Inside the US Housing Market

Unsurprisingly, higher mortgage rates are dampening housing activity. Some pundits, given the importance they place on housing’s economic footprint and very visible nature, see that as a prelude to wider contraction. There is little doubt the housing market isn’t in wonderful shape presently. But in our view, it is a mistake to overrate residential real estate’s economic effect. Let us walk through this together.

As many likely know, 30-year fixed mortgage rates’ closing in on 8%—the highest in 23 years—is causing existing home inventories and sales to shrink. Exhibit 1 shows the Mortgage Bankers Association’s (MBA) purchase applications index at its lowest since 1995, down -21.5% from a year ago, as 30-year mortgage rates climbed to 7.9%.^[i]

Exhibit 1: Not Many People Applying for a Mortgage Nowadays

Source: FactSet, as of 10/25/2023.

The effect of this is twofold: One, it encourages buyers to wait or seek cheaper, smaller homes. Two, it encourages would-be sellers to stay in their homes—if they have a low-rate mortgage originated at any point in the last, say, 15 years. Hence, there is a shortage of previously owned homes for sale—the primary source of housing in the US.

In response, homebuyers have been gravitating to newly built houses, with record amounts under construction—single- and multi-family units—over the last year.^[ii] That had driven up homebuilder sentiment and put a floor under residential real estate investment, which flipped positive in Q3’s GDP report for the first time in quite a while. But even here, rising mortgage rates have started to weigh. Homebuilders are finding it harder to meet end demand for cheaper price points, given the added financing costs. No longer as confident they can clear their current pipeline of houses, building permits and housing starts are turning down. This seems like a headwind to residential investment, which feeds into GDP. It suggests Q3’s housing upturn may fade.

For investors though, a few things to note. First, markets are well aware of this dynamic. After outperforming through July, S&P 500’s Homebuilding industry group has badly lagged since, falling -19.1%.^[iii] However, Homebuilding makes up less than 0.26% of the S&P 500’s market cap—that is about the extent of the impact it has on stocks.^[iv]

Second, reflecting its market weight, residential investment’s contribution to economic output is quite small. As Exhibit 2 shows, this is because residential investment makes up less than 3.3% of GDP—on the lower end of where it has been historically. Hence, although it flipped from nine-straight quarterly detractions to 3.9% annualized Q3 growth, this boosted GDP by only 0.15 percentage points.^[v] Negligible next to GDP’s 4.9% headline growth.

Exhibit 2: Residential Investment Tiny—and Getting Tinier

Source: FactSet and Federal Reserve Bank of St. Louis, as of 10/26/2023.

This is why residential investment’s prior nine-quarter contraction—including three-straight double-digit quarterly annualized declines last year—didn’t derail growth. (Exhibit 3) So if it were to contract in coming quarters, we don’t think its impact on overall GDP would be much different. Again, look to Exhibit 2: Given the nine quarterly declines, housing’s influence on GDP has gotten even smaller than it was before, when it wasn’t huge.

Exhibit 3: Contracting Residential Investment Hasn’t Derailed Overall GDP Growth

Source: FactSet and Federal Reserve Bank of St. Louis, as of 10/26/2023.

Third, it isn’t as if housing activity has come to a standstill. When affordability is a stretch, markets adapt. Prices could fall, although the lack of inventory has prevented that for existing homes overall. Still, people are managing workarounds. This is marginal, but some home sellers are using mortgage assumptions allowing them to pass on their existing (and lower-rate) home loans to buyers. Meanwhile, homebuilders are pivoting to—and homebuyers are settling for—tinier homes. About half of architects in a recent survey expect house sizes to shrink.^[vi] It may not be immediate, but when markets adjust, activity resumes and, eventually, recovers.

In the interim, some also suggest housing’s halo effect on broader spending—like on home furnishings, appliances and electronics—is set to diminish, weakening growth. But existing home sales—more than five times larger than new home sales—have been negative year over year since August 2021. Household expenditures grew fine since then. It could be that homeowners, electing to stay put, spend on upgrading their current residence. After all, it isn’t as though the only time you buy an appliance (or the like) is when you move.

Lastly, despite the mortgage spike, serious delinquencies (90+ days past due) ticked up to just 0.5% of outstanding mortgages in Q2, barely higher than Q3 2022 – Q1 2023’s record lows of 0.4%.^[vii] This really shouldn’t be surprising. In America, the huge majority of mortgages are fixed rate, unlike some other parts of the world. So rates nearing 8% apply only to (the few) folks taking out mortgages now. With housing turnover and purchase applications low, and most rates fixed (or refinanced) a lot lower, the mortgage dagger isn’t close to approaching most homeowners. That also extends to other households and consumer debt, too. As of Q2—the latest data available—just 2.7% of all outstanding debt was in some stage of delinquency, 2 percentage points lower than in Q4 2019 prepandemic.^[viii]

Mortgage rates may be weighing on housing, but don’t overrate its broader economic effects. And as much as it is in headlines, it isn’t taking markets by surprise.