What effect will the COVID-19 economic crisis have on US home values? We’ve had that question from a few clients recently, and it is an important topic. Many Americans, after all, have as much or more wealth tied up in the value of their home than in financial assets.
We’ll start with a long run (back to 1976) history of annual percent changes in US house prices using FHFA data, which closely mirrors Case Shiller but goes back further:
Three thoughts here:
#1: Changes in US house prices are cyclical, but the damage a given recession causes can vary quite widely; some merely slow the pace of gains while others leave a deeper mark.
- The recessions of the late 1970s/early 1980s saw annual price increases go from +15% (Q1 1979) to +1.6% (Q3 1982).
- Gains in house prices during the 1980s peaked in Q1 1987 (+7.3%) and troughed in Q4 1990 (+1.2%).
- Then you have the Great Recession, whose proximate cause was an overinflated US housing market suddenly bursting, when house price appreciation went from 11.9% (Q2 2005) to -7.0% (Q1 2010).
#2: The price of a marginal house comes down to 2 factors: access to credit for a potential buyer, and the cost of that credit.
- In the US, access to credit that enables home ownership correlates very strongly with income/educational attainment.
The US Census’ 2015 American Housing Survey found that the median income of established homeowners was $62,500, and for new homeowners it was $69,100. Meanwhile, the median income for renters was $34,000.
The survey also found that Americans with 4-year college degrees were much more likely to have recently purchased a home (39.3% of new owners) than those whose formal education ended with high school (22.8%).
- Prevailing interest rates and banks’ willingness to lend are the rest of the equation.
The latest data from Freddie Mac reports that a 30-year mortgage goes for 3.31%, essentially an all-time record low.
The offsetting negative just now is that banks are tightening mortgage lending standards because of labor market uncertainty.
#3: These points give us a basic framework to answer the question “where do US home prices go from here?”
- The most important factor is the eventual unemployment rate for college educated workers, since they are the marginal buyers.
The March 2020 jobs report showed this cohort at a 2.5% unemployment rate. History shows the US housing market can hold its own if this rate rises to 3% (it did so in 1992 and 2003, with only limited effect on prices). The warning sign is 5% unemployment, which occurred in 2010.
- The other issue to watch is bank lending standards. No one can blame a US financial institution for wanting to see a 700 credit score and a 20% down payment right now. But after a decade of reasonably prudent mortgage underwriting standards their loan books should be in good enough shape that when the US economy starts to reopen they can relax those a bit.
- The wild card is, of course, how long it takes for the US economy to recover. Our mental model for this is regional: some places will get back up to speed long before others. Sitting in NYC right now, we would put Gotham in the laggard camp. Unrelated but important: no matter what happens with the US economy, 2020 is an election year so we do not see a wave of foreclosures regardless of how/when the US economy reopens.
Bottom line, our best estimate: US house prices will basically go nowhere for 12-18 months because macro uncertainty will linger, affecting both college-educated cohort employment and bank lending standards. The counterbalance is, of course, very low mortgage rates.