The Big Idea
Housing’s impact on the economy and markets
Steven Abrahams | September 23, 2022
This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.
The highest inflation in 40 years has suddenly pushed housing into the spotlight. A rise in home prices of more than 50% since the start of pandemic has fueled a sizable part of the inflation surge, and the Fed has come after it. Housing has quickly come off the boil, and investors in rates, MBS, CMBS and corporate credit have raised new questions about future prospects. This special issue of APS Portfolio Strategy answers those questions. After sifting through supply and demand, policy, the mechanics of prepayments and credit, the implications for renters and the signals from homebuilders, the consensus seems modestly bearish on housing in the short run but bullish in the long run.
In this special issue, five analysts take a broad view of the impact of housing on their areas of expertise:
- Stephen Stanley, APS chief economist
- Laurie Goodman, a national expert in housing and mortgage finance
- Brian Landy, APS senior strategist in residential MBS
- Mary Beth Fisher, APS senior strategist in CMBS, and
- Dan Bruzzo, APS senior strategist in investment grade credit
Some of their key findings:
Housing, inflation and rates
The inflation fight in housing has already started to play out. High home prices and a doubling in mortgage rates this year has slashed housing affordability. And new home sales, existing home sales and home prices have started to slip. But the slow transformation of high home prices into higher rents means housing inflation will still likely keep rising and peak in mid-2023. This is a key reason Stephen Stanley argues inflation will persist and the Fed will remain aggressively hawkish. The Fed’s latest dots confirm that intuition, with median fed funds at the end of next year penciled in at 4.6%.
A chronic shortage, and the opportunities from solving it
Although the price of the average home may stand still for a year or more under pressure from the Fed, both Stanley and Laurie Goodman describe a chronic housing shortage that ultimately should keep the market tight. Demand has routinely exceeded supply ever since the Global Financial Crisis. But pandemic has shifted demand even higher. As the appeal of cramming multiple friends or families into dense housing wore out, Stanley notes, household formation surged. Goodman, however, emphasizes the forces stubbornly crimping supply—zoning, building codes, the cost of materials and labor and limits to housing finance. Innovation in each of these areas, she outlines, could help supply rise to meet demand. The companies that help solve these problems should reap the rewards, including housing manufacturers, builders or mortgage lenders that find ways to finance housing renovation and preservation or fund new forms of housing altogether. Figuring out how to create and fund backyard living spaces, called alternative dwelling units, or figuring out how to fund manufactured housing look like clear opportunities.
A direct impact on residential MBS
Brian Landy argues that housing has never been more important for MBS valuation, especially since almost all outstanding MBS trades below par. Housing will drive turnover and prepayments. And home prices will drive homeowner equity and mortgage credit. The agency MBS market, the private-label MBS market and the market in credit risk transfers are all leveraged to housing. Landy finds prospects for housing turnover much better than for housing overall. Home prices overall, however, look likely to put years of rapid acceleration in the rearview mirror and run flat for a few years to come.
American Dreams for rent
The macro and the micro of supply and demand point to a housing market likely to see a steady rise in renters. The latest drop in affordability has made renting almost the only practical choice for a rising set of households. This is bullish for rental demand for the next few years, and, beyond current circumstances, demographics promise to fuel rental demand for decades. As for rental supply, programs backed by Fannie Mae, Freddie Mac and Ginnie Mae promise to continue adding multifamily properties. And a combination of small investors and a new set of institutional investors promise to add single-family rentals. Fisher points out that single-family rentals provide a transition between renting and owning. She argues that the broad trends in rental supply and demand look bullish for the debt and equity that supports rental properties.
The impact on homebuilders
Finally, Dan Bruzzo looks through the window of US homebuilders for signals of a turn in housing and finds them in lower builder guidance, falling builder sentiment, fewer homes contracted and fewer homes delivered. But the investment grade homebuilders that Bruzzo tracks seem ready for the downturn. Lower leverage and lower debt-to-equity should let homebuilders navigate a softer housing market.