, as I understand it, is basically valued at GDP, plus the inflation rate, plus a given risk premium. If you look at a chart, excepting the crazy inflation of the late 70’s, the yield on the 10 yr. is around 5-6%. That said, considering the current stickiness of inflation and the lessons learned from the late 70’s, I would not expect the Federal Reserve to lower the Fed Funds rate any significant amount over the coming years, save for some Black Swan event, even with a moderate recession. This will make the problem of “rate locked” homeowners persist into the foreseeable future. This of course will give further support to home prices.

Going forward I would expect slow, steady progress on supply and potential homebuyers to slowly and begrudgingly accept the new normal as it pertains to mortgage rates. I expect wage gains to slow but continue, making the sting of higher rates more tolerable. That said, some of the greatest investors and risk managers like Jamie Dimon, Larry Fink, and Warren Buffett don’t attempt to make detailed predictions so take the aforementioned with a generous grain of salt!