Warning signs in housing
“There is a time to make money and a time to not to lose money” - David Tepper
Mortgage rates have risen sharply alongside a steep rise in house prices relative to incomes. Meanwhile, consumers real purchasing power has been eroded by wage increases that have lagged inflation. This was brought into heightened relief by comments made by the CEO of Restoration Hardware on a results conference call this week:
“While the first quarter sales and margin stand to remain healthy due to the ongoing relief of our backlog, we have experienced softening demand in the first quarter that coincided with Russia’s invasion of Ukraine in late February…and believe it is prudent to remain conservative until demand returns to normal”. He went on to say that “Its probably one of the most difficult gudes since 2008 and ‘09…I don’t think its all Ukraine and Russia. I think its triggered a greater awareness…all of a sudden the Fed is off to the races and that creates concern. You’ve got housing prices at all time highs. I mean, is it sustainable? I don’t know for how long the math. Doesn’t make sense what’s happening in the housing sector and other places…I don’t think anyone really understands what’s coming from an inflation point of view because either businesses are going to make a lot less money or they’re going to raise prices…and I think its going to outrun the consumer.”
This has been mirrored in weak performance in other housing-related shares (e.g. Whirlpool, Lowe’s and Home Depot and various homebuilders). In addition to concerns over the health of the consumer, the availability of money and credit will face significant downward pressure into next year judging by the signposts from the Federal Reserve (quantitative tightening) and from financial markets (a collapsing yield curve).
Taking all of these factors together, a best guess would be a 10% reduction in real home prices in the U.S. over the next three years. Below are the building blocks.
Affordability is a key determinant of house prices, but by itself is insufficient to dictate the direction. The chart on right measures the theoretical cost of buying a home today (relative to incomes) and then compares that to the prevailing cost over the recent past. The series leads by 3 years.
It is not just the cost of money which affects housing, but the availability of it. The second factor (on right) is the growth in broad money supply (M2) after accounting for inflation. This is a shorter lead of about 7 months. I have incorporated a $1trn annualized pace of QT into the M2 projections beginning in May.
These financial factors influence real estate fundamentals. Two key property metrics are inventories and the pace of investment into real estate (either through CapEx, building or purchasing existing units) relative to the total investment. While inventories are extremely low by historic standards, simply the base effects means they will be less supportive than previously the case. Meanwhile the level of investment into real estate is declining relative to the investment across the economy as a whole, suggesting that transaction velocity is beginning to fade. This would lead to inventories increasing relative to the rate of home sales. These elements are shown on the charts below.
Bringing these factors all together, along with a few others (e.g. employment and the yield curve), the picture looks like the one below. To get confirmation on whether this holds, I would look for (1) a decrease in pending home sales, which lead existing home sales data by 1-2 months; (2) the rate of growth in bank lending (weekly H8 data from Federal Reserve); and (3) the pace of QT guided and executed by the Fed.
