In August 2020, the Case-Shiller U.S. National House Price Index, a commonly used measure of changes in residential real estate prices, was up over 5.8% year-over-year. Over the next three months, the Case-Shiller Index rose to nearly 10% YoY. This rapid ascent returned focus to the housing market and left investors wondering: Is this growth justifiable or are we looking at 2007 all over again?
It is our view that the housing market stands on a firm foundation, supported by improved lending standards, reduced borrower leverage and a historic supply/demand mismatch.
During the years that led up to the Global Financial Crisis, almost 40% of first-lien mortgages originated were an affordability product (e.g., Short Reset ARM, Option ARM or Interest Only). Today, the Ability to Repay/Qualified Mortgage rules have led to significant reductions in these loan types, and now only 2% of first-lien mortgages originated are an affordability product. As a rule, the more consistent the payment, the easier it is for the borrower to maintain these payments.
In 2006, the housing market peaked with a market value of $25.6 trillion, of which $10.5 trillion was debt outstanding. Today, with the housing market having risen to $33.3 trillion, the total debt outstanding has only modestly increased to $11.5 trillion. Overall, there is far less leverage in the housing market and borrowers have more skin in the game, making them less likely to throw in the keys during times of stress. Currently, distressed sales are roughly 2 – 3% of sales.
Lastly, there is a huge supply-demand mismatch going on in the market. Existing inventory and new home construction sit near multidecade lows. The measure of how long it would take to sell the current inventory at the current sales rate stands at just 4.3 months, below the typical range of five to seven months. The largest rate of growth in home ownership is occurring in the largest U.S. cohort (Millennials) and with mortgage rates near all-time lows, we believe demand will stay elevated for some time.
For these reasons, we are constructive on housing market fundamentals. Our preferred way to gain exposure to the overall housing market is through the GSE’s Credit Risk Transfer program. These transactions allow you to gain exposure to a national pool of agency fixed-rate conforming loans while diversifying away any idiosyncratic risks that may occur in other more concentrated mortgage pools.