The resilience of the US residential property market in 2023 

December 2023

December 2023

Edward Leamer’s 2007 paper ‘Housing is the Business Cycle’ examined the relationship of housing cycles with business and employment cycles. His conclusion was that “of the components of GDP, residential investment offers by far the best early warning sign of an oncoming recession”. His study has since been replicated, observing consistent evidence of the US housing cycle as a leading indicator of growth and employment across business cycles.

At the start of 2023, there were serious concerns about the US residential housing market and its potential to cause a recession. If investors had foreseen the most aggressive Central Bank monetary tightening in history, there is no doubt that a serious crash would have been expected, but it hasn’t materialised. Below, we discuss why it never materialised and whether rates will actually come down as predicted.

The increase in rates may not have caused a market crash but it has had an impact on the sector. Construction activity has taken a hit due to increased building costs, and residential property transactions have fallen year-on year by 10%. As a result, US homebuilders have been offering incentives to support demand. However, this market weakness has not been as severe as it could have been because of the mortgage rate lock-in effect and increased resilience in the sector.

Mortgage rate lock-in effect

According to the Home Mortgage Disclosure Act, the US residential housing market is predominately made up of long-term fixed-rate mortgages with the 30-year loan term comprising over 70% of the US mortgage market. Based on data from Black Knight, more than 40% of all US mortgages originated in 2020 and 2021 due to a refinancing boom that was triggered by low borrowing costs during the pandemic, reducing average monthly mortgage repayments.

Therefore, mortgage holders have a strong incentive to stay in their existing properties, with mortgages financed at low rates (the mortgage rate lock-in effect), rather than re-financing at significantly higher rates. As of the end of October 2023, Freddie Mac reported that the average 30-year fixed-rate mortgage peaked at 7.79% – the highest level since November 2000 in contrast to an average of 3% in 2021.

Just like tracker mortgages in Ireland, this existing low-rate mortgage has become an asset that homeowners do not want to walk away from with mortgage originations down 30% year-on-year.

Increased resiliency in the US residential housing market

In contrast to the 2008 housing market crash, lending standards are tighter. Whilst house prices have come down in real terms, the resilience in nominal terms has meant there is unlikely to be negative equity. According to the Federal Reserve, US household owners’ equity is at its highest level in decades in contrast to the lows seen during the financial crisis.

While these factors cannot be relied on indefinitely to support the US residential housing market, the potential rate cuts in 2024 will help. We also take comfort that there has been no build up in private sector debt this cycle and that the underwriting standards have been extremely high. Housing inventory is also more constrained for prospective buyers which should keep up demand.

We are increasingly confident that the US residential housing market has avoided a potential crisis, ensuring a brighter outlook for risk assets.

Any views and opinions are those of the Fund Managers, this is not a personal recommendation and does not take into account whether any financial instrument referenced is suitable for any particular investor.

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