- The US housing market is poised for a tough couple of years.
- A mix of challenging supply/demand dynamics, combined with stretched affordability and deteriorating sentiment, will weigh on the market.
US housing is one of the most important markets in the world – you only need look at the central role it played as a catalyst for the 2007-08 global financial crisis (GFC) for evidence.
Looking ahead, the market’s performance this year could materially impact not only the US economy but the world. The US economy is broadly expected to outperform other regions this year. But if the American housing market falters, it could help tip the US into recession, deepening the global economic slowdown.
Worryingly, renowned US housing market expert Ivy Zelman expects America to experience a housing crisis. In a discussion with Macro Hive’s Bilal Hafeez first published July last year (the most listened-to Macro Hive podcast in 2022), Zelman laid out the argument for her pessimism towards US housing.
For 2023 and 2024, Zelman sees US house prices falling 4% and 5%, respectively. The speed of the deterioration in fundamentals, however, means Zelman thinks these negative forecasts could be conservative.
Inventory and Velocity
The key to understanding inventories is to consider the notion of what Zelman calls ‘velocity’ – the quickness of the turnover in housing stock.
From 2013 to the onset of Covid in 2020, this velocity measure was about 20-25%. That is, roughly one in four newly listed homes were sold within a month. That percentage plunged temporarily due to Covid, then skyrocketed to over 55%. It meant many of the new listings were never on the books long enough to be counted as inventory.
One big driver of this surge in velocity was what Zelman calls ‘the Great American Shuffle.’ This term describes the dynamic of people leaving high-cost US states and moving to low-cost states. This type of migration has happened for decades in America, and it exploded higher because of Covid.
After this surge in velocity, it became evident that this key metric was shifting in H1 2022. Zelman saw that inventories in certain markets, mostly within the West Coast, Southwest and mountain states were rising ‘at Mach speed.’ Some regions saw inventories up more than 100% – other regions almost 200%. That is not a good sign for the US housing market.
Demand and Velocity
Demand is another critical component of velocity, and Zelman notes that a significant drop in demand is causing velocity to plummet.
A few key factors are driving this – higher mortgage rates, a lack of affordability, plus buyers who are savvier and more cautious than before, having learned painful lessons from the GFC.
In the run-up to the housing crash in 2007-08, buyers were quite sanguine, with Zelman attributing this to a general complacency. In 2005, inventories were starting to build, but most thought house prices just would not fall. Therefore, property owners did not rush to lock in gains as inventories rose.
Contrast that with the current situation, where property owners are rushing to sell into what they see as a frothy market. For example, investors with, say, 10 or 15 properties are now trimming their portfolios aggressively.
Buyers, too, are more cautious, unwilling to pay inflated prices in a market they think is at or near the top. This is true of single-home buyers and institutional investors.
Zelman notes that the softening of demand means the severity of the rate of decline in velocity is noticeably sharper than going into the GFC. So much so that ‘the velocity has just fallen to levels that are shocking, frankly, in some of the markets in the country.’ Again, that is not a good sign for the US housing market.
Affordability, Supply Backlogs, and Sentiment
Lack of affordability is a problem, caused by a combination of rising interest rates and higher home prices. An affordability index that Zelman measures is even exceeding the stretched levels seen in the last cycle. Her conclusion is that ‘we need to see a pretty substantial decline in rates and/or home prices to see affordability more attractive.’
Another headwind for home prices in the US is the supply backlog of multi- and single-family homes. Backlogs are at the highest levels ever, and, notably, a material proportion of that number is from the build-to-rent market. Combined with a lack of affordability, this increased supply will also weigh on the market.
Zelman contends that housing is very much driven by sentiment. At present, with affordability so tight, she describes sentiment as akin to the bloom being off a rose. She suggests ‘private investors are getting out big time.’ And while most institutional investors will look at housing prices on a long-term basis, some are ‘also starting to recognise it’s probably a good idea to take some money off the table.’
One important difference today from the run-up to the GFC (and housing market collapse) is that the exotic mortgage products that drove the excess back then are no longer prevalent. So, while the combination of velocity, supply, demand, affordability and sentiment are significant headwinds, the more stringent regulation of mortgages provide a guardrail that should mitigate a downturn as severe as in 2007-08.
Investors who experienced the GFC directly know that the US housing market can significantly impact the broader macro environment. The US Federal Reserve certainly watches the housing market closely, as this recent paper demonstrates.
Ivy Zelman points to a combination of unfavourable supply/demand dynamics, which together form a velocity metric, that have deteriorated rapidly. Stretched affordability has led to a similar deterioration in sentiment towards the housing market.
While Zelman expects the declines in 2023-24 to be less pronounced than during the GFC, she still sees the market declining 4% this year and 5% in 2024. Given the pace of the negative slide in the fundamentals, these pessimistic forecasts may be conservative.