Activity in the US housing market is rapidly declining. New home sales fell more than 12 per cent in July, the biggest drop since February last year. It was also the sixth decline in seven months. Compared to the peak, 51 per cent fewer new homes were sold.
By comparison, in 2009, the overall decline came to 70 per cent. So this is a considerable cooling off of the US housing market, to say the least. As a result, the stock of unsold homes is skyrocketing. On average, it now takes almost 11 months for developers to get their newly built homes put away. It is easy to guess what these high inventories are doing to house prices.
In addition, the affordability of US homes has fallen sharply. The figure below shows the National Association of Realtors’ Housing Affordability Index. That has now dropped to almost 100, the level at which an American seen with a median income has just enough money to buy a house at normal financing.
The affordability of a home is largely determined by two obvious factors: price and interest rates. Both have made a house unaffordable for a good number of Americans. Since December last year, 30-year mortgage rates have risen by more than three percentage points, 300 basis points.
The chart below shows that the recent interest rate spike has been extreme, giving homebuyers little opportunity to buy a house at more attractive interest rates.
In recent decades, fewer and fewer houses are being built relative to the number of people. This secular trend has certainly contributed to house prices rising well above the long-term trend.
Should the value of an average US home fall back to the long-term trend, the price should fall by 27 per cent. In the Eurozone, the difference is less, but would still require a 13 per cent fall to reach the long-term trend.
The secular trend of fewer homes per capita cannot prevent cyclical forces from pushing down house prices. Based on a simple model with mortgage rates and the stock of unsold houses as inputs - which together can predict the change in house prices reasonably well - prices are going to fall by an average of 12 per cent over the next 12 months.
With a growth slowdown or, in Europe’s case, a recession already in the making, and consumer confidence historically low due to persistently high inflation, this does not bode well for consumer spending. It does feel just that little bit nicer to buy that new washing machine knowing that house prices are soaring.
Jeroen Blokland is founder of True Insights, a platform that provides independent research to build diversified multi-asset portfolios. Blokland was most recently head of multi-assets at Robeco. His “chart of the week” appears every Monday on Investment Officer Luxembourg.
This contribution first appeared in Dutch on InvestmentOfficer.nl.