Morning Report: Housing Affordability Woes

Vital Statistics:

S&P futures4,1240.75
Oil (WTI)75.161.06
10 year government bond yield 3.66%
30 year fixed rate mortgage 6.23%

Stocks are flattish as we await Jerome Powell’s speech this afternoon. Bonds and MBS are down.

Neel Kashkari went on CNBC this morning to say that the Fed still had to raise rates “aggressively” in order to get inflation under control. The data “tells me that so far we’re not seeing much of an imprint of our tightening to date on the labor market. There’s some evidence that it’s having some effect, but it’s pretty muted so far,” Kashkari said. “I haven’t seen anything yet to lower my rate path, but I’m obviously keeping my eyes open and we’ll see how the data comes in,” he added. Neel Kashkari thinks the Fed Funds rate will have to rise to a range of 5.25% – 5.4% in order to cool off the labor market.

Rate locks saw an uptick in January as mortgage rates fell, according to the Black Knight Mortgage Monitor. “Based on our Optimal Blue rate lock data, we can see definite signs of a January uptick in purchase lending on lower rates and somewhat lower home prices,” said Graboske. “Indeed, locks on purchase mortgages soared 64% from the first through the fourth week in January. On the surface, it may seem the market has been stirred by a full point decline in interest rates and home prices coming off their peaks – but it’s not that simple. Yes, according to the Black Knight Home Price Index, December did see home values post their sixth consecutive monthly decline, and prices at the national level are now 5.3% off their June 2022 peaks. But affordability still has a stranglehold on much of the market, with the monthly mortgage payment on the average-priced home more than 40% higher than it was this time last year. It’s also important to keep January’s surge in purchase activity in perspective. While up, purchase locks were still running roughly 13% below pre-pandemic levels for the last full week of the month.

The affordability metric is (the monthly mortgage payment as a percentage of income) is above levels we saw during the bubble years, and compares to levels last seen in the early 1980s when the Fed took the Fed Funds rate into the teens to whip 1970s inflation.

In order to square the affordability circle either mortgage rates have to fall, home prices have to fall or wages have to increase. The problem is that we need a dramatic move in at least one of these to fix the issue. If mortgage rates fall somewhat and wages rise by 4%, we still have an affordability problem. Ultimately I think the lack of supply carries the day and homes stay unaffordable for the near term until homebuilding rebounds. And if you look at the big decreases in backlog reported by the builders (along with elevated cancellation rates) that doesn’t appear to be in the cards this year.

With home prices stabilizing or even falling, some financial “power buyers” are stuck holding the bag. These companies would bid for a property on behalf of a buyer and then sell the property to the buyer at the same price once they got a mortgage. The power buyer would earn a fee and the buyer would get to submit a non-contingent offer. Some of these buyers are now backing out of these deals because they can’t qualify for a mortgage at current rates. Ribbon, one of these power buyers is stuck with 400 homes and has been forced to cut 85% of its work force.

“There was sort of a power shift, from the power sitting with the seller knowing that their home is going to sell within a day, to the power sitting with the buyer,” said Tim Heyl, founder of the Austin-based power buyer Homeward Inc. Note the location. Goldman recently said that Austin could see a 2006-esque decrease in prices.

Given the track record of Zillow, OpenDoor and these power buyers, perhaps investing in real estate is harder than it looks, and a gee-whiz model to value real estate isn’t enough to crack the code.

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