The U.S. housing market appears to be stuck. Our co-heads of
Securitized Product research, Jay Bacow and James Egan, explain
how supply and demand, as well as mortgage rates, play a role in
the cooling market.
Read more insights from Morgan Stanley.
----- Transcript -----
James Egan: Welcome to Thoughts on the
Market. I'm Jim Egan, co-head of Securitized Products Research at
Morgan Stanley.
Jay Bacow: And I'm Jay Bacow, the other
co-head of Securitized Products Research at Morgan Stanley. And
after getting through last week's blistering hot temperatures,
today we're going to talk about what may be a cooling housing
market.
It's Monday, June 30th at 2:30pm in New York.
Now, Jim, home prices. We just got another index. They set
another record high, but the pace of growth – the acceleration as
a physicist in me wants to say – appears to be slowing. What's
going on here?
James Egan: The pace of home price growth
reported this month was 2.7 percent. That is the lowest that it's
been since August of 2023. And in our view, the reason's pretty
simple. Supply is increasing, while demand has stalled.
Jay Bacow: But Jim, this was a report for
the spring selling season. I know we got it in June, but this is
supposed to be the busiest time of the year. People are happy to
go around. They're looking at moving over the summer when the
kids aren't in school. We should be expecting the supply to
increase. Are you saying that it's happening more than it's
anticipated?
James Egan: That is what we're saying. Now,
we should be expecting inventories today to be higher than they
were in, call it January or February. That's exactly the
seasonality that you're referring to. But it's the year-over-year
growth we're paying attention to here. Homes listed for sale are
up year-over-year, 18 months in a row. And that pace, it's been
accelerating. Over the past 40 years, the pace of growth from
this past month was only eclipsed one time, the Great Financial
Crisis.
Jay Bacow: [sighs] I always get a little
worried when the housing analyst brings up the Great Financial
Crisis. Are you saying that this time the demand isn't
responding?
James Egan: That is what we're saying. So,
through the first five months of this year, existing home sales
are only down about 2 percent versus the first five months of
2024. So they've basically kind of plateaued at these levels. But
that also means that we're seeing the fewest number of
transactions through May in a calendar year since 2009. And that
combination of easing inventory and lackluster demand, it's
pushed months of supply back to levels that we haven't seen since
the beginning of this pandemic. Call it the fourth quarter of
2019, first quarter of 2020, right before inventory has really
plummeted to historic lows.
Jay Bacow: All right, so 2009, another
financial crisis reference. But you're also – you're speaking
around a national level, and as a housing analyst, I feel like
you haven't really spoken about the three most important factors
when we think about things which are: Location. Location. And
location.
James Egan: Absolutely. And the
deceleration that we're seeing in home price growth – and I would
point out it is still growth – has been pervasive across the
country. Year-over-year, HPA is now decelerating in 100 percent
of the top 100 MSAs, for which we have data. In fact, a full
quarter of them, 25 percent of these cities are now actually
seeing prices decline on a year-over-year basis. And that's up
from just 5 percent with declining home prices one year ago.
Jay Bacow: As a homeowner, I do like the
home price growth. And is it the same story when you look more
narrowly around supply and demand?
James Egan: So, there might be some
geographical nuances, but we do think that it largely boils down
to that. Local inventory growth has been a very good indicator of
weaker home price performance, particularly the level of for-sale
inventory today versus that fourth quarter of 2019. If we look at
it on a geographic basis, of 14 MSAs that have the highest level
of inventory today compared to 2019, 11 of them are in either
Florida or Texas. On the other end of the spectrum, the cities
where inventory remains furthest away from where it was four and
a half years ago, they're in the Northeast, they're in the
Midwest.
Jay Bacow: As somebody who lives in the
Northeast, I'd like to hear that again. But you're also; you're
quoting existing prices, which that's been the outperformer in
the housing market. Right?
James Egan: Exactly. New home prices have
actually been decreasing year-over-year for the past year and a
half at this point. It's actually brought the basis between new
home prices, which tend to trade at a little bit of a premium to
existing sales; it's brought that basis to its tightest level
that we've seen in at least 30 years. And that's before we take
into account the fact that home builders have been buying down
some of these mortgage rates. But Jay, you've recently done some
work trying to size this.
Jay Bacow: Yeah. First it might help to
explain what a buydown is.
A home builder might have a new home listed at say, $450,000. And
with mortgage rates in the context of about 6.5 percent right
now, the home buyer might not be able to afford that, so they
offer to pay less. The home builder – often many of them also
have an origination arm as well. They'll say, you know what?
We'll sell it to you at that $450,000, but we'll give you a lower
mortgage rate; instead of 6.5 percent, we'll sell it to you for
$450,000 with a 5 percent mortgage rate. Then maybe the home
buyer can afford that.
James Egan: And so, new home prices are
actually coming down. And by that we're specifically referring to
the median price of new home transactions. They're falling
despite the fact that these buy downs might be influencing prices
a little bit higher.
Jay Bacow: Right. And when we look at how
often this is happening, it's a little actually hard to get it
from the data because they don't have to report it. But when we
look at the distribution of mortgage rates in a given month –
prior to 2022, there were effectively no purchase loans that were
originated less than one point below the prevailing mortgage rate
for a given month.
However, more recently we're up to about 12 percent of Ginnie Mae
purchases, and those are the more credit constrained borrowers
that might have a harder time buying a home. And about 5 percent
of conventional purchase loans are getting originated with a rate
1 percent below the outstanding market
James Egan: And so, this might be another
sign that we're seeing a little bit of softening in home prices.
But what are the implications on the agency mortgage side?
Jay Bacow: I would say there's probably two
things that we're keeping an eye out on. Because these are
homeowners that are getting below market rate, the investors are
getting a below market coupon. And because they're getting sold
at a discount, they don't want that, but they're going to stay
around for a while. So, investors are getting these rates that
they don't want for longer.
And then the other thing you think about from the home buyer
perspective is, you know, maybe they – it's good for them right
now. But if they want to sell that home, because they're getting
a below market mortgage rate, they bought the home for maybe more
than other people would've. So, unless they can sell it with that
mortgage attached, which is very difficult to do, they probably
have to sell it for a lower price than when they bought it.
Now Jim, what does all this mean for home prices going forward?
James Egan: Now, when we think about home
prices, we're talking about the home price indices, right? And so
those are going to be repeat sales. It’s going to, by definition,
look at existing prices and not necessarily the dynamics we're
talking in the new home price market.
Jay Bacow: Okay, so all this builder buy
down stuff is interesting for what it means for new home prices –
but doesn't impact all the HPA indices that you reference.
James Egan: Exactly, and at the national
level, despite what we've been talking about on this podcast, we
do think that home prices remain more supported than what we are
seeing locally. Inventory is increasing, but it also remains near
historically low levels. Months of supply that I mentioned at the
top of this podcast, it's picked up to the highest level it's
been since the beginning of this pandemic. We're also talking
about four to four and a half months of supply. Anything below
six is a tight environment that has been historically associated
with home prices continuing to climb.
That's why our base case is for positive HPA this year. We're at
+2 percent. That's slower than where we are now. We think you're
going to continue to see deceleration. And because of what we're
seeing from a supply and demand perspective, we are a little bit
more skewed to the downside in our bear case. Instead of that +2,
we're at -3 percent than we are towards the upside in our bull
case. Instead of that plus two, we’re at plus 5 percent in the
bull case. So slower HPA from here, but still positive.
Jay Bacow: Well, Jim, it's always a
pleasure talking to you, particularly when you're highlighting
that the home price growth is going to be stronger in the place
where I own a home.
James Egan: Pleasure talking to you too,
Jay. And to all of you listening, thank you for listening to
another episode of Thoughts on the Market. Please leave a review
or a like wherever you get this podcast and share Thoughts on the
Market with a friend or colleague today.
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