Trumponomics In The Housing Market

| About: SPDR Homebuilders (XHB)
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Summary

Regulation drives up the cost of new houses.

The increase in home prices follows, with a lag, the rampant growth in regulatory costs.

Some investors might be inclined to think that costs were passed on to buyers and that existing homes and new homes compete for buyers.

Rising interest rates are making home ownership more difficult, but new programs expand eligibility for extremely high leverage.

Who wants to cut regulations, send house prices falling, and tell the American public highly leveraged losses on home equity turn out well?

With the market soaring high on Trumponomics (the belief that Trump's business experience will fix the country), we should take a look at some of the "unnecessary regulation" that might seem ripe for elimination. Before getting into this, it is important to stress that this is not a political article. This article is going to focus strictly on the impacts regulation has on housing prices and the impact housing prices have on the economy.

How Much Does Regulation Cost Buyers?

I'm going to operate on a simple assumption here. I'm going to assume that home builders will build homes when it is profitable to do so. Crazy idea, right? I will also assume that for a large portion of the population it would be acceptable to buy either a new home or a… "used?" home. Let's go with that term, it sounds great.

The charts in this article all come from a piece published by NAHB, which is the National Association of Home Builders. It would seem reasonable to believe that they are both well-informed and have a vested interest in influencing the costs and revenues of their members.

We start with Figure 1. For simplicity's sake, I'm going to stick to using the averages, but I do appreciate that they posted figures for lower quartile and upper quartile as well.

We can see immediately that the total proportion of a new home price that is attributed to these costs comes from various regulations. We don't see exactly which regulations, though some generic data was provided. The important thing for investors to understand is that on a $200,000 home, the price with "zero" regulatory costs would be cheaper by about $48,6000.

Further, we can see that the increase in regulatory costs from 2011 to 2016 was quite dramatic.

That's funny. So regulatory pressure on home builders was ramping up around 2011? I wonder if anything else happened in the year or two following an increase in the costs imposed on building new homes. Let's check the Case Schiller Index:

Wow. That is incredible. Would you believe about a year after that we saw home prices start to pick back up? It is almost as if regulatory burden's restricted supply at the former prices. You might even think that the increase in regulatory pressure was a major factor contributing to the rise in prices for existing houses. Is that just silly? I mean, would you make the decision between buying a new home or a used home based off metrics as pedestrian as the price? What kind of frugal world do we live in?

So What Happened to the Rest of the Market?

Another nice chart shows the change in several different indexes since 2011. We are back to charts provided by NAHB, but now I've added a green arrow to highlight one of the bars. What else could I do? most of the chart was already bright pink…

The price index on homes under construction soared by 19.3%. That is massive, and it appears one of the major factors was the 29.8% increase in regulatory costs. While most of the market was experiencing very tame rates of inflation, housing values were skyrocketing. Of course, demand may also have been stimulated by the Federal Reserve's role in the economy. I hear quantitative easing can drive down interest rates and help more buyers qualify for mortgages. Not only can they get "a mortgage", they can get a much bigger one with the low rates.

Who Benefits From Higher Prices

Well, the home builders are arguing against the higher costs, but it appears they have been able to pass them on to customers quite effectively. The real winner though is anyone who stands to benefit from higher house prices. Who would that be? Well, there were all those banks that foreclosed on homes and needed to sell them…

Then there were also the various REITs that may use some debt leverage to own even more real estate. When house prices rise substantially, that means a larger portion of the population will need to be renters. In turn, that drives up rent values quite substantially. I mean, how much could rental values really increase though? It isn't like we have any way to find out since no one tracks that data. Well, okay, maybe someone does. A Wall Street Journal article (registration required) was able to get a chart from Reis Inc. which shows the rates:

Based on that chart, we can say that from 2011 to 2015 (note, not 2016), the average effective rent was up 16.6%. Amazing, if that trend continues, rents might increase at a level similar to home prices. Who would have imagined such a coincidence?

Why the Regulation Stays

Whether the regulations are improving quality is entirely outside the scope of this article. Strictly from a cost standpoint, those regulations are unlikely to take any major hits. The increase in interest rates is already creating a problem for potential home-buyers. The only "solution" to that problem is expanding access to low-down payment loans. Clearly, the market needs more highly leveraged buyers.

If we see regulations decrease the cost of producing new homes, it would stimulate demand for labor (great for employment), but it would slam into existing home prices. How happy will the homeowners and REIT owners be if they find out their assets are rapidly decreasing in value because producing new competing assets just became vastly cheaper? Most people want more affordable housing to exist, they just don't want the value of the housing they own to fall. Neither party would be likely to present the American public with the news: "We dropped the cost of regulations. Your home value may drop by 15%. Did you get one of those new highly-leveraged loans? You may be under water by 10% in a year. Thank goodness nothing bad happens when housing values fall rapidly with highly leveraged homeowners." The Democrats didn't do it in the last 8 years and the Republicans are unlikely to do it in the next 4.

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