Home prices minus the rate of inflation equal real home prices. The historical performance of house prices should be analyzed in terms of inflation-adjusted returns, not nominal house prices. If your house goes up 10% in a year, but inflation also goes up 10%, you didn’t have a 10% return, your house was just acting as a hedge against inflation, and the increase in value might just be the increase in value. in replacement costs. to build a new one with the same materials and labor.
What will cause the housing market to crash?
Also, if you live in a growing area and see your home increase 50% in value in two years, that could simply be a short-term speculative bubble based on buyers’ fear of missing out on a home. Long-term homes are primarily an inflation hedge by securing a mortgage that a homeowner avoids the risk of rent increases over the life of the home purchase.
The further nominal house prices move away from intrinsic value and the inflationary trend, the more likely it is that this is a housing bubble. The further home prices move from the historical average price, the greater the chances of a mean reversion.
Real estate market indicators
The current upward movement in nominal house prices from 2012 to 2022 is very similar to the same housing bubble from 1998 to 2007, where homes far exceeded the rate of inflation and generated returns as investments on a national scale.
Historical inflation-adjusted and nominal home yields have been very stable in the US, when either line begins a steep upward slope, it usually indicates a bubble that could burst, but most housing bubbles they last for many years.
Leading indicators for house prices may indicate that the peak of the housing market is approaching and may be about to start to decline.
The requirements for leading indicators are that they make logical sense, have a proven track record, and have a large historical sample size.
the months supply of new houses for sale is now more than 10, which has been an accurate predictor of a recession dating back to the 1970s. Nearly 11 months out, the supply of new homes in the US is near multi-decade highs.
The offer of the month is the ratio of new homes for sale to new homes sold. This statistic is an indicator of the size of new inventory for sale relative to the number of new homes currently selling. The months supply indicates how long current new inventory would last for sale given the current sales rate if no additional new homes were built.[1]
Monthly Supply tracks available homes coming on the market and helps meet buyers’ demand curve for homes and can lower prices as it grows. The higher the supply, the more options it gives buyers and sellers must compete to sell their home, slowly turning the real estate market into a seller’s market.
The lows in the monthly supply of homes occurred near the end of 2020, after which more homes entered the market as prices prompted homebuilders to increase production while also driving sellers to capitalize on your capital by putting houses on the market.
The monthly supply coming in at around 11 is probably the sign of a short-term high in housing market prices, as it was in all previous housing downturns. However, this can take time as both buyers and sellers balance with prices as the market adjusts to supply and demand in each specific geographic area.
The 30-year fixed mortgage spread represents the difference in interest rate between the 10-year US Treasury bill and the average rate on a 30-year mortgage. Typically, mortgage rates remain about 1.5% above the rates paid on 10-year Treasury bills. However, prices fluctuate daily and the spread is constantly changing.
The spread between the 10-year Treasury rate and the 30-year average mortgage rate grows during recessions when large numbers of borrowers default on mortgage payments and eventually loans. Conversely, the spread can narrow and become small when Treasury rates are low and real estate investors are willing to take the risk of mortgage-backed bonds to try to achieve higher yields. [2]
The spread represents the risk.
30-year fixed mortgage rates have broken their 2018 highs, while 30-year bond yields have not. Both are correlated, with mortgage rates in the lead. If history is any help, then 30-year Treasury yields still have more upside potential. (Margin for charts below is 2.3%)
Mortgage rates may decline because Treasury rates are falling or because mortgage spreads are narrowing. The decline in Treasury rates may indicate that economic conditions are worsening. It is necessary to separate if the mortgage fall comes from the type of treasury or the spread. Mortgage spread widening preceded the housing slump in 2007 and mortgage spread tightening preceded the housing rally in 2010. This has been a good leading indicator of risk or risk in the housing market for the past two cycles .
This signal did not work in 2007, so it is important to use a confluence of multiple indicators to get a complete picture of the market environment. The monthly supply indicator showed no signs of growth in 2000. The more indicators that align at the same time, the greater the chances of success.[3]
Will real estate sink in the future?
The growth of the M2 money supply can also lead to an increase in house prices, since the liquidity of the currency in the market can be used as investment capital to increase asset prices.
M2 is a measure of the US money stock that includes M1 (coins and coins held by the nonbank public, demand deposits, and traveler’s checks) plus savings deposits (including money market deposit accounts) , short-term deposits of less than $100,000, and shares in retail money market mutual funds. [4]
The more money the Federal Reserve allows into the system, the more of that money can be used to buy, invest, or invest in real estate. The expansion of the M2 money supply may indicate an increase in property prices, the decrease in the M2 money supply may indicate a decrease in property prices. Liquidity and the amount of investment capital in the financial system is the most important fundamental of the real estate market. Expansionary monetary policy is a stimulant for house prices.
Currently, while the Federal Reserve is using monetary policy to fight inflation, raising rates and applying quantitative restrictions and trying to contract the M2 money supply, it is a sign that the housing market could be peaking.
We currently have the trifecta of bearish real estate signals. More homes coming onto the market as higher prices motivated sellers and falling prices made the sale more urgent reflected in the monthly supply. Rising mortgage spreads show that risk is rising for borrowers and investors. In addition, the Federal Reserve tries to deflate asset prices by tightening the money supply.
Home prices have not crashed yet because we are still in the first stage of the price decline coming from the run up and potential bubble.
Image created by Holly Burns
