Is U.S. housing becoming (a little) more affordable?

Every June, the Department of Housing and Urban Development celebrates National Homeownership Month in the U.S. But prospective buyers may not be in such a celebratory mood, as access to affordable housing remains a nationwide challenge.

What we’re watching:

The “American dream” of owning one’s home—as a way to gain household stability and financial security, and to build generational wealth—has been delayed for many. The Federal Reserve’s inflation-fighting tightening of monetary policy has helped push mortgage rates to their highest in decades, and the limited supply of new homes being built and existing homes coming to market has pushed prices out of reach for many first-time buyers.

With conventional mortgage rates peaking at more than 7% for 17 weeks combined last year, and with only a four-month inventory of single-family housing, it’s no surprise that median home prices have risen. At the same time, much of the existing housing stock is mortgaged at record low fixed rates. This has reduced the likelihood that homeowners will move and take on new mortgages at higher rates—what is known as the lock-in effect—and this in turn has put downward pressure on existing home supply.

Interest rates and home-price appreciation (HPA) aren’t the only factors affecting affordability. Insurance premiums have also jumped, in many cases due to climate-related events, and these recurring costs could be starting to play a role in the decision to buy a home—and in home values.

On the bright side, overvaluation has been easing since the middle of last year. We view home prices as overvalued or undervalued based on how much a specified region’s price-to-income ratio is above or below its long-term average. Our latest assessment of nationwide valuations showed a decline in overvaluation of approximately one percentage point, to 14.3%, due to per-capita income growth and negligible gains in HPA. The calculation—for the fourth quarter of 2023—showed 25 states experienced some home-price depreciation, compared with only two states in the previous quarter. (Note that the index has historically increased 0.86% on average in the fourth quarter.)

What we think and why:

Nationwide, overvaluation remains high, with 89% of metropolitan statistical areas (MSAs) still overvalued—albeit with substantial regional variation in both the number of overvalued MSAs and the extent of the overvaluation. For instance, certain MSAs—including several in Northern California—remain undervalued by as much as 20%, while numerous areas in Florida are overvalued by more than 40%.

Further up the East Coast, New York City’s limited affordable housing inventory is unlikely to ease any time soon. While wider affordability has improved somewhat, as mortgage rates fell and remained below 7% during the first quarter of this year, New York seems to have been immune to any relief. Median and average single-family home sales prices and rental costs in the Northeast and New York City are the highest in the nation. Worse yet, much of the New York metropolitan area is undervalued, suggesting that any reversion to the mean will increase the price-to-income ratio in that region.

From a credit perspective, there’s a silver lining to low housing supply and resilient demand, in that these conditions will likely be a tailwind for the U.S. homebuilding sector in the next two years. We think homebuilders will enjoy year-over-year growth in both revenues and EBITDA this year, and better growth momentum into 2025. Even as profit margins remain pinched by incentives that many offered early in the year, we expect margins to normalize in coming quarters as builders pull back on incentives and demand recovers. We expect relative ratings stability after several upgrades last year pushed more homebuilders into investment-grade territory. Also, some 93% of ratings are on stable outlook and stronger-than-expected performance could make for some ratings upside.

?

What could change:

The bulk of an American homeowner’s monthly housing-related payment typically comes from the mortgage principal and interest, with other monthly costs, such as taxes and insurance, being secondary. Generally, mortgage rates are based on the 10-year Treasury note yield—which, in turn, is affected by the Fed’s policy rate. With the U.S. economy outperforming expectations and the central bank continuing its battle against persistent above-target inflation, S&P Global Ratings now believes that conditions for a monetary policy easing won't be in place before autumn—and more likely not until very late in the year. S&P Global economists forecast the 30-year mortgage rate will average 6.4% in the fourth quarter, declining only to 5.6% in 2025.

We think it would take a sharp slowdown in U.S. GDP growth, along with a sudden jump in unemployment, to cause a quick Fed pivot. And even if policymakers begin lowering the key rate, it’s unclear how much of an effect that could have on home prices. A cheaper mortgage would likely bring more prospective buyers to market, which would likely underpin prices given the short supply.

All told, we believe U.S. home prices will continue to depend on a combination of factors, including the trajectory and stability of the 30-year mortgage rate, local housing dynamics, and economic fundamentals.

CreditWeek, Edition 33

Contributors: Tom Schopflocher

Written by: Joe Maguire