But then the yellow dots happened. Home valuations increased as rates increased, just as in the housing bubble. Perhaps that is turning around now, as housing prices are beginning to decline (typically before we see large price declines we see softening markets — fewer buyers and sellers, longer delays between listing and sales — as have been happening in the last few months) and the Fed is raising rates. But looking at the data so far, it looks like a bubble.

Maybe you shouldn’t pay much attention to what I think now, since I was exactly wrong two years ago. But I’m still not panicking about a housing crash. I expect valuations to revert to long-term mean because rents will continue to increase rapidly, meaning no dramatic drop in home prices is necessary. I base that on expectations for more legal immigration and legalization of existing undocumented immigrants and lifestyle changes — mainly more working from home — triggered by the pandemic, but not reverting to past practices. 

Eoin Treacy's view

The big difference between the housing bubble in 2005 and 2021 is consumer leverage. In the mid-2000s lending standards disappeared. People were buying houses with little more than a signature and never intended to pay the mortgage. Today, 20% down payments are still the norm in the USA. That is beginning to change with Bank of America floating zero down options but it is not commonplace.

That does not mean prices can’t go down. Mortgage rates have doubled this year to 6%. That’s means homeowners need to come up with 42% more cash to meet the payment or $178 a month per $100,000 borrowed. Without substantial wage gains that is a heavy burden. Some might be betting the rate is going to fall so they can refinance into cheaper debt but that is a risky bet if rates stay higher for longer.
 
The most likely scenario is prices fall to where they are affordable. That will be influenced by wages, availability of credit and supply. Jay Powell said yesterday they will keep hiking rates until unemployment rises enough to dampen down demand. Shelter is one of the biggest sections of the PCE indicator they use to measure inflation. That implies they are directly targeting the housing market.

There is no question that US housing prices are elevated and affordability is at a troubling level. However, the issues in other countries are worse and floating rate mortgages are a major differentiating factor. The risks for property markets in the UK (half of borrowers on five year fixes, most others are on less than two years), Australia (40% of low interest fixed rates expire in H2 2023), Canada (53% variable rate) and New Zealand (80% of mortgages refix in the next 18 months) are obvious.

These issues are so obvious and so potentially disastrous to voters that we can expect politicians to intervene to support prices. Already, the new UK administration is talking about cutting VAT, stamp duty, capping energy prices and they reversed the national insurance hike today. That’s potentially a lot of new money hitting the market, which will inevitably cause issues in the future, but should support prices in the near term.