2020 is full of surprises. First it was the virus, then the shutdowns, then the drop in the markets, then a dizzying rebound in the markets. One rebound which is also defying expectations is the housing market. It’s not just the US market either, all over the developed world, prices are seeing broad increases. American homes are up 5% and German home values are up 11% from the same time last year. Despite Brexit, the U.K. is touching new highs.
So what’s behind this? Normally house prices tend to sag with the economy. As more people lose their jobs, there are less buyers or maybe they buy a smaller place to be more conservative. Rates are cut to stimulate demand but it takes time for confidence to regain in the economy. Eventually people will refinance into lower rates and upgrade homes as the economy improves, prices start to rise and values increase again. This recession is different however, despite the initial downturn this year and an expected annual fall in GDP of 3.8%, house prices are on the rise.
Those in suburban areas have been the winners. Despite the fear that people may move far away from large cities, it seems many are content to just move further away from the urban centers they already occupy, rural home values have actually fallen.
Source: The Economist
Even though I am benefitting from the current state of things, I am increasingly worried about this phenomenon. If I ever want to upgrade or move from my current location, prices could rise so much that they become prohibitive. Not to mention the fact that this spurs on further inequality and risks further resentment and unrest by those that feel locked out of the ownership class.
So I decided to take a look at the main overarching factors that are contributing to this recent home price rise and what, if anything can be done about it.
3 Main Factors
- Interest Rates – The first and most obvious is interest rates. After the crisis, market watchers looked on amazed as 30 year fixed mortgage rates dipped below 5% for the first time in many people’s lives. I remember getting a 4.5% rate and thinking I had a steal of a bargain which I needed to lock in for a very long time. Fast forward to 2020 and the same mortgage can be had for under 3%. This is bound to push up prices. Even for refinancing, it’s a no brainer. There are national governments that pay more than 3% for 30 year money and any Joe Schmo with decent credit and some savings in the US can borrow for less. The fact that rates were low already and we had seen the extreme desire for liquidity and safety during the last crisis meant that treasury rates sunk to new all time lows this time around. Elsewhere the story is the same, rates in much of Europe and other developed countries are seeing a secular decline in rates which feed homes prices in itself.
- Building – This one wasn’t so obvious to me but it’s becoming a perfect storm for a lack of building. Home builders are complaining more young people go to University than trade school so it is getting more difficult to find the right skilled labor. Immigrants were able to fill much of the gap previously but their presence has been stifled by recent politics. Add to this restrictive building codes in many cities, as well as new environmental requirements such as the requirement in California for all new homes to have solar panels (which can add tens of thousands to a new home price) and you start to understand why supply may be falling faster than demand. In fact, new housing starts are at a prolonged all time low.
Source: WSJ - Stimulus – I find this argument a bit more flimsy but will repeat it here because it may not be a driving force but may have some relevance. A moratorium on evictions has artificially kept supply of homes limited. Normally, some people who lost their job will unfortunately also lose their home if they can’t keep up with payments. This puts foreclosures onto the market at lower prices and drags down overall prices. For now, this phenomenon is absent and prices are dominated by less distressed purchases. In addition, being locked up with nowhere to go has pressed some forced saving upon the general public. Some are able to use these savings to either upgrade or move further away for more space, pushing up those suburban prices.
The last part belies and uncomfortable truth: this recession has been harder on people working manual or physical jobs, which tend to be lower paying ones. Many of these people were already renting, their being unemployed just may not affect housing prices as much.
Inflation Will Play a Factor
More and more attention has been drawn recently not just to headline inflation but to the fact that different demographics experience inflation differently. For those that rent, the Fed’s signal that it is willing to withstand higher than target inflation to get headline inflation back to its long term target is worrying. Renters may be disproportionately affected by inflation compared to owners and housing costs are over 2/5 of inflation in the US.
Source: Advisor Perspectives
This is softened by the fact that owners have to pay more taxes but owners also have more options. If prices rise they can refinance their mortgage and receive cash to them hedge against higher inflation through other real assets. Or they can choose to rent all or part of their place and pass on part or all of that inflation to others. It’s the renters who are stuck with no other options.
Rather than stop subsidizing homeowners through the mortgage interest deduction, governments tend to just throw price controls and subsidies towards the poor to keep them quiet. This only works for a time being though. Programs expire, subsidized homes get filled and the next generation will struggle even harder. Price controls and subsidies will only benefit those who are struggling now. When prices rise further or another downturn eventually happens, there is a whole new demographic of struggling people that they are forced to help all over again.
This vicious cycle can be seen even after the housing crisis as home prices started to once again decouple from median incomes.
Source: Long Term Trends
It’s no wonder from the above that both Gen X and Millennials are way behind where Boomers were at the same age when it comes to home ownership. The modern economy requires high levels of education and large down payments compared to the period from 1960 – 2000.
What Will Change It
What will fix this is a concerted effort on behalf of governments to incentivize building in the private sector, much as the government did post WWII. At that time, the government converted land and purchased land to turn over to developers and offered cheap financing for them to develop new housing and neighborhoods. Just to take one example, with retail moving online and malls dying all over America, why can’t programs be created to revitalized malls and turn them into apartment complexes?
The lessons to be learned from the post WWII building boom are to not exclusively zone single family housing to new developments and to not create ghettos by explicitly excluding minorities. In addition, loosening control on rental prices and zoning in large cities like NYC and San Francisco will free up the market for cheaper rentals as well as new homes for purchase, enabling even more skilled workers to move to the places and benefit from the knowledge economies there.
Low rates are a large part of the current high prices but they aren’t the only factor. The housing market is heavily subsidized, stimulated and controlled by the government in many developed countries, the rise in prices and the shutting out of a large portion of the population to ownership is a failure of government policy, not a mystery.
If You Can’t Buy Private, Buy Public
In the mean time, people can also take advantage of the home price increases even if they rent. Just because the stock market is mostly owned by the top 10% of income brackets doesn’t mean that others can’t participate. Purchasing residential REITs or if you are bullish on the entire sector, diversified REITs enable those who are renting to benefit from this phenomenon now and not have to wait until they are owners. It’s not ideal to have to revert to this method but conditions are never ideal to start helping yourself, it just takes the will to do it.
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