U.S. HOUSING MARKET UPDATE
In our November 2023 Monthly Market Commentary, we discussed the housing market, which, during the prior year and a half, had experienced the impact of a dramatic rise in mortgage rates. We observed that housing affordability had fallen to a record low and speculated that the recent unsustainably high year-to-year increases in house prices would begin to revert to the long-term average of about 4.3%1.
Since then, home affordability has improved only marginally and is still close to the historical low (see Exhibit 1). Let’s recall that affordability is a measure of how easily the U.S. family with median income can afford to buy the median price home. The inputs to the measure include U.S. median house price, the current mortgage rate, and median U.S. family income. When the index is equal to or above 100, the median family can theoretically afford to buy the median house; conversely, when the index is below 100, the median family cannot. In November 2023, the index value was about 92. Today it’s just above 100. The historical average has been 138.
Exhibit 1. National Association of Realtors Home Affordability Index
Source: Bloomberg, AAFMAA Wealth Management & Trust LLC
1 Since the late 1980s.
Based on data from the Federal Housing Finance Agency, U.S. existing home prices appreciated by 4.7% in 2024, down from 18.1%, 11.3%, and 5.9% in the years 2021 to 2023, respectively. The house price increase in 2024 did not lead to lower affordability because median family income rose more than house prices (5.1% versus 4.7%), and mortgage rates started and ended the year at close to the same level, 6.94% and 7.18%, respectively.
In 2025, we expect house prices to increase by a much more modest 1.2% (see Exhibit 2). Our forecast is based on the large inventory of unsold houses currently on the market, the slowing momentum in prices from the unsustainably high 2021 to 2023 period, the latest one-year inflation expectations from the University of Michigan consumer survey, and the slightly negative beginning of the year six-month outlook provided by the National Association of Homebuilders/Wells Fargo Housing Market Index.
The green and red parallel lines above and below the 1.2% forecast in Exhibit 2 show our 95% confidence interval, suggesting that the actual change in house prices could be as high as 6.7% or as low as -4.2%.
Exhibit 2. Historical and Forecast U.S. Existing Home Price Appreciation
Source: Bloomberg, AAFMAA Wealth Management & Trust LLC
A question we occasionally get is whether decelerating house prices translate to more difficult equity and bond markets. As it turns out, house prices and equities have been largely uncorrelated. Therefore, we wouldn’t necessarily expect either negative or positive equity returns solely because of a continued slowdown in house price appreciation.
The relationship between house prices and bonds is a little more complicated. Historically, annual Treasury returns have been negatively correlated with house price changes. Though that correlation has been relatively weak, it suggests that house prices have tended to decline at the same time that Treasury yields have fallen since Treasury yields go down when Treasury returns increase. That might seem counterintuitive because mortgage rates are highly correlated with Treasury yields, and, all else equal, lower mortgage rates would result in lower monthly mortgage payments, which should make house purchases more attractive – which would seem to imply that house prices should increase when Treasury yields fall.
If all else were equal, given the current effective 30-year fixed mortgage rate of about 7.2%, home affordability would increase or decrease by about 8.9% for every one percentage point move down or up, respectively, in the mortgage rate.
But all else is, of course, not equal. Inflation, wage growth, GDP growth, and unemployment all come into play. In fact, median family income has tended to fall when mortgage rates fall, mitigating at least some of the benefit of lower mortgage payments.
The complexities of what should happen versus what has happened aside, an interesting and important point to take away from this discussion is that homeowners who are concerned that house prices might fall should consider increasing their allocation to fixed income. The low end of our forecast for 2025 house price changes is negative. Thus, the negative correlation between Treasury returns and house price changes provides the potential to hedge overall family wealth in this environment.
Yours in trust,
Paul
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