A Positive Note From Housing

May 18, 2016

A Positive Note From Housing

  • Housing starts, positive homebuilders and a pickup in Chinese building all create a good feeling about the economy and markets.
  • Average house prices have increased but median prices show that the current situation is not even close to a bubble.
  • Rent prices are rising and therefore more buying is expected as people switch to buying instead of renting.

Introduction

Recent news about housing is positive. On Monday, the National Association of Home Builders reported the housing market index at 58 where a reading above 50 means that home builders have a positive feeling about the single-family housing market. Two days earlier, on Saturday, the Chinese National Bureau of Statistics reported that property investments in the first four months of 2016 rose 7.2% and construction starts gained 21.4%. And on Tuesday new housing starts came in at 1.17 million or 6.6% higher than in March. All of this is very positive news but the most important thing for investors is how this affects the economy and markets. As housing ignited the great recession, it is important to constantly be aware of what is going on in the housing market.

Housing, the Economy and Markets

Housing is an essential sector in an economy but it’s also one that has been the source of crises. The environment for house buying is cyclical as it is related to interest rates and employment. The result is that house prices also have boom and bust cycles. Economists and policy planners have to be aware of the cycles and try to keep things stable as stability is preferred. As there is not yet a clear policy toolkit on how to manage housing booms or on how to evaluate if the housing market is overvalued, investors might still get the short end in an eventual housing crisis.

In relation to the economy, a stable housing market is what enables mortgages and labor mobility. Labor mobility is essential for the reach of full employment and mortgages are essential for a healthy monetary policy. International monetary fund (IMF) research shows that more than two thirds of the systemic banking crises in recent decades were influenced by housing.

Current Housing Situation

The current housing situation is still below the highs experienced in 2007 but showing good signs for a strong recovery.

1 figure shiller home prices
Figure 1: S&P/Case-Shiller U.S. National Home Price Index from 2006. Source: S&P Indices.

The low of the home price index was reached in 2012 at 134 points, or 28% lower than the peak reached in 2006 at 184.62 points. The current value is 175.61 and up 5.2% year-over-year. An indication of the overvaluation of a housing market can be extrapolated by looking at rent to price ratios. House prices and rent should move in tandem, if one gets high people tend to switch between renting and housing.

2 figure price to rent ratio
Figure 2: Gross rent price ratio 1960-2015 Q3. Source: Lincoln Institute.

The last available rent to price ratio (Q3 2015) was exactly 4% which is still good when compared to the 3.13% reached in Q3 2006, but the declining trend creates some concerns as house prices do not move along with rents. It is especially strange that rent prices do not go up as fast as home prices as the ownership rate has declined and keeps falling.

3 figure homeownership
Figure 3: US homeownership rate. Source: United States Census Bureau.

The above might create some concerns, but don’t be fooled by statistics. The above gross rent price ratio uses average prices (figure 2), but by using median prices (median shows the middle point of a number set) the results differ.

4 figure median asking rent
Figure 4: Median asking rent for vacant rent units 1995-2016. Source: United States Census Bureau.

Median asking rent has constantly increased, especially in the last 5 years while median asking house prices have rebounded a bit, but not much since the 2012 lows.

5 figure median asking price
Figure 5: Median asking sales price 1995-2016. Source: United States Census Bureau.

The difference between average and median rent and home prices shows that there is a segmentation in the US housing market where some properties skew the market index and make it look overvalued in relation to rent. From a median perspective it looks like the housing market still has plenty of room to grow as rents are soaring and not house prices. This might be the result of the great recession and tighter mortgage regulations, but with strong employment the outlook is positive and is confirmed by recent housing data that shows a 6.6% April increase in residential starts (1.17 million seasonally adjusted). Also, from an historical perspective there is still a huge gap to be filled with new homes as residential starts are still far from the historical average of 1.5 million.

6 figure housing starts
Figure 6: New privately owned housing units started. Source: FRED.

Housing in China

As China is the world’s second largest economy, it is also important to see what is going on there. China is a developing country and therefore its housing sector has a strong influence on commodity prices around the world. The good news is that property prices are increasing as a result of the government monetary policy.

7 figure china real estate
Figure 7: Chinese housing. Source: Wall Street Journal.

This might keep the Chinese economy growing at expected levels and keep the global markets stable.

Conclusion

It is interesting how similar statistical data can tell a completely different story. As Benjamin Disraeli used to say: “Lies, damned lies and statistics.”

Median rent prices are still surging and therefore house prices should not be considered in a bubble just because the average house prices increased in the last 4 years. Median house prices show that there is plenty of room to grow and that the recent growth is a sustainable one, especially with high employment. The situation in the Chinese housing market is also improving and therefore the outlook for the economy and financial markets should be positive from a housing perspective.