According to National Association of Realtors Even against the backdrop of a national housing slowdown, the South is expected to remain a booming region for home sales in 2023. “The demand for housing continues to outpace supply,” says NAR Chief Economist Lawrence Yun.
The Top 5 Markets identified by NAR are
Atlanta-Sandy Springs-Marietta, Ga.
Dallas-Fort Worth-Arlington, Texas
Builder Permit and Housing Market at Glance
Builder Permit and Housing Market at Glance
Over all housing decreased by 4.5% to a seasonally adjusted annual rate of 1.31 million units
Housing construction weakened in January as ongoing affordability conditions fueled by high mortgage rates and building material costs challenged the market,” said Alicia Huey, chairman of the National Association of Home Builders (NAHB)
Mortgage rates increase by 2 basis points to 6.32% for 30 years and 5.51% for 15 years according to Freddiemac
Inflation appears to be sticky. Although inflation shows a downward trend. CPI numbers released on Feb 14th, 2023 were higher than expected According to the U.S. Bureau of Labor Statistics CPI rose 0.5 percent MOM in January on a seasonally adjusted basis, after increasing 0.1 percent in December 2022. Shelter was the highest contributor, accounting for half of the increase. The food index rose by 0.5% followed by energy at 2.0%.
Y/Y, core CPI climbed 5.6%, vs. +5.5% expected and +5.7% prior and representing the smallest 12-month increase since December 2021.
Where are interest Rates Heading
Loretta Mester, president of the Cleveland Fed, believes the economy is on a strong path, and that it may be appropriate for the Fed to raise interest rates sooner rather than later.
Cleveland Fed President Loretta Mester told, “I didn’t see a change in my outlook, that the funds’ rate would have to go above 5%,”. In Addition to Ms. Mester. St. Louis Fed President James Bullard also felt a 50-basis point hike was necessary to tame inflation.
Contributor: Capital Markets – Ishan Pandey | Real Estate: Balgovind Pandey
Have interest rates peaked?
As of this writing, Fed Daly poured cold water and sees that the rate may go up another 1%. St Louis Fed James Bullard seems to believe that the lower limit is 5% and the upper limit could be as high as 7%. The stock market seems to be in Euphoria S&P inched higher and Nasdaq jumped 1.5%. On other news the mortgage rates plunged to 6.61 from 7.08%, the largest drop since 1981
If the rates are bound to go up how come risk on is back fashion. We will try to answer this question and some others in this blog post.
The market is a future looking mechanism. Although the market has priced in all the rate hikes, but the inflation story is still not yet over.
The October consumer price index was lower than expected. The CPI came at 7.7% an increase of 0.4% over the last year. The expectation was 7.9%.
Core CPI that strips the volatile food and energy components came at 6.3% a 0.3% increase YOY. Expectation was at 6.5%.
How did the markets react to October CPI number
Nasdaq jumped 7.5% biggest gain since March 2020.
The bond yield started to fall.
S&P 500 was up 5.5%
This was all driven off a one low CPI Print. The question is are we out of the woods? Let’s try to answer this in the next paragraph.
The Fed will not tolerate an over headed economy and will not pivot until they have seen multiple data points that confirm a slow-down inflation. The Fed’s 2 main mandates are asset price stability and full employment.
Fed Chair, Jay Powell has reiterated numerous times “ it’s premature to talk about pausing rate hikes”. The FOMC committee seems to indicate “Recent indicators point to modest growth in spending and production. Job gains have been robust in recent months, and the unemployment rate has remained low. Inflation remains elevated, reflecting supply and demand imbalances related to the pandemic, higher food and energy prices, and broader price pressures.”
This brings us to the point why the sudden jubilation in the market and risk assets. There are many theories one of them happens to be that markets were oversold and there was lot of cash on the sideline that was looking for a place. The other theories are most of the trades were algorithmic and the rally was driven by short covering. Bear Market rallies are strong, and these rallies are known to push indexes upwards of 20%.
The more the financial conditions ease the Fed will have all the ammunition to keep accelerating the rate hikes.
Where are the Mortgage rates and Bond Market
Mortgage rates – as of Nov. 16, 2022
The 30-year rates stood at 7.08 %
15 year stood at 6.38%
5/1-Yr ARM stood at 6.06 %
2 year US treasury stood at 4.37 up 0.009 basis points
The long-term treasury yield went down across the board starting from
5 years stood at 3.855% down -0.066 basis points
10 years stood at 3.699 down -0.1 basis points
The bond markets seem to indicate that the rates are going to go down. However, the Fed Speak tends to be hawkish.
A recent snippet from CNBC, during her interview with CNBC Fed Daly seems to indicate that the hike will continue, and the rate would go up at least another percentage “Pausing is off the table right now. It’s not even part of the discussion,” Daly said.
The markets seem to be overly jubilant with just one inflation read. Will the inflation go down from here only time will tell. I’m not a future teller to make a judgment on way or other, but the fed will not stop if the financial conditions ease. Markets are yet not pricing in a recession. There is a high likelihood of recession next year and the Fed is prepared to overdo rate hikes than undercut inflation.
What rates is the market pricing in
As of now, the market seems to be pricing in a probability of 85% for a fed fund rate of 425-450 basis points. Fed Daly sees the rate at 4.75% to 5.25%.
What does this all mean for the Housing Market
According to Fortune magazine, There are at least 219 markets that are down from their 2022 peak. 181 markets remain at their peak. The increase in the Fed fund rate has led to a reset in asset prices and overall asset validation be it stocks, bonds, homes or any other risk assets like bitcoin or ETH.
There are some markets where the prices will correct a lot and some where the prices may not correct at all. The key point to note here is that we have underbuilt homes in the past decade. The demand for homes far out ways the supply.
Supply and Demand of homes in Texas
According to the Texas Real Estate Research center.
“Mortgage rates have elevated significantly as a result of the Federal Reserve’s rate increases,” said Dr. Harold Hunt, research economist for the Texas Real Estate Research Center. “The result has been a real hit to affordability across the housing sector. Although interest rates are typically higher for manufactured homes compared with site-built products, the much lower purchase price still gives manufactured housing a strong advantage in the affordable-housing niche.”
Total home sales improved 10.9 percent since July’s steep decline, reaching a seasonally adjusted rate of 31,000 closed listings.
In the higher-end home (> 750K) market sales went down by 20% QOQ. due to the rising Mortgage rates.
Homes are sitting on the market longer because of slowing sales.
Texas’ average days on market (DOM) inched up to 42 days, continuously climbing from 29 days in March.
DOM was shortest in Dallas at 35 days and longest in San Antonio at 47 days
Home prices fell in Austin-Round Rock and increased in Dallas-Fortworth
Some Keys Stats on Supply
Texas’ single-family construction permits dropped to a two-year low, although Texas remained the state with the most issuance with 10,934 permits. The lumber producer price index (PPI) fell three times in the past four months, and the year-over-year price elevation decelerated from 74.3 percent in January to 17.6 percent in September.
New single-family construction saw an 18.2 percent QOQ cutback in September, and single-family private construction values balanced at a two-year low. All major metros reported double-digit negative year-to-date (YTD) growths.
The Consumer Price Index for All Urban Consumers (CPI-U) rose 0.1 percent in August on a seasonally adjusted basis after being unchanged in July.
Increases in the shelter, food, and medical care indexes were the largestof many contributors to the broad-based monthly all items increase.
These increases were mostly offset by a 10.6-percent decline in the gasoline index. The food index continued to rise, increasing 0.8 percent over the month as the food at home index rose 0.7 percent.
The energy index fell 5.0 percent over the month as the gasoline index declined, but the electricity and natural gas indexes increased.
The core consumer price index, which excludes volatile food and energy prices, rose 0.6% in August from July, double July’s pace. Economists follow core inflation closely as a reflection of broad, underlying inflation.
Stronger service-sector prices could trouble policymakers by reflecting how solid demand and growing incomes have enabled companies to continue raising prices.
Higher than expected inflation led to a hawkish Fed who reaffirmed that he will not halt until he sees meaningful drop in inflation confirmed via data.
FED and where are rates heading
The Fed’s Anxiety about not letting Inflation go high will derail the long-term economic prospects.
This week Fed raised the Fed fund rate by 0.75%. The market is pricing in a terminal rate of 4.25% – $4.5% according to the fed futures market.
Fed’s projection seems to indicate a median rate of 4.3% and a range of 4.1 –5.0% for 2022.
This could go higher if the inflation continues to persist. There are increasing signs that inflation has peaked as commodity prices have eased.
Impact on Home Sellers
Most sellers have refinanced at a historically low rate. Many sellers have pivoted towards renting rather than selling driven by higher rent they could collect in the current environment.
Renter market is as resilient as it has been in the recent past.
Rate hike impact on Builders
The increase in rates has pivoted builders to construct buy-to-rent homes. There is a great demand for rentals. The supply of homes is far lower than the demand and historical average. The time to build a home averages anywhere between 6-9 months.
Builders were not able to meet the supply due to covid supply chain issues to start with due to COVID lockdowns As the supply chain eased they were hit by high material costs due to inflation.
Overall messaging from the FED and its impact on housing
Near-term crash in housing unlike the financial crisis is not to be seen any time soon unless the market is hit by foreclosure.
The rate of foreclosure will be very low as most homeowners have financed at historically lowest rates.
Fed Chair Powell in his interviews with reporters did reiterate the fact longer term he is looking at “supply and demand to get better aligned so that housing prices go up at a reasonable level, at a reasonable pace”
The Fed is willing to go as long as it takes to contain inflation.
Impact of rates on Capital Markets
Dow Jones industrial average dropped 500 points touching the June 2022 lows and Nasdaq dropped roughly 200 points.
High growth Nasdaq is eviscerated due to the front-loaded rate hikes
Most tech companies have embarked on the journey of implementing cost-cut Measures META, GOOGL
Stronger Dollar has already dented the earnings of many of these multinationals.
Alarm bells have been run by noted investors – Ray Dalio, and Scott Minerd about the pain ahead for the stocks as rates continue to raise.
Valuation have already been reset.
What does this mean for the DFW Real estate market?
DFW real estate has been stable and slowing heading towards supply and demand normalization.
The inventory of homes for sale is improving and is at 2.6%
New home sales increased to 28.8% in august 2022 (Market Watch)
There has not been a dramatic correction in the prices and prices generally have remained stable.
The other advantage that Texas metros are enjoying is high energy prices. The oil and gas companies are some of the largest employers in Texas and Oklahoma.
Given Putin’s use of energy as a weapon I see the energy companies and those employed tremendously benefitting in the near term.
Net-Net DFW and its surrounding Real estate Market will be resilient in the near term.
Interest Rates trajectory
2 Year treasury rate rose as high as 4.20%
Impact on Leases and Rentals:
Most tenants are choosing to opt for 2-year leases due to the impact of inflationary pressure on the rent according to the US bureau of labor statistics
About 9 percent of tenants had a lease term other than 12 months or month to month.
Of these tenants, 29.9 percent had a 24-month lease
14.8 percent had a 13-month lease, and 12.4 percent had a 6-month lease during this period.
Ever since mortgage rates have gone up, I have received a lot of questions on what is happening to home prices. In the following section I will cover some of those.
Supply and Demand are not at equilibrium
At the outset of pandemic more homeowners have refinanced their mortgages to a lower rate. These homeowners are in no mood to sell in this rising rate environment. The supply of homes is still historically at lower levels than it has been due to supply chain issues, lockdown, and other macro-economic factors.
The process of construction has slowed down tremendously due to the supply chain shortage and labor shortages.
Most builders are still operating with reservation list.
Competition is high
The stock market boom has also contributed to the increase in home prices. There are more cash buyers today than there have historically been. This is adding strain on first time home buyers. Most buyers are stretching to buy their dream home and a lot of contracts are written with appraisal waiver clauses. This will eventually slow down as liquidity is flushed out of the market.
Accessing Credit is not easy today
Ever since the collapse of the housing market. Credit and underwriting requirements have become increasingly stringent. Most Americans are still not able to qualify for home purchases.
Prices are still historically high, and rents have gone up. This will prevent consumers from saving on down payments.
The Fed has started playing its part in raising rates and taking their foot off the gas pedal from stimulating the economy.
The Median prices of homes in DFW as of the latest data from Texas Real Estate Center in Dallas County has gone up by 19% compared to March 2021
Month of inventory is at 0.8
Increasing rent has prevented American consumer from saving for down payment towards purchase of their home.
Inventory is low – Listing of Preowned homes are drying up.
A lot of homeowners capitalized on sellers’ markets and sold their homes cashed in their Equity where in some of them downsized, most upsized to homes with dedicated office spaces and multiple rooms.
The influx of out-of-state residents from states such as California, New York, and New Jersey in search of warmer weather and larger homes has depleted the inventory further.
Most homeowners have preferred to stick to their homes for now as they have locked in historically low fixed mortgage rate.They are in no mood to move out and buy something at soaring prices and higher rates.
Builders are building less as they too are also feeling the pinch of rising rates.
Inflation is eating away Affordability
The top-line inflation reading for May was 8.3 as inflation is going up and the affordability of homes is deteriorating. The cost of raw materials compounded with the supply chain problem has made affordability difficult
The Midwest was the most inexpensive area, with an index score of 170.6. The West remained the least affordable area, with a score of 97.1.
In March, affordability deteriorated as monthly mortgage payments rose 32.0 percent while median household income decreased 6.6 percent.
From the previous month, affordability was lower in all areas. At 25.7 percent of income, the West has the greatest mortgage payment to income proportion. At 14.7 percent, the Midwest had the lowest mortgage payment as a proportion of income.
Mortgage Payments have gone Up
The American consumer is paying more towards their mortgage than they used to pay a year ago. if they have purchased their home after the recent rate hikes.
The normalization in home prices especially in certain cities of DFW metro may take time.
There are four things that need to happen before normalization
Supply and demand has to get back to normal levels.
War in Ukraine and zero Covid policies in China would have to ease so supply chain can be normalized especially energy supply and other finished products that is contributing to escalating inflation.
The current ongoing volatility caused by the Fed in its fight against inflation is not helping going to help the consumer in short and medium term. Fed has already given sufficient warning in its fight on inflation . Inflation would have to drop to meaningful and acceptable levels for fed to stop raising rates.
In the process to contain the inflation the Fed may cause a recession. Fed’s Softish landing is highly unlikely. I see gyration in equity and bond markets.
Until these four things happen, we are not going to see a broader normalization in prices. There may be pockets where the prices may come down but not broadly. We may hear and there news snippets on decline in mortgage application, but that will not be meaningful to prices.
Last but not least, We are in for a long haul as far as normalization of prices is concerned. Each of these points will take time some are in Fed’s control especially the demand side but others are out of its control (Supply Side). Equity Markets will flush first. I hate to say this but, people will have to panic sell the equities before the housing markets starts to see the effect. We are still not at that point. All signs points to a multi-month or multiyear grind of ups and down.
My take of the current Market conditions
The Fed recent warning on getting inflation under control with softish landing of the economy currently is questionable.
Equity markets have not yet priced in the recession factor which is highly likely given the acceleration in asset prices recently across the board.
The effect of recession on housing prices is not yet fully understood as we have not seen something like this in a while.
The 2008 financial crisis was caused due to laxity in credit and underwriting requirements leading to subprime mortgage crisis.
This is not the case today. Credit is still tight, consumers are strong. Equity markets are not fully flushed.
Last but not least consumer are sitting on the highest home equities in long time. We are still not at the point where there is fear or capitulation leading people to tap on some of their hard-assets. We are still far off from any meaningful correction in Housing markets.