Monday, August 22, 2016

The US Real Estate Big Picture...A Thesis in Moral Hazard

Economists and the like often get highly academic and granular in their discussions of the economy and markets.  It needn't be so...with the idea of KISS (keeping it simple, stupid)'s a look at the US housing market which has almost regained it's 2007 bubble valuations.

US Housing Valuation Index

What Factors Drive Housing?
Since 1980 (and even before), there has been a stable ratio of new homes built vs. core population growth (15-64yr/olds), and net new full time job growth.  Historically homes are purchased by those with good incomes (full time jobs) and in their prime working years (15-64yrs/old).  The fact the Federal Reserve has driven it's federal funds rate down 97% resulting in a decline in 30yr mortgage rates of 80%+ is probably noteworthy in the rising prices of homes (and rising need for homebuyers to take on greater debt and leverage).

This isn't to say 65+yr/olds don't buy homes, but they typically already own a house that they are also selling on the other side of the transaction.  65+yr/olds are typically net downsizing at this point in their lives.  However, since '08 a wealthier minority have opted out of bonds and into rental RE for the cash flow.  Still, to support greater demand for need a younger population of buyers with the income to support the market growth.

The chart below is an overview since 1981 of new home creation, core population growth, and net new full time job growth per period.

------>1 new home per 1.5 net new full time jobs
------>1 new home per 2.1 persons growth among working age population

•9.5 million new homes added
•21 million increase, 15-64yr/old population
•15 million net new Full Time jobs
--->30yr mortgage 17.8% to 9.1% (-49%)

------>1 new home per 1.5 net new full time jobs
------>1 new home per 2 persons growth among working age population

•14.5 million new homes added
•30 million increase, 15-64yr/old population
•23 million net new Full Time jobs
--->30yr mortgage 9.1% to 6.6% (-28%)

------>1 new home per 0.5 net new full time job (RED FLAG)
------>1 new home per 2 persons growth among working age population

•5 million new homes added
•10 million increase, 15-64yr/old population
•2.6 million net new Full Time jobs
--->30yr mortgage 6.6% to 3.4% (-47%)

And based on the Census population growth data and linked trends...the chart below represents the rate of population growth and natural rate of new homes over the next decade.

•1.6??? million new homes will be added???
•3.2 million increase in the 15-64yr/old population (includes anticipated immigration)
•? million net new Full Time jobs
--->30yr mortgage 3.4% to 2%? (-40%???)

In the '16-->'25 period, we already know the working age population will grow the least since prior to WWII...only adding 3.2 million 15-64yr/olds.
  • If homes are added at the same historic pace to core population growth, only about 1.6 million homes will be needed and added over the next decade and the negative impact on GDP will be severe absent all the secondary activity new housing drives.
  • However unlikely it may seem, if the nearly 4 decade interest rate tailwind is ceasing or turning to an outright headwind, the lack of further cuts or rate hikes would likely slow home buying and exacerbate a demographic driven housing slowdown.  The implications of rising rates would go far beyond housing, including CRE, cost of leverage in the markets, and consumer credit (cars, colleges, credit cards) not to mention the derivatives market (most of which are interest rate "insurance" absent capital to pay for the losses)...even a 1% upturn would trigger all these avalanches which would cause rates to collapse to new lows.
  • Another very worrisome trend since 2000 is the fast full time job growth among the 55+yr/old population vs. declining full time employment among the 25-54yr/old population (charts below).  There are now a half million fewer 25-54yr/old full time employees than in '00 vs. 11 million more 55+yr/old full time employees.  Simply said, the population of elderly (who generally already own homes) will soon be looking to sell.  They will be selling to a marginally growing number of potential younger buyers that among them have a declining number of potential buyers with means?!?  Outlined HERE.

The chart below highlights the slowing growth of the 25-54yr/old population and employment from '00 corresponding with the rise in mortgage leverage.  As available core population buyers and buyers with means ceased growing, cheaper credit was substituted to maintain "growth"...and since the peak of '07 core population... ZIRP has been the double edged sword to cheapen credit and simultaneously drive primarily older investors out of bonds and into rental RE.

  • Then again, perhaps the Fed can arrange a negative 10yr Treasury yield (as the BoJ and ECB have) to achieve a 2% 30yr/mortgage (a 40% decline from current rates) to incent the biggest speculative bubble yet???  The trend (below) seems to support this direction.

The declining debt service (as shown in the below chart) has allowed the same $1426/mo payment that was necessary to control $100k in mortgage debt @17% to control $322k now @ 3.4%...and if mortgage rates get to 2%, the same monthly payment will be able to control nearly $400k or four times the debt.

Given central banks are all in and have no credible ideas (or credibility period), a NIRP driven speculative new housing bubble (for a population that is barely growing...hello China?) seems most likely.  If you haven't already, get busy front running the next moral hazard moonshot and then stay tuned.  Because as you read this, central bankers are already devising their next (even more destructive) "plan".

And just in case it's not clear, the chart below shows what central banks are fighting in a system premised on perpetual growth...

And below, what it looks like from presidential term perspective (all based on 2 terms except Carter & Bush)...and why the next president (assuming 2 terms) will govern in the worst demographic period in US history.