Mortgage Rate Declines Aren't Boosting U.S. Housing

Federal Reserve Chairman Jerome Powell is facing a housing conundrum. The market is in the midst of a 15-month slump, with home price gains and sales having slowed dramatically and permits to build new dwellings slumping by 6.6% to the lowest level in more than two years. This despite a big drop in market interest rates thanks to the Fed’s dovish pivot earlier this year.

Of course, a recession would pull down prices and solve the affordability problem (a National Association of Realtors index shows housing is less affordable now than any time since before the financial crisis). But a recession is exactly what Powell hopes to avoid by lowering benchmark interest rates that are already near historic lows. The thing is, though, 30-year mortgage rates are already at a very low 3.75%, down from almost 5% in November, and housing hasn’t responded. Applications to purchase a home have declined for four weeks running according to the latest Mortgage Bankers Association data. It’s not clear that even lower rates will help.

Meanwhile, plans to buy a home within six months are at multi-year lows and look to have turned for the cycle. The value of residential construction is 7.8% lower than the first six months of 2018, accelerating a trend that’s seen a persistent contraction for six quarters, the longest stretch since the last recession. There is, however, some appetite to purchase a new home, albeit off a very low base (see the right-hand scale in the chart below). And while off the lows from last year’s spike in mortgage rates, buyer traffic in those model homes has been negative for nine consecutive months.

There can be benefits to a true housing recession. If the Fed can manage to contain itself and hold the line on negative interest rates, even a small contraction should be enough to flush the proliferation of speculators out of the market. Stories abound of homes swept up at auction that might have otherwise been razed, as in eradicated from the housing stock altogether.

Think of these dwellings as the equivalent to the “zombie” companies that have hung on thanks to artificially low rates that spurred a boom in the market for junk bonds and loans. The divergent trend between residential and nonresidential investment is striking, reflecting malls across America being bulldozed and the build out of a warehouse nation.

It’s no coincidence that yield-hungry investors are the root of the increase in the median age of homes sold rising from a low of 15 years as the market last turned to where 28 years currently. The irony, as is always the case in tragedies, is that investors are so intent on maintaining their cash flow stream that they’ve entered the business of buying new homes to rent out. As if entry level homebuyers needed competition from price agnostic buyers in the new home market as well.

If there is one trend that should reverse in a true housing recession, it’s that of homebuilding. Between the need for baby boomers to downsize and millennials who are procreating, demographics alone dictate housing starts should be running at multiples of their current levels. And while the market has improved off its 2009 lows, fresh supply in sufficient numbers is conspicuous in its absence. With millennials set to outnumber the boomers next year, it’s hard to believe that housing starts per million Americans is running at a third the rate of 1972, which is around the time my parents bought their first home alongside millions of their contemporaries.

The tricky part to writing a happy ending to the worsening housing downturn is the complexion of the current housing stock. Not only are millions of homes occupied by boomers very old, they are also in areas millennials don’t want to live. A best-case scenario would entail a slow descent in the prices of those homes that allowed a hand-off to slightly less reluctant Generation X-ers looking to buy their final homes as they age into their 50s.

That process may be underway. Existing home inventories have been on the rise since late last year. Coupled with the industrial recession, that trend of supply hitting the market should continue to weigh on prices until demand rises to close one deal at a time. Boomers won’t like taking the haircut, but it beats the alternative, which is a disorderly downturn. It’s all bets off if stocks or bonds or both correct, taking a third swipe in as many decades at boomers’ retirement savings and prompting housing speculators to rush the exits.

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