Conditions are favorable for investing in the sector and, still, for buying a home.
Dan Alter, Executive Director, Mortgage Solutions, J.P. Morgan Private Bank
Over the last year, we’ve seen the real estate market evolve from largely dormant to red hot in a number of areas—and several important factors point to a continued increase in home prices. Mortgage rates have risen, but are still historically low. Home construction still falls short of meeting demand. Remote work is likely to keep suburbs attractive. And very importantly, Millennials—the largest generation in U.S. history—are expected to keep buying homes.
Whether you are a homebuyer, an investor, or both, now may be a good time to consider buying U.S. real estate—for personal use or strategically—within your portfolio.
Homebuyers—interest rates are still historically low, though they are inching up. Housing prices have spiked during the last six-to-nine months, but we don’t expect them to fall soon, and we believe they are more likely to keep rising. If you are looking to purchase a new home, conditions now may be be better than 12 months hence, especially if you are looking in the suburbs or the U.S. South.
Investors—consider making an allocation to the U.S. housing sector. Since 2008, the shortage in construction of new homes has been so extreme that there is now a lack of homes available for sale. It will take time to reverse this supply shortage. We expect the current construction cycle, already heating up, to continue for years.
The homebuilding sector currently seems reasonably priced: It’s trading at a 2x discount relative to its 10-year average P/B ratio versus the S&P.1 But note that publicly traded homebuilders are not the only companies likely to benefit. We suggest you also look into companies tied to home improvement and other aspects of robust construction activity.
What will fuel the U.S. housing market?
Four forces that recently helped revive U.S. housing are likely to help keep it humming: government support, suburban bliss, a flight to the South and all those Millennials ready for the family stage of life.
1. Government support
The Federal Reserve and the Biden administration both support the U.S. housing market.
The U.S. housing revival might have started sooner, except that the Federal Reserve hiked interest rates aggressively in 2017-18, raising the cost of borrowing and depressing demand.
Now, the Fed is on the side of housing strength: Mortgage rates are still low, though rising, and it is widely expected that the Fed will be very slow to raise interest rates. Indeed, we think the Fed’s next rate-hiking cycle won’t begin until sometime in late 2023.
We acknowledge that since the start of the year, the 30-year mortgage rate has risen from an all-time low of 2.65% to 3.25%, according to Freddie Mac as of March 24, 2021. But we’re not concerned that rates are likely to stifle the housing recovery anytime soon.2
Although mortgage interest rates are rising, they are still below the effective rate at which buyers were financing home purchases and fueling the housing market at the end of last year.
Homebuilders say that mortgage rates would need to rise to around 3.8% (with a low of 3.5% and a high of 4.25%) before they would start to choke off housing sales, according to a survey done by ISI recently.3 Rates are not there yet!
As long as inflation is well behaved, we think the move higher in long-term rates will be at a slower pace from here. To further understand our view on interest rates, take a look at our latest thought leadership, Worried about inflation? We’re not.
Why we think the increase in long-term rates will remain slow
Meanwhile, the Biden administration has an accommodative policy toward housing. In its infrastructure and tax bill, which may pass sometime later this year, the administration is aiming to set aside several hundred billion dollars for affordable housing construction over the next five to 10 years.
2. Suburban bliss
People are moving out of cities into surrounding suburbs. Movement began during the pandemic lockdowns, as people, fearing COVID-19, wanted to flee city congestion and small apartments. Remote work during the pandemic made it more possible to live farther away from urban centers.
Now, almost half of office workers and employers appear to agree: Two to three days of working from home may be ideal. This new norm may keep the demand for suburban housing to remain strong.4
Long-term housing in cities such as New York offer good value. However, we do not expect a rapid bounceback after the COVID-19--inspired lockdowns and remote work adjustments. If you are not in it for the long haul, you may want to temper your expectations regarding near-term appreciation.
3. Flight to the South
Already underway before the pandemic hit, the “flight to the South” greatly accelerated during the COVID-19 crisis. We believe it is likely to continue.
The issue: Big cities in the Northeast and the West Coast are expensive, and their state and local taxes, already high pre-pandemic, are likely to get more onerous in the virus’s wake.
Business is booming in the U.S. South
Who will keep buying homes? Millennials! They not only form the largest generation in U.S. history, but also have plenty of scope to become homeowners. Indeed, their move into homeownership has only just begun.
Millennials have driven the household formation rate (the rate at which they establish homes of their own) from a low of 600,000 in 2010 to 1.5 million today. This generation is expected to maintain a “household formation” pace of 1.5 million to 1.75 million annually after the COVID-19 crisis has passed.5
This is not a housing bubble
Those who remember the housing bubble of 2006-2007 may be nervous watching U.S. housing prices soar now.
But the previous bubble was fueled by speculative buying, which we do not think is the case today. Indeed, today:
- Leverage ratios remain low6
- Home buying has been rational (thus far), as most mortgage lending is to those with high FICO scores, and credit quality has remained strong relative to 2006-077
- Construction activity should power on, as high home prices make new construction attractive, especially when there is a shortage of inventory8
We can help
Bottom line: We expect U.S. housing to remain an important source of strength for investors over the next several years.
Of course, there are potential risks: Interest rates and price inflation could go higher than expected. However, we think these risks will be manageable.
1 Bloomberg Finance L.P., March 2021.
2 Federal Home Loan Mortgage Corporation, March 24, 2021.
3 Evercore ISI, March 19, 2021.
5 Census Bureau, December 31, 2020.
6 Federal Reserve Board of New York Consumer Credit Panel/Equifax/Bureau of Economic Analysis, December 31, 2020.
8 Census Bureau, December 31, 2020.