Debunking The Housing Crash

COVID-19 is one of the most deflationary global events to hit the earth since the meteor that took out the dinosaurs. When much of the United States and many other countries began enforcing stay-at-home orders, the economies of the world came to a grinding halt. 

How is it then, that a deflationary event of this magnitude could not trigger a housing crash in the U.S.?

Yesterday, I spoke with a medical professional who is entertaining the idea of buying her first home. She is wicked smart and has already done a significant amount of research on housing and mortgage loans.

As her career has advanced and her income has climbed to a point that will enable her to easily make payments on a home, she has decided now is a good time to try and “time” the housing market and scoop up the deal of a century in real estate.

I cannot fault her intuition. From the outside, it seems there might be some desperate sellers out there who need to sell their homes immediately and at any cost. This means her dream home could be on the market being sold by someone who needs to sell quickly.

Unfortunately, “timing” the housing market is not that easy; if it were, we’d all be Warren Buffett wealthy and be sitting on billions. The challenge with timing the market is that both equity, bond, and real estate markets are awfully complicated and there are too many facets for most outsiders (someone who has not studied the markets for as long as Warren Buffet) to ever correctly guess which direction the market is going to go.

As deflationary of an event as COVID-19 has been globally, there are equal and potentially greater inflationary pressures currently pushing U.S. housing prices higher than they are today.

Here are a few reasons why housing prices in the U.S. might continue to climb higher.

1.      Record-low Inventory

As of year-end 2019 there were only 1.8 million homes for sale in the United States – an all-time low as a percentage of total population. Does 1.8 million homes for sale sound like enough housing inventory for a country with 328.2 million people and 128.58 million households?

Let me say it another way – for every 100 households in the U.S. today, there are only 1.4 homes for sale. Granted, not every household wants to buy a home (some prefer to rent), and not every household that currently owns a home wants to buy another one.  

According to the U.S. Census, the current homeownership rate is 65.3%, and we know the average amount of time a homeowner stays in their home is about ten years. This tells us there are approximately 83,962,740 households that own a home currently in the U.S. 

If each of these households move every ten years on average, this tells us there is a need for approximately 8,396,274 homes each year to fill the needs of buyers who want to move up, move down, relocate across the country, etc. By the way, this does not account for new household formations, we’re just looking at the number of existing homeowners likely to seek a new home this year. 

Based on that math, there is roughly 4.6 times the number of buyers than sellers in the market. Could this be why multiple offers on the best homes in the best neighborhoods are commonplace right now even in the middle of the COVID-19 crisis?

2.      Rising Homeownership Rates

Far too many young adults witnessed the pain associated with losing a home and the ensuing Great Recession in 2008. Imagine the psychological damage that can be dealt to a child or young adult as they watch their parents lose their homes and retirement funds while, in far too many instances, divorcing under the stress. 

Not surprisingly, homeownership rates plunged in the United States from 2006 through late 2016. A decade of fear and recovery from the Great Recession, resulted in a wave of Millennials renting apartments and choosing low-risk savings vehicles like FDIC insured savings and money market accounts to place their money in. 

However, since late 2016 the homeownership rate has been recovering and shows no signs of fatigue. As we approach ten years of consistent real estate appreciation, we are seeing renewed confidence in real estate as more renters become buyers.

3.      Demographics Are Changing

On January 22, 1973 the United States Supreme Court affirmed the legality of a woman’s right to have an abortion under the Fourteenth Amendment of the Constitution in the landmark case of Roe v. Wade.

This ruling may seem irrelevant to the real estate and housing market today, but if you study the delayed impact of this court decision and its related social behavioral changes you will find some shocking data.

According to the National Association of Realtors, the average American homeowner purchases their first home at the age of 33. Not coincidentally, the peak of U.S. household formations was in 2006 at the height of the real estate bubble and exactly 33 years after Roe v. Wade.

Was the legalization of abortion fully to blame for the Great Recession? Absolutely not, but it did contribute to a demographic shift that very few saw coming.

Before 2006, household formations had been on the rise and a seemingly endless supply of new home buyers were entering the market. This sea of buyers conveyed to homebuilders and mortgage lenders that demand for housing would be permanent and investment in land development, home construction, and loosely underwritten mortgages would all be safe investments. 

We all know what happened when the demographic tide shifted at the peak of this speculation and greed from real estate investors, home builders, and mortgage banks alike – the real estate market plummeted and home prices did not recover until 2012 (the year which also happened to be the bottom of the household formation dip caused by the ruling in Roe v. Wade).

Beyond the fascinating correlation of Roe v. Wade to the housing bubble and eventual crash, this data is relevant to current and future real estate markets and home values. What’s important for us to pay attention to is in the years following 2012, household formations took off and quickly eclipsed previous numbers.

Household formations have exceeded the number of annual completions of housing units (new home construction) every year since 2015. This is the primary reason we do not have enough housing inventory to meet demand today. Demographics shifted towards higher household formation growth and the builder community has not been able to keep pace. 

COVID-19 is further exacerbating the issue as many expect the stay-at-home orders to lead to a baby-boom that will drive families out of rentals and into home ownership.

This anticipated spike in demand for homes also comes at a time when COVID-19 has also deeply impaired the number of housing starts (new construction homes) being built. 

Take a look at the far right of the chart below and note the drop in housing starts in 2020. The number of new housing starts now looks to be headed back toward 800,000, which is near the lowest levels we’ve seen since 1960 when household formations were much lower. 

Additionally, in the graph below we can see a substantial dip in the number of people turning 33 years old (which is the median age of first-time home buyers) from 2006 to 2012.

 By following the U.S.-birth chart below, we can see the population of 33 year olds today (people born in 1987) is surging and anticipated to bring more first-time buyers to the market over the next four years. 

After the 1990 birth rate peak, we see a mild pullback in birth rate but with numbers still elevated near 4 million - significantly higher than the depressed levels following the impact of Roe v. Wade which were just above 3 million. This indicates we have another 4 years of significantly improving demographics and higher demand from first time homebuyers.

4.      Home Prices Aided By Low Interest Rates

When the unemployment rate starts to surge and the economy contracts for two consecutive quarters, we are technically in a recession. Recessions are normal and they happen with fairly regular frequency – usually five to ten years apart.

A recession is a time for the economy to slow down and evaluate what’s working and what’s not. Some companies don’t make it through recessions and have to shut down, while others find new opportunities and lead the economy into the next expansion phase. This is normal and should not be thought of as scary, unusual, or unexpected.

It’s also why financial advisors tell us we need “rainy-day” funds - three to six months’ of living expenses saved up so we can make it through something like COVID-19 or if the company we work for goes out of business. 

Most of us know and understand the importance of having a few months of living expenses in reserve. However, very few understand why recessions have historically been good for home values. 

Many who lived through the Great Recession and the mortgage meltdown erroneously correlate recessions with real estate crashes, but the graph below shows this correlation is actually very low.

Going back to 1970, we can see there has been seven recessions (shown by the grey shaded bars). During each recession, except 1991 and 2008, home prices either stayed the same or increased. In 1991, housing prices only dipped by 1.9% before recovering and steadily rising for the next 17 years.

Looking back over the last fifty years, residential real estate has appreciated at approximately 5% per year despite the seven recessions we’ve survived. 

5.      Homeowners are Sitting on Record Amounts of Home Equity

According to CoreLogic, U.S. homeowners gained 6.5% in home equity over the last twelve months. Looking back to 2010, the average homeowner gained $106,000 in equity.

Homeowners today are sitting on record amounts of equity and have not been using their homes as ATM machines with massive cash out refinances and home equity lines of credit. 

Today, 87% of homeowners have at least 20% equity in their homes and 95% have at least 10% equity.

The CoreLogic chart below shows the percentage of homeowners and the percentage of home equity. We can see the vast majority of homeowners have built up significant equity and are not “equity stripping” like they were prior to the 2008 real estate crash.

Somewhat surprising to me is the staggering number of mortgage-free homes in the U.S. Approximately 42.1% of homeowners own their homes free and clear, and the average equity in homes with a mortgage is estimated by CoreLogic to be $177,000. 

This all goes to show that U.S. homeowners are not overly leveraged like they were when we entered the last recession and maybe more importantly, this time we have strong demographic trends in our favor instead of working against us.

Conclusion

Let’s circle back to the medical professional I recently spoke to who is trying to “time the market” so she can get a deal on a home. While I hope this works out in her favor and she ends up being one of the lucky few who are successful, the odds of doing so do not seem to be in her favor.

Demographics and the homeownership rate both indicate we are going to be seeing more first-time homebuyers entering the market than any other time in history. Meanwhile, the number of new homes being built is crashing in the wake of COVID-19. After a decade of new-construction levels that are significantly lower than new household formations, inventory of new and existing homes seems likely to continue the trend toward record housing inventory shortages, multiple offer situations, and more buyers than sellers in most U.S. markets (excluding high cost-of-living areas and areas hit particularly hard by COVID-19).

So, while our medical professional friend sits on the sidelines trying to “time the market”, she may very well miss the lowest mortgage rates in history and watch U.S. housing appreciate another 6.5% annually.

If you having been thinking about buying real estate, now is the perfect time to purchase a nice home in a great neighborhood that is likely to see future economic prosperity and growth. It’s possible for you to jump into the market and allow time and the trend of 5% home appreciation, which has been consistent over the last fifty years, to work for you and build your net worth.