Back when I briefly worked in mortgage securities, when some people would exclaim that the home price rises were moving up too fast, a common response was: home prices in the US have never fallen. We all know where that logic led in 2007-2008.
That boom was driven by a combination of low rates and loose lending standards. Yet now, we are in the midst of yet another housing boom 15 years later. This time lending standards are seemingly holding up but even lower mortgage rates are driving up prices. I pointed out in a post a few weeks ago that the price rises can be blamed squarely on interest rates. The Fed now owns 2/3 of all mortgages in the country and has been hovering up billions each month. So much so that there is some speculation that tapering will start not across the board, but with mortgage securities in order to slow the market down a bit and allow for some healthy retrenchment.
A Repeat or Investment Opportunity?
Besides rates though, the significant twist of the current housing boom is the regionality of the price increases. In 2005-2007, price increases were concentrated in markets along the coasts with a few inland markets also experiencing a frenetic boom. Think the Bay Area along with places like Las Vegas and Phoenix. When the market crashed, these places also saw the biggest price declines.
Housing then was seen as an important investment vehicle. The crash taught many a painful lesson in risk taking and how things could go wrong when invested in a falling market with such an illiquid asset as a house. At that time the stock market was re-approaching all time highs that it had experienced in the early 2000’s. Housing was seen as an important diversification vehicle from the stock market, which had fallen by 40% only a few years before.
I can’t help but think we find ourselves in a similar situation in the US now with the current market. Based on the median price to income ratio in the US, which currently sits at 6.43, homes are nearing their all time high of 6.96 set in 2005. Again, there are many nuances to this figure however.
In 2015, the median home in the US was 1000 feet larger than the median home 40 years earlier in 1975 or about 48% larger. The occupants per home also decreased by over 15% during this same time as well. This means that the square footage per person is at an all time high in the US. On a per square foot basis adjusted for inflation though, homes overall in the US cost about the same for what you are getting compared to 40 years ago.
In reality, homes are still affordable but consumers are demanding even larger homes. This then makes a case for investing in homes even though we find their pricing at all time highs compared to income.
From the standpoint of an investor right now, if we assume that home prices grow in a faster growing market (which I will get into later) and assume a 20% down payment, the income, combined with the price appreciation can offer very attractive returns compared to other traditional investments like stocks. Let’s take a home in a place like Texas, whose growing population may precipitate a rate of home price appreciation above the national average of 3% over the last few decades. In this case let’s assume 4%. A home valued initially at $300,000 will garner $12,000 in price appreciation in the first year. If we assume an interest rate around 3% on a conventional 30 year mortgage, around 40% of this is going towards principal replacement, or about $400 of a mortgage payment around $1,000. When more people are moving in, higher rents can be charged. It wouldn’t be uncommon to see rents 35% higher than the cost of owning. In fact, this figure comes close to the lower costs estimated by Trulia of owning versus renting. Assuming taxes and insurance around $500, this would put that $300k home at a cost of around $1500 a month which could then rent for about $2,025. This would net the owner $1,000 a month in price appreciation, $400 in principal and $525 in cash income, a return of about 33% annually before maintenance costs and factoring in the chance of default from the renters.
Location Matters
Real estate at the end of the day is all about location. To reap these types of rewards, the location has to be one where homes are relatively cheap, rent is still reasonable relative to income and people are moving to in order to live. A recent study from the Federal Reserve may point to exactly where these places are.
In the study called High Housing Valuations Move Inward, the researchers looked at the 9 different census divisions of the country and compared the home prices in those places as of March 2021 to their last peak in 2005-2007. The way the information was presented was a bit confusing at first and even took me some time to try to understand and interpret, but they seem to reach a conclusion which I had suspected for some time and which confirms the census data on the continued movement of people slowly over time to the South and West.
The first chart that was presented in the study shows the regional valuation peaks in 2005-2007 and 2021 compared to the entire US valuations.
What this shows is that valuations in the Pacific and Mountain West were both higher than the national average both in 2005-2007 and 2021. It’s already well known that places like California are expensive and that this is producing an exodus of people to places like Las Vegas and Phoenix, cheaper markets which are close to expensive hubs.
Those regions where the blue lines are greater than the orange ones are seeing prices higher in 2021 than their peak in 2005-2007. Only the mid-Atlantic is seeing prices still below the last peak.
Yet another chart that the study shared is more telling of the long term momentum of these different regions. The US as a whole is seeing prices higher than the peak of 2005-2007, but some regions are now finding prices greatly exceed the highs reached in 2005-2007 and those aren’t in the markets we saw in San Fran and New York the last time around.
Although the Mountain region is hot, think Boise, Phoenix An’s Las Vegas, it’s the West South Central that is seeing the boom this time around, with prices almost 20% higher than their peak during the last boom. This shows the general momentum of where buyers are headed. That area just so happens to include Texas, where a look at the largest county population growth since 2010 shows Texas dominates the rankings.
6 of the ten counties that added the most people overall were located in Texas. This points to a general movement of people to where the weather is warmer, jobs are plentiful and more controversially, regulation is less stringent.
Follow the Prices
As an owner of homes in both New York and NYC, I am well aware of how restrictive yet well intentioned housing policies drive up prices. The states now seeing most of the housing price growth are likely reaping the rewards of the housing policies of other states which limit building and new developments. Places like Arizona, Nevada and Texas tend to have a friendlier stance towards home builders and less cumbersome regulations governing how homes are built. Case in point is the well intentioned, yet misguided policy in California of requiring all new single family homes to have solar panels. An environmentally friendly idea but in practice puts the burden of energy production and it’s costs on individual homeowners and renters as it raises the price of new homes by an additional $10,000 if not more.
Add this to the rent control recently imposed state wide in California which limits any rent increases by 5% plus the local rate of inflation in any given year. The glaring exception to this rule is that it exempts individual owners, who get to benefits from lower housing supply, while corporations have their potential future revenue capped, thus making the large scale construction which is needed to meet the state’s housing needs, even less likely.
New York, and especially New York City have been making these blunders for decades. Only NYC is managing to maintain its population due to its status as an economic powerhouse, the rest of the state has been seeing a population drain for 40 years as high taxes and bad weather just don’t seem to be a big attraction to both companies and people.
The question now will be, as voters from these same places make their way towards the South and Mountain West, whether these places will be able to maintain the policies that attracted them there. Larger populations require ever more infrastructure investment and grinding congestion will likely produce calls for more public transport, both of which are expensive and eventually lead to higher taxes. These factors will be key to these places continuing their current boom, but for the time being it pushes on.
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