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US Housing market stasis’ threat to GDP growth is under-appreciated

US residential real estate has been on a tear for the last five years, beating global equities and significantly outperforming the total return from global bonds. However, in every boom are sown the seeds of the next bust: after years of rising faster than wages, US property is now more expensive relative to incomes and rents than at any time in its history.
US Housing
Nicolas Lyle
Nicolas Lyle

Senior Equity Analyst

US residential real estate has been on a tear for the last five years, beating global equities and significantly outperforming the total return from global bonds. However, in every boom are sown the seeds of the next bust: after years of rising faster than wages, US property is now more expensive relative to incomes and rents than at any time in its history.

 

Chart 1: US housing vs global bonds and equities (rebased to 100 at September 2018)

US house prices have shrugged off the steepest rate hiking cycle in recent history but, more importantly, housing activity (as measured by housing starts and existing for sale inventory) is at 40-year lows, perpetuating the structural shortage of residential real estate after 10 years of under-building (as measured by household formation).

 

This is why we believe that residential real estate prices are likely to have peaked for this cycle, at least in real terms. We think that weak housing activity is under-appreciated as a risk to US economic growth as the labour market softens in 2024.

 

Since US house prices bottomed in Q1 2012 in the last cycle, they have more than doubled. The new all-time high in August 2023 was 70% higher than the 2006 peak before the Global Financial Crisis. Housing (both buying and renting) has never been more unaffordable: from 2010 to 2022 the average US wage increased by 54%, while the price of the median US home rose by 74% to $407 000 (equivalent to c.7x the national average wage). The cost of buying as opposed to renting is also at multi-decade highs, with rents more reflective of wage growth.

 

Chart 2: US housing price to rent ratio (Trading Economics)

The key to unlocking the US housing market is supply. Estimates of required supply range between two and four million units, against an annual expected supply of approximately 1.2 million units. Just under a million new homes will hit the market in 2024, reflecting the record surge in housing starts in 2021-2022 when interest rates were low and the government ramped up welfare under Covid.  From now on, we expect the supply of new and existing homes will remain constrained, due to the combined effects of:

 

  1. The lock-in effect. The majority of US homeowners have 30-year mortgages at fixed rates of 3-4%. Refinancing now would expose them to prevailing mortgage rates of 7-8%, a multi-decade high.
  2. The growing share of US homes owned by retirees (one-third of all houses are owned by over-65s) who are less likely to move.
  3. Insufficient new supply due to cost inflation, stubbornly high prices for land and higher capital costs.

 

As a result, the number of homes for sale is at a record low, as the chart below shows.

 

Chart 3: US housing inventory for sale

US residential real estate is the world’s largest asset class and a major driver of US economic growth. The US real estate sector employs 2.4 million people directly (according to the National Bureau of Economic Research) and 13 million people (8% of the workforce), including construction. Rising house prices encourage consumption through the ‘wealth effect’. But housing activity is much more significant as a driver of the economy: decades of data confirm that US GDP growth is deeply affected by the number of homes which are built, renovated, bought and sold every year. According to Edward Leamer’s 2007 NBER Working paper, ‘Housing is the business cycle’, eight of 10 recessions are preceded by weak housing activity (i.e. the number of new houses built).

 

Chart 4: US business cycle components, deviation from trend (Strategy Capital, Leamer 2007, NBER)

Historical correlations suggest that slowing housing starts pose a significant risk to US GDP growth, placing the onus on the government to increase the fiscal deficit by spending on measures such as the Inflation Reduction Act, Chips Act etc.  US GDP has been remarkably resilient in the face of one of the biggest and steepest hiking cycles in living memory. Should the unemployment rate increase meaningfully from its current 3.9%, US house price growth is likely to reverse. Supply should improve, not least due to the supply-side measures in President Biden’s Housing Supply Action Plan, while we expect demand to remain subdued until the affordability gap closes.

 

STANLIB’s Global Property Fund is positioned to benefit from rising rents in the US. The fund owns shares in the country’s largest apartment (‘multi-family’) REITs such as Equity Residential and Avalon Bay. It is also overweight Invitation Homes (INVH), a REIT that specializes in renting out stand-alone family properties in the Sun Belt. This region has an acute shortage of rental property due to the number of millennials who need to upsize to accommodate growing families. This is a secular tailwind which should underpin rental growth for INVH for years to come.

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