U.S. housing affordability poised to fall to lowest since GFC on soaring prices, rates

Jul. 23, 2022 11:13 AM ETKBH, TOL, PHM, HOV, DHI, LEN, NLY, BZH, MFA, DX, CIM, EFC, AGNC, NYMT, TWO, ARR, ORC, TMHC, TPH, TCBy: Max Gottlich, SA News Editor99 Comments

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As home prices hover near historical highs and mortgage rates keep soaring, housing affordability in the U.S. is about to reach its lowest point since the 2007 Great Financial Crisis, according to a report by S&P Global Ratings released on July 20.

“High home purchase prices don't necessarily mean that homes have become unaffordable, but after over a decade of relatively benign home purchase conditions, our analysis of housing market conditions shows affordability has worsened in recent years,” S&P Global explained.

Assuming a down payment of 10%, first-time homebuyers will have to pay 28% of their income to cover mortgage payments by the end of 2022 – the highest level since Q1 2007, S&P Global noted, adding that mortgage payments as a percentage of a household’s income shouldn’t surpass 25%, noting the National Association of Realtors’ (“NAR”) guidelines.

In turn, it’ll take a long time for prospective homebuyers to sign a contract. By Q4, entry-level buyers will take 11.3 years to save for a 10% down payment, S&P Global said. That’s twice as long as the pre-pandemic rate of five years when consumer price inflation was below the Federal Reserve’s 2% target. But now the central bank is embracing its path for tighter monetary policy in a move that has triggered mortgage rates to reach their highest since 2008 amid 40-year high headline inflation, and thus first-time buyers find themselves in a tough position as buying conditions wane.

As a testament to how much mortgage rates have risen since the onset of the pandemic, the 30-year fixed-rate mortgage averaged 2.66% in the week ended December 24, 2020 vs. an average of 5.54% in the week ended July 21, 2022.

“Mortgage spending that is too high can squeeze resources for other essential spending and even lead to defaults on home loans,” the ratings company warned. Meanwhile, numerous headlines about a cooling housing market have been piling in in recent months, ranging from shrinking mortgage applications to falling existing home sales, pointing to increasingly slowing demand for housing. Inventory still remains near record lows suggesting that competition among homebuyers is high, which partly explains why prices are as expensive as they are.

Some of those supply constraints, though, have started to ease, so "the game isn't necessarily over for homeownership," Ali Wolf, chief economist at housing market research provider Zonda, told Seeking Alpha via email. "Housing inventory is starting to grow, a necessary condition to take the pricing pressure off. Further, new home builders still have some cards to play. Higher density, smaller, and/or attached homes can all help keep the overall home price down," she added.

Meanwhile, Wolf contended that "those that already own have enjoyed wealth accumulation tied to home equity, but those renting are finding converting to homeownership is increasingly difficult and expensive."

In the midst of earnings season, fiscal Q3 results of D.R. Horton (DHI), one of the first homebuilders to report earnings, showed a cooldown in demand for housing. Its cancellation rate, for example, jumped to 24% in Q3 from 17% in the year-ago quarter amid rising mortgage rates fueled by the Fed’s aggressive rate hiking campaign as well as elevated pandemic-related inflationary pressures. “Their normal cancellation rate is in the 16% to 20% range. So, 24% is somewhat above normal,” Bill McBride, authors of Calculated Risk economics blog, wrote in a Twitter post on July 21.

Mortgage REITs that may be impacted: Annaly Capital (NLY), AGNC Investment (AGNC), Chimera (CIM), Two Harbors (TWO), ARMOUR Residential (ARR), Orchid Island (ORC), New York Mortgage Trust (NYMT), MFA Financial (MFA), Dynex Capital (DX), Ellington Financial (EFC).

Homebuilder stocks: D.R. Horton (DHI), KB Home (KBH), PulteGroup (PHM), Toll Brothers (TOL), Lennar (LEN), Beazer Homes (BZH), Tri Pointe Homes (TPH), Hovnanian (HOV) and Taylor Morrison (TMHC).

Take a look at the Quant Rating’s screen for the best-rated real estate stocks.

Previously, (July 18) home sales in June perked up the most of 2022, as market moves toward greater balance.

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