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- The housing market is starting to cool as mortgage rates rise.
- José Torres of Interactive Brokers warns that steep declines in home prices are ahead.
- Torres expects the declines to play out over the year ahead.
For José Torres, supply and demand dynamics in the housing market are moving in such a way that creates a perfect recipe for home price declines.
On the supply side, in order to catch up to skyrocketing demand during the period of low interest rates since early 2020, homebuilders began putting up houses across the country at a rapid pace.
Even though housing starts (marked by the red line below) have started to fall, they still remain at elevated levels.
Housing inventory was also up 18.7% year-over-year in June, according to Realtor.com, and has risen around 50% since the start of the year.
But as the free-money environment helped to fuel 41-year-high inflation rates at 9.1%, the Federal Reserve has also pivoted hard this year to a more hawkish stance, causing mortgage rates to nearly double. Additionally, average 30-year mortgage rates have climbed as high as around 5.8% after starting the year at 3.1%, Freddie Mac data shows.
That’s killing demand.
“A perfect storm is brewing in the real estate market due to near decade high construction levels and plummeting demand,” said Torres, senior economist at Interactive Brokers, in a commentary on Tuesday.
“Homebuilders said, ‘Jeez, we’re making so much money, there’s so much demand, everyone wants a house. Let’s build like crazy,” Torres added in a phone call to Insider on Thursday. “Now, the Fed is reversing all that [stimulus] because they’re admitting basically, in their minutes and their meetings, that they stimulated too much. But all that construction that was starting, it has to finish. So it’s the misalignment of time between supply and demand.”
The result, Torres said, will be a severe pullback in home prices. He said he expects median US home prices to drop by 25% when all is said and done. That’s how much the S&P/Case-Shiller US National Home Price Index dropped during the mid-2000’s crisis.
“We’re going to see something very similar to what we saw during the Great Financial Crisis” in terms of price declines, he said.
He said he expects to see double-digit declines in early 2023, and said that the market would bottom when the Fed pivots to more accommodative policy, which he expects to happen in mid-to-late 2023.
Torres also said he thinks home prices are going to come down so much because the Fed is just getting started on their quantitative tightening campaign (the market has priced this in already to a degree, though it remains uncertain how how inflation will go and how hard the Fed will be forced to tighten). This means they’ve stopped buying new mortgage-backed securities, and could begin selling them. Right now, they own about a third of the mortgage-backed securities market.
Buyers of mortgage-backed securities essentially lend their money to homebuyers. When there is less demand in the market for the securities — and therefore less liquidity for borrowers — mortgage rates increase.
The central bank has been buying up the assets at a pace of $40 billion per month.
Another reason Torres is bearish on home prices is because housing affordability has been dropping at an unsustainable pace. UBS highlighted this in a recent note, showing that housing affordability is at its lowest level since 2006.
“At this point, housing is unreachable when considering household incomes and individual incomes,” Torres said. “The percentage of the average monthly payment to household incomes and individual incomes is at record highs — similar to levels that we saw during the 2008 financial crisis.”
The general tone of the industry has seemed to shift more bearish in recent months as mortgage rates have soared. Redfin CEO Glenn Kelman said on CNBC on Tuesday that he sees a rocky road ahead for home prices.
“62% of Boise homes have dropped their price. More than half have done so in Salt Lake City and Denver. So I don’t think it’s going to be a smooth landing. It’s going to be a very bumpy landing,” Kelman said.
“The markets that were the hottest have the furthest to fall,” he added.
Homebuilder sentiment posted its second-worst month in the last 37-years in June, when housing starts had their worst month since September. Existing home sales in June were also down 14.2% from June 2021.
The Mortgage Bankers Association said this week that they expect 30-year mortgage rates to stay above 5% through the first half of 2023, and for existing home sales to fall 8% this year from 2021.
Still, some don’t see severe — if any — price declines ahead. Morgan Stanley said in a note on Thursday that constrained supply in the housing market would prop up prices.
“Overall, housing activity continues to weaken as affordability pressures, rising inflation, and higher mortgage rates weigh on housing activity. Our economists have discussed how demand for housing has begun to wane and is expected to continue to weaken due to tight housing supply and rising mortgage rates. Despite weakening activity, tight supply should keep home prices elevated,” the bank said.
Redfin chief economist Daryl Fairweather told Insider earlier in July that she doesn’t expect declines of more than 4% in a recessionary scenario because of constrained supply.
But the degree to which supply and demand dynamics are inputs for what home prices do in the months ahead is being debated. For example, the Federal Reserve published a research paper in June showing that price gains over the last two years have been demand-driven thanks to low interest rates.