Editor's Note: Click the play button or read the excerpt below for insight from a new conversation between hedge fund manager and MacroVoices podcast host Erik Townsend and Hedgeye Housing analyst Josh Steiner.
Erik and Josh discuss the state of the Australian, Canadian and U.S. housing markets (Click here to get a special offer on Market Edges, our weekly macro newsletter.)
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Erik: Let’s go ahead and return to the US and talk about that market. We went through, obviously, a major housing crisis. Prices have pretty much recovered to where they were before the crisis. Are we at risk of another one? Or did we learn our lesson?
What’s the story in the good old US of A?
Josh: The US property market is quite strong. I don’t think the outlook is – for that to inflect in any sort of material longer-term standpoint. I do think in the short term you may see a little bit of weakness.
There are a couple of things. One, from a price standpoint, 2017 was just an unbelievably good year for equities, US equities that were exposed to housing. There are different ETFs. There’s the XHB, the ITB. And then there’s the S-5, and S-15, home super-composites, which are the subsectors of the S&P that looks specifically at home builders. And those were generally the best-performing categories within the US market over the course of ‘17.
And a lot of that had to do with enthusiasm around fiscal stimulus from tax cuts. But the yin and the yang to housing stock investing in the US is that what’s good for the fiscal side is good for the stocks.
But, typically, the yang is that you tend to stoke inflation. And that tends to cause the rates to rise, and the long end of the curve to move up, which obviously impairs affordability. And there’s an incredibly strong inverse correlation between rapid moves up in the long end of the curve and housing equity deflation.
So, in looking back over three historic periods, you’ve seen, basically, housing stocks get cut in half any time mortgage rates have risen by more than one and three quarter points within an 18-month period. And there’s three episodes of that in the last 20 years.
So that was kind of the concern in late 2016. Between the day of the election and the end of January 2017, you had this massive move across the US equities in the US equity complex. What really got left out of that was the housing component.
But then housing stocks basically spent the rest of 2017 catching up, because the long end of the curve actually came back in. So rates stayed planted. And suddenly you had this fiscal tailwind without what is the normal offsetting complement which is mortgage rates moving higher.
And that’s kind of where we’re at today, is that suddenly you’ve got the long end of the curve moving up pretty sharply again here, so that’s going to probably take a little bit of the air out of the enthusiasm post- the tax cut change.
So that’s one thing to keep in mind. But, bigger picture, housing prices have risen nationally for – really since late-2011 which was kind of the low-water mark. So they’ve risen pretty steadily. There was a little bit of a cool-off period briefly in 2014 when these so-called qualified mortgage rules were put in place. It took a little bit of the air out for about 9–12 months.
But, notwithstanding that speed bump, the US housing market has generally been inflating pretty steadily. In the last few years, prices have been rising between 5% and 6% nationally, year-over-year.
I think what’s going on now is interesting. You have this severe shortage of supply of homes for sale across the US. And where it’s most acute is at the entry level, at the low end. Normally, the general route in a “balanced market” is about six months of supply. That’s a level at which neither buyers nor sellers have excess bargaining power.
In that environment, what you tend to see is home prices generally rising at a rate consistent with inflation. So, if inflation is running around 2%, you see home prices in that environment going up by 2%–3%.
But what we’ve got instead of six months’ supply is currently around three and a half. Which is all-time lows for aggregate US housing supply. And so, as a result, you’re seeing home prices accelerate. Prices are now rising up between 6% and 7 % nationally, and that pressure is going to continue. And the reason is that they’re not building enough homes.
So, in the most recent data, single-family starts were running at about 930,000. That’s seasonally-adjusted annualized. Our math shows that that number would need to be all the way up around 1.5 to 1.6 million (up from the current 930,000) in order to essentially equilibrate that supply-demand imbalance, get the three and a half months of inventory back up to six months.
And so the good news/bad news is – well the good news is that’s really good for builders. Because it means there’s a path for them to basically double output if they can source the land and if they can source the incremental construction labor, both of which are sort of hard to come by these days. The point is there’s a long-term tailwind there, not going away at least for the next five to six years.
And the reason why is because, if you look at the demographics of the US, we’re at a really interesting point. So right now – people talk about the millennials. The millennials are an incredibly important generation from a housing standpoint. If you look at the numbers – I’m trying to remember if I put a chart in here – unfortunately I did not – but we have this chart that shows the number of people in each age cohort.
So the number of people who are 26, the number of people who are 27, and so on and so forth – what’s interesting is that, currently, the average age at which people rent their first property is 26 to 27. Meanwhile, the average age at which they buy their first home is 32 to 33.
And what you’ve got is this thing sort of creeping into the investment lexicon: “peak millennial”. Which is the largest cohorts of millennials right now, those who are 26 and 27 i.e. first-time renters.
Meanwhile, you’ve got a much smaller number of 32- and 33-year-old millennials. What that means is that, over the coming five to six years, these 26- and 27-year-olds become 32- and 33-year-olds. You’re going to have this tidal wave of tailwinds of millennials moving out of renting into home ownership for the very first time.
And behind those 26- and 27-year-olds, there are far smaller numbers of 25-, 24-, 23-, and 22-year-olds. So what you’ve got coming down the pike from a housing standpoint in the US is you’re definitely at peak in terms of rental demand. And you’re going to start to see that industry begin to – which has benefited, by the way, over the last five to six years from enormous tailwinds demographically – but they’re now just about to be on the other side of that.
Meanwhile, you’re going to have enormous tailwinds shifting into first-time home buyers. So if you’re a large publicly-traded builder who has a focus increasingly gravitating toward first-time buyers in some of these states like Florida and Texas and elsewhere, you’ve got the wind at your back for the next five to six years.
And in terms of affordability, which is the longer-term governor on what is possible across the housing landscape, nationally affordability trends still look incredibly favorable. Home ownership relative to renting is still much closer to its all-time lows than its all-time highs. So that looks very favorable.
Now, once you dive into certain select cities like San Francisco, Manhattan, Boston, the affordability dynamic there is much less compelling. And, by the way, that’s also part of the reason why these people, these peak millennials are now moving out of the cities once again.
For the last five years the narrative around these people was they want to live in urban centers, they’re different than previous generations. All of that is sort of a fallacy. Really, they’re no different than previous generations. They’re just more stunted or lagged from a progression standpoint.
So what’s going to happen over the next five years is the millennial generation is going to do the same thing that previous generations have done. They’re going to start to want to move out of the city, buy a house, get married, have kids, have a back yard and a dog and some property or some land. So that’s going to be the next five years, what you’re going to see increasingly across the US.