Will 4% Mortgage Rates "Halt the Housing Market"?

Some comments on an interview with Ivy Zelman

On Friday, CNBC’s Sara Eisen interviewed housing analyst Ivy Zelman, CEO at Zelman & Associates. The interview is here.

Zelman’s Track Record

First, Zelman has a solid track record, and she is focused primarily on new housing (single and multi-family). Ms. Zelman gained fame among housing bloggers when she confronted Toll Brothers CEO Bob Toll during an analyst conference call in 2006 by asking: "Which Kool-aid are you drinking?" (see my comments when she left Credit Suisse in 2007)

And in 2012, Zelman joined other former housing bears in calling the bottom for the housing market. (My call in early 2012: The Housing Bottom is Here). Zelman - along with housing economist Tom Lawler, economist Chris Thornberg, and your humble scribe - was one of the few to call both the top and bottom for housing.

And in 2013, she made her famous “Nirvana” call on CNBC. Some excerpts:

"I think we are in Nirvana for housing."

"I'm probably the most bullish I've ever been fundamentally [on housing], and I'm dating myself, but I've been around for over 20 years and I've seen a lot of ups and downs".

[We are in] "the first or second inning of the fundamental recovery that could be five to ten years in duration ..."

New home sales have just about doubled since she made that call.

When Zelman speaks, people should listen!

Excerpts from October 15, 2021 Interview

On Friday, Sara Eisen asked: “Do you think this hot housing market gets even hotter?”

And Zelman answered:

No. I don’t.  I think the housing market is already starting to show some moderation.  And I think that it is going to become even more evident as rates are starting to back up.   And the continued upward pressure on home prices which is not sustainable is really impacting affordability.   We are starting to see incentives by builders creep back into the market.   And we are seeing resistance by consumers that are really questioning whether or not, not only can they can afford it, and do they really want to buy at the top of the market.

Zelman is correct that the housing market (she is talking new homes) is “starting to show some moderation”. Rick Palacios Jr., Director of Research at John Burns Real Estate Consulting has made a similar comment based on a recent survey.

Rick Palacios Jr. @RickPalaciosJr

Just published September home builder survey results (sales, prices, costs, communities, etc.). Big themes: 1) Supply chain, supply chain, supply chain. 2) Monthly price hikes no longer the norm. 3) Some of the hottest markets sounding toppy. Market commentary to follow…

This is also true in many existing home markets. We are seeing some divergence between markets - if you are in San Diego or Miami, the market frenzy is ongoing, and inventory is at record lows. Other markets are seeing some increases in inventory and sales are slowing slightly (This is why I track so many local markets).

The most controversial phrase in Zelman’s first paragraph was “do they really want to buy at the top of the market”. This implies that prices will decline going forward. Although prices are making me uncomfortable, I’m not forecasting price declines. As I wrote in the Housing Conundrum back in June: “My Spidey senses are tingling again, however it isn't obvious why this time - or what the outcome will be.”

Zelman on Overbuilding

Zelman went on to say:

In the US, the overall population growth, and US household growth,  is the slowest it has been on record for household growth, and population growth is the slowest since the 1930s.  So we don’t believe that we have a deficit.  .., Every forecaster out there is saying we have a 4 to 6 million unit deficit.  We believe we are already actually overbuilding in single family by 20% to normalize household demand, and in multi-family above normalized demand about 12%.  … But because of all the investors in the market place, and including second home owners, its clouded by a lot of dual ownership as well as institutional capital that’s coming into the market.

She is absolutely correct about the dismal population growth in 2020 (and in 2021). However, we can infer that there has been a surge in household formation in 2021 because both house prices and rents are increasing sharply (and vacancy rates falling). See Household Formation Drives Housing Demand. My sense is this household formation (if it is happening) is due to several factors:

1. Young adults moving out of their parent’s homes

2. Demand from roommates separating as their incomes increase

3. Demand from more separations and divorces in 2021

My sense is this surge in household formation will not continue (if it is even happening). Zelman thinks the data is “clouded by a lot of dual ownership as well as institutional capital”. That is possible - for example, second home buying has been off the charts.

I’m a little skeptical of the overbuilding argument. Although I’m also skeptical of the analysis suggesting we are missing 5 million housing units. For example, the “NAR report calls an "underbuilding gap" of 5.5 to 6.8 million housing units since 2001.” See from the NAR: Once-In-A-Generation Response Needed to Address Housing Supply Crisis I’ll try to address this issue in the future.

Halt the Housing Market

Zelman concluded:

What changes it is – if rates rise, even as little to 4%, we think that will completely halt the housing market.   So we’ve got some risk in store, especially as we know the Fed is going to likely start tapering.  .. buying mortgage-backed securities which has been artificially keeping rates low.

“Completely halt the housing market” is an obvious exaggeration (makes great TV). If mortgage rates rise to 4%, the housing market will likely slow, but we saw 4% 30 year mortgage rates as recently as 2019, and the housing market survived. We even saw 5% briefly in October and November 2018, and new home sales slowed a little.

Here is a graph showing the change from 2017 to 2018. In late 2017, rates were around 4%, and in October and November 2018, 30 year rates hit 5%. Sales were down a little year-over-year in October and November 2018 - but the market didn’t halt.

Of course relative rates matter - and mortgage rates have been in the 2s during most of the pandemic (now around 3.16%), so rising to 4% will have a large impact than in the earlier period.

Finally, the Fed’s asset purchase program was intended to flatten the yield curve to stimulate the economy. Research has shown that interest rates are impacted by the stock of assets the Fed holds, not the flow (so tapering will not push rates up quickly). The Fed will have to reduce their balance sheet to increase rates.

Mortgage rates (and Treasury yields) will mostly be determined by the strength of the US economy. And a strong economy will be positive for housing - so that will work as a counter balance to higher rates.

In conclusion, I agree with some of Zelman’s comments, but I’m skeptical of the “overbuilding” argument, and the “halt the market” is a clear exaggeration. Also I disagree with her apparent reference to prices falling (“top of the market”) . But I pay attention when Ivy Zelman speaks (and reconsider my views)!