Physicians' Guide to Wealth

A guide for anyone pursuing financial independence

Cooling Housing Market

Apr 27, 2022

For those of you who own or have piloted a boat, know that when you bring the throttle back, the boat doesn’t stop right away. Depending on how fast you are going, it might take several minutes before you come to a complete stop. The bigger the boat the longer it takes to come to a stop. The biggest of all ships are the supertankers that can carry more than two million barrels of oil, or enough to power all US auto traffic for four hours. These ships take about 20 minutes to come to a complete stop from normal speeds. The point is that all moving objects have various durations required to stop or change direction.
This phenomenon of Newton’s Second Law of Motion is also true in economics. Smaller businesses are nimbler to increase or slow down their production, some in weeks or months, while larger companies may need many quarters or years to make significant changes.

The housing industry comprises of a wide assortment of businesses, from small local contractors to multi-national suppliers. In addition, are a variety of real estate properties, from single-family houses to downtown skyscraping office towers. All is well for small and large companies and properties when markets are rolling along consistently without any major disruption. However, throw in a world pandemic, society-changing working standards, and dramatic changes in the cost of funds and interest rates, and everyone in this industry is impacted one way or another.

The pandemic and subsequent government restricting regulations on society and businesses in 2020 was the beginning of major disturbances in the residential market. As businesses adopted quickly with remote work arrangements for their employees, people realized they could move out of their high-priced small metropolitan residences to larger houses in more affordable suburbs that substantially increased housing demand in these areas. The fastest-growing suburbs in size and price increases were lower-cost areas or states as millions of people freed from their offices were now able to work remotely anywhere with the internet.

Many had favorable arbitrage of equity moving from higher housing cost areas to lower-cost areas, and with sub 3% mortgage rates, had significant buying power. Builders could not keep up with this new demand, and the lack of supply resulted the same explosive housing appreciation of the early 2000s, with some areas increasing in price by 20% to 50% in just two years. Illustrated below is the significant recent rise in housing prices indicated in the Case-Shiller Home Price Index in the US.

However, just as quickly as this housing boom started, it may be ending just as fast. The flow of migration seems to be dimensioning as those that want to move to have, and the sudden 100% increase in 30-year fixed mortgage rates has substantially changed the cost of housing. Mortgage applications in the US declined 8.3% last week and the 7th consecutive weekly decline. In last week’s report, refinancing applications declined by 9%, and purchase applications declined by 7.3%. At the end of last week, the 30-year fixed-rate mortgage's national average increased from 5.2% to 5.37% which is the highest rate since 2009.

What Does This Mean to Me?

People’s plans can change quickly but not so easily for national developers and suppliers. Stocks for major housing developers have sold off sharper than the S&P 500 so far this year. Below illustrates the rise and recent correction of stocks. Toll Brothers, Pulte Homes, and DR Horton are down 27% to 37% YTD.
The same selloff took place with dominant home suppliers Home Depot and Lowes.
We would project more volatility in the housing market as the areas begin to settle into a more normal balance of supply and demand. We would anticipate the pace of rising house prices to slow or even flatten for the next several quarters into 2023. Monitoring new mortgage applications will give direct insight into the future of housing prices. If the number of new applications continues to decline, that will indicate a declining number of new buyers for new purchases. Builders are in full swing just as demand may be slowing, resulting in the opposite imbalance of growing supply with declining demand, which typically is a scenario of declining prices.

Circling back to stocks of home builders and suppliers, we view the recent decline in stock prices as a buying opportunity. The housing supply and demand imbalance will be resolved over the next several quarters. The rise in mortgage rates only returned to the average rate through the entire housing boom in the early 2000s. Stocks prices for Home Depot and Lowes will also in our opinion recover as their sales are still strong (have you been to Home Depot lately, people everywhere) and we believe the selloff of these stocks was an overreaction to the fear people would suddenly stop remodeling or fixing up their houses whether to prepare to sell or because they just bought a new house.

Give us a call or send an email if you have any questions about your account or this Weekly Brief. We truly appreciate your comments and communication. Now go buy some lumber.




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