Back in March I wrote an article titled “The Honest History of Home Prices and Mortgage Rates,” demonstrating why the most recent great inflationary period in the 1970’s is not relevant to today’s housing market. In that article I came up with a graph that I thought — despite being a bit ugly — provided some great historical context for the relationship between mortgage rates and home prices. At the time 30 year mortgage rates were around 5%. Seven months later, 30 year mortgage rates have climbed over 7% according to the benchmark index provided by Mortgage News Daily, so I thought it was a great time to revisit that graph.
The honest history of home prices and mortgage rates in one chart, updated
The latest data point was added using median home price data for September 2022 from Realtor.com, and 30Y mortgage rates as of the Friday close from the MND index. Click to enlarge the graph:
First, what is this graph? It is a way to reduce the three most important variables governing housing affordability — home price, income, and prevailing mortgage rates — into a two-dimensional chart. Taking a ratio between the median home sale price and the median household income inherently abstracts away inflation while maintaining the relevance of both variables for comparisons over time.
Note, since 1982, the graph’s general trend of “up and to the left.” This occurs because as interest rates fall, borrowers can take out a larger loan for the exact same monthly payment. For example comparing two 30 year loans, a $400k loan at 7% interest has the exact same monthly payment as a $444k loan at a 6% rate. So for the same income level, home buyers are able to borrow a larger mortgage, thus influencing the Y-axis variable to grow as the X-axis variable shrinks.
Also note there are several “loop-the-loops” in the graph. We see one occurring at the data points for 1981, 1994, 2006, and 2018. What is happening here is that during the period from 1981–2021, mortgage rates steadily fell from around 18% to below 3% following general Federal Reserve policy. This four-decade trend was briefly interrupted by shorter periods of monetary tightening and rising interest rates which generally causes a cooling in the broader economy, and coincident with increasing the cost to borrow on a mortgage, puts downward pressure on the prices of homes (or causes them to appreciate less than the rate of wage growth) because home buyers primarily “buy the monthly payment” rather than the nominal home price.
There were of course other factors in 2008 specific to the mortgage market which deepened that crisis’ impact on home prices, but home prices had already stagnated and declined slightly from their 2005 record prices prior to the September 2007 implosion of Lehman Brothers. Hence why that loop-the-loop is the most stretched in the Y-axis than any other.
Obviously the history in all of these cases is already written, so we know that in each of these cases The Fed has followed up with rate cuts which were greater in magnitude than the hikes, juicing home prices to continue growing relative to median household incomes and continuing the “up and to the left” trend.
The Fall 2022 housing market in historical perspective
From the updated chart we can draw two conclusions:
- The median home sale price to median household income ratio is higher today than during the 2008 bubble, and higher than at any point in this 50 year data set.
- Mortgage rates are now officially higher than they were at their peak during 2006, and are at the same level as around 2001 when the median home cost ~4x the median income compared to ~6x today.
This can be consolidated into the single conclusion that for the median household, affordability in today’s housing market is undeniably worse than it was during the 2008 housing bubble.
Notably, mortgage rates have never relatively risen this much, this quickly, ever. We’ve seen about a 4% increase in 30Y mortgage rates since the start of the year. While 1979 and 1980 posted similar increases in absolute terms, rates were in the double digits already in those years so this year’s 4% rise in relative terms starting from around 3% is multiple times larger.
Almost everyone agrees in hindsight that 2008 was a housing bubble. If this situation today is worse, how is it not also widely considered a bubble?
Around 2014, the usual permabears began sounding the alarm because the median sale price of homes had finally reached once again the previous high set in the mid-2000’s. Of course, nobody took them seriously because they didn’t even adjust for inflation and mortgage rates were lower in 2014 than in the mid-2000’s, so affordability was much better at the time.
In inflation-adjusted terms, homes finally hit the same price point as the peak of the 2008 bubble in Q3 of 2021:
However, in late 2021, 30Y mortgage rates were around 3% compared to over 6% in 2006, so affordability-wise it was still a better situation than the mid-2000’s bubble even though home prices had reached that lofty peak once again in real terms.
Now the Federal Reserve’s tightening actions have sent mortgage rates above their mid-2000’s levels all while prices are higher both in real terms and relative to median incomes. Year-to-date, the principal and interest payment portion of a mortgage on the median home at prevailing interest rates with 20% down has increased nearly $1,000 per month, comparing the median $392k home with a 2.95% interest rate at the end of 2021 to the median $427k home with a 7.12% interest rate today. Many municipalities are additionally hammering home large property tax increases to capture their share of the pie. Buyers in higher-than-median cost of living areas and/or those who cannot muster 20% down have seen their potential payments skyrocket even further.
The low interest rates argument against this being a housing bubble has been torpedoed. Affordability is officially worse than at any time during the 2008 run-up for the median household.
The last two arguments being trotted out as to why home prices will not decline significantly is low housing inventory levels, as well as some variation of 2008 being a once-in-a-lifetime event where the conditions such as toxic loan products are not present today. Let’s take a look at both of those.
The housing shortage myth
Realtor.com’s data shows the number of actively listed homes for sale in September 2022 as 732k. This is a historically low number; for context some pre-pandemic data points from 2017–2019 show the number of active listings in September of those years around 1.2-1.3 million:
Some people like to say that low levels of housing supply is the new normal, we have underbuilt since The Great Recession and therefore since supply is restricted with continuing millennial demand, home prices will stay flat or continue to rise. They claim that it’s a paradigm shift where median home price to income ratios can stay elevated since median income households are not the ones buying homes anymore and have likely been priced out of the market forever.
However that is easily disproven by looking at transaction volume. By doing so, we can see that there is not a housing supply problem, rather it was a temporary demand problem which I believe was primarily caused by government and Federal Reserve stimulus injecting trillions of dollars into the economy including purchasing $1.5 trillion in Mortgage Backed Securities which artificially reduced mortgage rates. People had more money in their pockets than ever and mortgage rates were lower than ever, meaning Americans could borrow more than ever relative to their incomes to buy a home — and American consumers as usual spent like sailors at port. Additionally, the pandemic accelerated many households’ plans to buy a home, which is clearly a one-time effect of pulled-forward demand.
Let’s take a look at that transaction volume:
We can clearly see that in both 2020 and 2021, more existing homes were sold than any year since 2006. About 1 million extra homes total were sold in 2020 and 2021 compared to what would be expected based on transaction volume from the prior 5 years.
Those million homes were pulled-forward demand that ate into the supply of active listings, leading to the myth of a housing shortage. We have already seen the number of active listings increase 26.9% year-over-year, so as continued Federal Reserve tightening actions crush the demand side even harder for houses at these prices and mortgage rates, the number of active listings will continue to grow.
That domino is already falling, and perhaps when the number of active listings surpasses 1 million again we can stop hearing this myth of a housing shortage.
“2008 was a once-in-a-lifetime event” faces off with the reality that today is probably the worst time in your lifetime to buy a home
Finally, let’s take a look at the argument of 2008 being a once-in-a-lifetime event where the conditions such as toxic loan products are not present today, therefore a crash in home prices will not occur.
This type of thinking exhibits characteristics of recency bias and selection bias. 2008 was not that long ago and is still forefront in many peoples’ memories when they think of the word “recession.” It was also the first time since the Great Depression where home prices declined in nominal terms, so it is also most peoples’ foremost example of what a housing correction or crash looks like.
As a singular data point, it gets conflated that the symptoms that caused the 2008 bust are the symptoms of a housing bubble, therefore if we do not have things like toxic CDO products and “No Income No Job” (NINJA) loans present today, there can be no housing bubble in 2022.
Obviously the above thinking is wrong for a multitude of reasons but the most important one is that no two financial market events are the same. Every market shock has different causes and varying degrees of negative outcomes. As the saying goes, history does not repeat but it does rhyme.
Perhaps 2008 was actually a “first-of-its-kind” event caused by the increasing financial commoditization of real estate loan products and Americans’ psychological shift around the 1990’s toward viewing their primary residence as an investment rather than a commodity? Regardless, it’s correct that this isn’t 2008 all over again. This is 2022, under a wholly different set of circumstances, and for anyone under 60 years old this definitively the worst time in their lifetime to buy a home.
Generally I am a proponent of the common wisdom that “time in the market is better than timing the market.” But for a couple of reasons, I do not think that this applies to real estate today:
The first is that unlike stocks, you cannot dollar cost average into a house. The price you pay today is the price you paid, and you cannot average down the cost you paid for your primary residence by purchasing more shares. Refinancing should not be counted on to bail you out of a high monthly payment as nobody knows when or if mortgage rates will go down again, and it’s also important to point out that you cannot refinance if home prices decline and you have negative equity (unless you bring more cash to the table to pay the difference between your loan value and the home value).
Secondly, I’m a firm believer that there are very rare times where markets simply break beyond any rationalization. While studying Japan’s financial crisis of the 1990’s, I noted that approaching the peak of the bubble during the late 1980’s, their Nikkei 225 index was trading around a 1% earnings yield. At the same time, one could buy 10 year Japanese Government Bonds yielding 6% interest, while inflation was between 1–3%. The suggested equity risk premium was massively negative but this strange situation persisted for several years before the irrational exuberance dissolved and the Nikkei 225 was slowly crushed by nearly 80% between late 1989 and 2002.
I know the housing market is broken because it has become nonsensical; while we were searching during 2020 and 2021 and putting in bids on homes we figured we’d be overpaying a bit, but that was a price we were willing to pay for the benefits of having a house. The numbers don’t even come close to adding up anymore. Compared to other households in our county we’re around the 90th percentile for household income; we also have huge savings rates and nearly no debt. Rising mortgage rates have caused us to stop looking at homes completely until prices in our area soften. Financially, the premium over renting makes no sense and doubling our housing cost just to get into a mediocre starter home is not an expense we are willing to incur. Who is even left to buy in this market?
I predicted earlier this year that The Fed’s impending tightening actions would cause a housing correction in a vacuum. In the past few weeks, Chair Powell said that the housing market needs a “difficult correction” to get affordability back into balance (note that Powell used the term “reset” in reference to housing in June; the shift in vocabulary seems like intentional jawboning). Additionally Fed Governor Waller said in a speech on Thursday, “while this market correction could be fairly mild, I cannot dismiss the possibility of a much larger drop in demand and house prices before the market normalizes.”
And that’s a price they’re willing to pay to get inflation under control. Potential homebuyers, sit tight and don’t fight the Fed.