Our Co-Heads of Securitized Products Research Jay Bacow and James
Egan explain how mortgage rates, tariffs and stock market
volatility are affecting the U.S. housing market.
Read more insights from Morgan Stanley.
----- Transcript -----
Jay Bacow: Welcome to Thoughts on the
Market. I'm Jay Bacow, co-head of Securitized Products Research
at Morgan Stanley.
James Egan: And I'm Jim Egan, the other
co-head of Securitized Products Research at Morgan Stanley. And
today we're here to talk about all of the headlines that we've
been seeing and how they impact the U.S. housing market.
It's Thursday, April 24th at 9am in New York.
Jay Bacow: Jim, there are a lot of
headlines right now. Mortgage rates have decreased about 60 basis
points from the highs that we saw in January through the
beginning of April. But since the tariff announcements, they've
retraced about half of that move. Now, speaking of the tariffs, I
would imagine that's going to increase the cost of building
homes.
So, what does all of this mean for the U.S. housing market?
James Egan: On top of everything you just
mentioned, the stock market is down over 15 per cent from recent
peaks, so there is a lot going on these days. We think it all has
implications for the U.S. housing market. Where do you want me to
start?
Jay Bacow: I think it's hard to have a
conversation these days without talking about tariffs, so let's
start there.
James Egan: So, we worked on the impacts of
tariffs on the U.S. housing market with our colleagues in
economics research, and we did share some of the preliminary
findings on another episode of this podcast a couple weeks ago.
Since then, we have new estimates on tariffs, and that does raise
our baseline expectation from about a 4 to 5 per cent increase in
the cost of materials used to build a home to closer to 8 per
cent right now.
Jay Bacow: Now I assume at least some of
that 8 per cent is going to get pushed through into home prices,
which presumably is then going to put more pressure on
affordability. And given the – I don't know – couple hundred
conversations that you and I have had over the past few years, I
am pretty sure affordability's already under a lot of pressure.
James Egan: It is indeed. And this is also
coming at a time when new home sales are playing their largest
role in the U.S. housing market in decades. New home sales, as a
percent of total, make up their largest share since 2006. New
homes for sale – so now talking about the inventory piece of this
– they’re making up their largest share of the homes that are
listed for sale every month in the history of our data. And
that's going back to the early 1980s.
Jay Bacow: And since presumably the cost of
construction is much higher on a new home sale than an existing
home sale, that's going to have an even bigger impact now than it
has when we look to the history where new home sales were making
up a much smaller portion of housing activity.
James Egan: Right, and we're already seeing
this impact come through on the home builder side of this,
specifically weighing on home builder sentiment and single unit
building volumes. Through the first quarter of this year, single
unit housing starts are down 6 per cent versus the first quarter
of 2024.
Jay Bacow: All right. And we're
experiencing a housing shortage already; but if building volumes
are going to come down, then presumably that puts upward pressure
on home prices. Now, Jim, you mentioned home builder sentiment.
But there's got to be home buyer sentiment right now. And that
can't feel very good given the sell off in equity markets and
what that does with home buyer's ability to afford to put down
money for down payment. So how does that all affect the housing
market?
James Egan: Now that's a question that
we've been getting a lot over the past couple weeks. And to
answer it, we took a look at all of the times that the stock
market has fallen by at least 20 per cent over the past few
decades.
Jay Bacow: I assume when you looked at
that, the answers weren't very good.
James Egan: You know, it depends on the
question. We identified 10 instances of at least a 20 per cent
drawdown in equity markets over the past few decades. For eight
of them, we have sufficient home price data. Outside of the
Global Financial Crisis (GFC), which you could argue was a
housing led global recession, every other instance saw home
prices actually climb during the equity market correction.
Jay Bacow: So, people were buying homes
during a drawdown in the equity market?
James Egan: No home prices were climbing.
But in every instance, and here we can go back a little bit
further, sales declined during the drawdown. Now, once stock
markets officially bottomed, sales climbed sharply in the
following 12 months. But while stock prices were falling, so were
sales.
And Jay, at the top of this podcast, you mentioned mortgage rate
volatility. That matters a lot here…
Jay Bacow: Can you elaborate on why I said
something so thoughtful?
James Egan: Well, it's because you're a
very thoughtful person. But why mortgage rate volatility matters
here? While sales volumes fall in all instances, the magnitude of
that decrease falls into two distinct camps. There are four of
these roughly 10 instances, where the decrease in sales volumes
is large; it exceeds 10 per cent. And again, one of those was
that GFC – housing led global recession. But the other three all
had mortgage rates increased by at least 200 basis points
alongside the equity market selloff.
Jay Bacow: So not only were people feeling
less wealthy, but homes were getting more expensive. That just
seems like a double whammy.
James Egan: Bingo. And there were more
instances where rates did actually decrease amid the equity
market selloff. And while that didn't stop sales from falling, it
did contain the decrease. In each of these instances, sales were
virtually flat to down low single digits. So, call it a 3 or 4
per cent drop.
Jay Bacow: All right, so that's a really
good history lesson. What's going to happen now? We've been
talking about the housing market being at almost trough turnover
rates already for some time.
James Egan: Right, so when we think about
the view forward, and you talk about trough turnover rates, I've
said some version of this statement on this podcast a few times…
Jay Bacow [crosstalk]: You’re saying it
again…
James Egan: … but there’s some level of
housing activity that has to occur regardless of where rates and
affordability are. And coming into this year, we really thought
we were at those levels. I'm not saying we don't still think that
we're there, but if mortgage rates were to stay elevated like
they are today as we're recording this podcast, amid this broader
equity market volatility, we do think that could introduce a
little bit more downside to sales volumes.
Jay Bacow: All right, but if we've got this
equity drawdown, then I feel like we've been getting other
questions from homeowners’ ability to pay for these mortgages –
and delinquencies in the pipeline. Do you have anything to
highlight there?
James Egan: Yes, so I think one of the
things we've also highlighted with respect to the unique
situation that we're in in the US housing market is – just how
low effective mortgage rates are on the outstanding universe
versus the prevailing rate today.
We've talked about the implications of the lock-in effect. But if
we take a closer look on just how much bifurcation that's led to
in terms of household mortgage payments as a share of income,
depending on when you bought your house. If you bought your house
back in 2016, your income, if we at least look at median income
growth, is up in the interim.
You probably refinanced in 2020 when mortgage rates came down.
That monthly payment as a share of today's income, today's median
household income, roughly 8.5 per cent. If you bought up the
median priced home at prevailing rates in 2024, you're talking
about a payment to income north of 26 per cent. When we look at
performance from a mortgage perspective, we are seeing real
delineations by vintage of mortgage origination – with mortgages
before 2021, behaving a lot better than mortgages after 2021. So
the 2022 to [20]24 vintages.
I would highlight that losses and foreclosures, those remain
incredibly contained. We expect them to stay that way. But when
we think about all of this on a go forward basis, we do think
that mortgage rate volatility is going to be important for sales
volumes next year. But everything we talked about should lead to
continued support for home prices. They're growing at 4 per cent
year-over-year now. By the end of the year, maybe 2 to 3 per cent
growth. So, a little bit of deceleration, but still climbing home
prices.
Jay Bacow: Interesting. So normally we talk
about the housing market. It's location, location, location. But
it sounds like the timing of when you bought is also going to
impact things as well. Jim, always a pleasure talking to you.
James Egan: Pleasure talking to you too,
Jay. And to our listeners, thanks for listening. If you enjoy
this podcast, please leave us a review wherever you listen and
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