The U.S. housing market has picked up of late. Sales of new residential units, after falling through most of 2018, have risen smartly during the past couple of months. Residential construction, as measured by starts of new homes, has also rebounded. The reason for this sudden turn lies far from our shores. Brexit as well as other economic troubles in Europe and Japan have kept interest rates in these regions so low that a flood of foreign money as arrived in the United States, driving down longer-term yields here including mortgage rates. American homebuyers have rushed to take advantage. This, more than anything else, explains the recent real estate turnaround. It is welcome and may hold. But the improvement will not likely build on itself as it might once have done.
The causality from Brexit and other global troubles to the recent housing turn, though perhaps obscure on the surface, is really quite direct and straightforward. Brexit has brought considerable uncertainty to the European outlook and has accordingly driven investors there into safer bonds. The uncertainties surrounding Italian politics, not the least because the two coalition partners in the present government have openly discussed leaving the European Union, have only reinforced the trend. Signs that Europe’s economy has faltered, even the German economy, its strongest and largest, have accelerated the trend. Rates on German government bonds have fallen below zero. On the other side of the globe, ugly economic news in Japan has kept rates there near zero of lower.
The prospect of actually losing money on an investment, no matter how secure, does not sit well with many. Lots of European and Asian money has gone in search of good credits that also pay a positive return. Those funds have found their way to U.S. Treasury bonds, where yields on the 10-year bond have dropped from 3.2% last November to 2.4% recently. And since treasury yields, as always, have set the tone for the rest of the market, mortgage rates have fallen in tandem from 4.9% last November to 4.3-4.4% more recently. Prospective homebuyers have noticed. And just as they were discouraged by rising mortgage rates last year, this year they have rushed to take advantage of the improved financing environment. The housing market and real estate agents in Topeka and elsewhere have gained at Europe’s and Japan’s expense.
Prior to these global influences, the U.S real estate market was sinking. Housing demand in earlier years had begun to raise home prices, which, according to the National Association of Realtors had risen over 15% for early 2017 to mid 2018. At the same time, the Federal Reserve had pushed up interest rates so that short-term rates had risen from 1.3% in November 2017 to 2.1% by mid-2018 and 30-year treasury yields had risen from 3.1% to almost 3.5%. Mortgage rates had risen in train. With rising prices and rising mortgage rates, the cost of home buying had risen relative to people’s income so that the affordability index calculated by the National Association of Realtors deteriorated some 18% from early 2017 to mid 2018. Accordingly, the housing market softened. New purchases dropped almost 15% and building starts of new residential units fell almost 5%.
But with the recent rate declines, the affordability equation has improved. Especially since housing prices in response to the earlier softness, continued to drop almost 10% from mid 2018, the affordability index has improved just over 13% during the last seven months, returning to levels not seen since 2017, before the deterioration of the housing market began. Accordingly purchases of residential properties have ticked up some 14% over the last two months, and construction, as measured by starts of new residences, has risen by almost 2.0%.
This recent brightening will help buoy the overall economy, but it is unlikely to build on itself, as it might have in the past. Prior to 2008-09, homebuyers, when housing prices rose, would buy, even in the face of deteriorating affordability, on the assumption that prices would continue to rise and they would have an appreciating asset. But the crash of 2008-09 brought a sobriety that seems to have remained. It is why in the second half of 2018 as rising home prices and mortgage rates caused a deterioration in affordability, buyers pulled back, in an orderly way to be sure, but pulled back nonetheless. There was no speculation. Since this more sober approach to home buying seems likely to persist, rates would have to fall farther and prices not rise in response to market improvements to get this uptick in buying to build. Because neither prospect seems likely, the improved level of activity may well hold but not likely build as it might have in the past.