In other words, there won’t be a housing crash:
And this is the reason I’m worried about the housing market.
There can’t be a housing crash if 75% of Americans want to buy a home in the event of lower prices.
Demand will be strong, therefore prices can’t really fall all that far.
Even if, let’s say, housing prices crash by 40%, then people will just flood into the market at the lower prices and buy up all the homes at the lower prices, causing prices to go right back up.
There’s no way a housing market crash can actually happen with such ravenous demand for housing.
It’s simply not possible for 75% of Americans to buy a home all at once and prices to remain low.
The only way a crash happens is if there are no buyers for homes.
But if there are no buyers out there looking for new homes, then sellers aren’t just going to sell their homes at a cut rate–they’ll just stay put.
So housing inventory will remain low, and thus prices will remain elevated.
It seems we are stuck in this catch-22 situation where everyone knows the housing market is wildly overpriced, everyone is waiting for prices to come down, but unfortunately prices will not come down as much as everyone wants them to come down if everyone is locked and loaded and ready to pounce on a home the second prices drop.
The only way there will be a substantial drop in home prices is if there is a substantial drop in demand.
In other words, the American consumer has to be destroyed– by mass unemployment and layoffs.
And that’s what I think people are missing here.
75% of Americans say they will buy a home if there’s a crash, but what they fail to understand is that if there’s a housing crash, then that means the economy itself has crashed, and chances are, the vast majority of those people who say they’ll buy a home won’t actually be able to afford one, because they’ll be unemployed.
The housing market does not work like the stock market. You don’t just sit there and watch the charts go up and down and buy when it’s low and sell when it’s high. It’s a lot more complex than that.
These are homes we’re talking about. You can’t just buy them and sell them like stocks unless you’re stupidly rich.
Homes are, mostly, occupied. They’re not just empty units that change hands from investor to investor. They’re not pieces of paper like stocks are.
If you sell your overpriced home, you will have to go out and buy another home that is probably overpriced as well. So you don’t really come out ahead. If your $400k home is now worth $700k, you can’t just sell for $700k and then upgrade. You’ll just be buying another home that used to cost $400k and now costs $700k–you’re not actually upgrading your house. The house that used to dream of living in that cost $700k now costs $1.3 million. It’s even more unaffordable now than it was 2 years ago.
The only real way homes come down in value is if people are losing their jobs en masse, and are either forced to sell and downsize, or they’re straight up foreclosed on.
As I was saying earlier, the difficult thing about the housing market is that when prices are falling, people don’t rush to sell their homes like they do their stock portfolios. They tend to just stay put, unless they’re forced to sell for whatever reason (it could be they have to move for work, in addition to foreclosures and downsizing).
Nobody wants to sell their home at a discount.
People have the wrong idea if they think the people who own $500k homes today are going to be thrilled to sell them down the road at $300k. Something very bad has to happen for prices to come down like that.
Another factor here is income levels: if home prices are going to fall, then average incomes will have fallen first. Now, a lot of the fall in incomes will likely be attributable to mass layoffs: if all of the sudden millions of people are earning $0 per year, then that drives the average income down.
If home prices are falling, then that means your income level is either falling or you’ve straight up lost your job entirely.
A housing crash is representative of Americans literally tumbling down the economic ladder: people are no longer in the same income bracket as they once were, they’re in a lower one now. So therefore they must move into a lower-income neighborhood.
Say a neighborhood has an average income of $125k with an average home price of $400k. If the average income goes down to $90k, then the average home prices in that neighborhood will come down as well, because $90k is the new $125k. So $400k homes will come down to ~$300k.
One additional but extremely important factor here is interest rates. If, as I expect, interest rates have to go exceed the rate of inflation, then that means mortgage rates will have to go way up as well, and that will absolutely kill home prices–and your ability to afford a nice home.
I overlooked this in my previous post about home prices in the 1980s. I pointed out that home prices were only about 3.5x the median household income back in 1984, whereas today, homes are 6.7x the median household income. It would seem homes are more expensive today, right?
Well, not exactly: today the average interest rate on a 30 year mortgage is about 5.2%. In 1984, it was over 14%.
And that is a major factor in the housing market. So houses back in 1984 were not significantly more affordable than they are today, in fact they were significantly less affordable, all things considered.
This chart I found recently shows (the red line) US mortgage payments as a percentage of monthly income. In 1984, it was nearly 40%, compared to about 25% today.
That’s because of interest rates. Interest rates arguably have a bigger impact on housing affordability than home prices themselves.
Washington Post has a nice graphic that illustrates just how much a rising interest rate adds to the overall cost of your home:
So what this shows is that if you buy a $450k home at 3%, you’ll end up paying $546k for that home over the duration of your 30 year loan: $360k in principal, and $186k in interest. Plus, you’ve already put down $90k as a down payment.
However, if interest rates rise to 4.9%, you’ll end up paying $687k for that $450k home–your $360k in principal, plus a $327k in interest.
In other words, a 1.9% increase in the interest rate on a 30 year mortgage means you’re paying an additional $141,000 on that same $450k home.
They show the difference in monthly payments that comes out to:
A 1.9% increase in mortgage rates means you’re paying an additional $393 a month on your monthly mortgage payment. And that doesn’t include mortgage insurance, HOA fees, property taxes and other expenses. That’s just your principal + interest per month.
An extra $393 a month comes to $4,716 extra per year just in interest payments alone.
So when we look back at the 1980s example, what does that come out to? The Washington Post calculator lets us plug in whatever number we want and see the difference in monthly payments based on interest rates.
Say you got a mortgage on a $150,000 home in 1984 after putting down 20%. You lock in a 14% interest rate, which was standard at the time.
That means you’d have been paying $1,422 a month on your mortgage back in 1984. If your interest rate was 4.9%, your monthly payment would only be $637.
So an increase in mortgage rates of only about 9%–from 4.9% to 14%–leads to a more than doubling of your monthly mortgage payment.
That’s why the rise in interest rates matters so much to the housing market. If interest rates continue rising, that means mortgage rates are going to rise. And that means home prices are going to come down.
And people are not going to be able to buy the dip because they won’t be able to afford it.
You buy a $300,000 home at a 3.5% interest rate, you’re paying about $1087 a month on your mortgage.
But say mortgage rates go up to 7% (and we’re assuming they will because in order for home prices to drop, mortgage rates will have to go even higher than they already are today, and they’re at 5.2% currently).
The monthly payment on that $300k home is now $1,597–and again, that’s just principal and interest.
People are thinking they’re going to be able to get $300k homes at 3.5% interest rates equaling about $1100 a month. That’s not going to happen.
If $1,100 a month is your max limit on a mortgage payment, instead of a $300k home, you’re going to be looking at a $200k home–because at a 7% interest rate, a $200k home comes out to about $1,064 a month.
So you used to be able to afford a $300k home when interest rates were at 3.5%. Now you can only afford a $200k home with mortgage rates at 7%.
The worst part of this is that we’ll be lucky if mortgage rates top out at 7%. They’ll probably be higher–way higher.
Remember what I said earlier: the Fed is likely going to have to raise interest rates to above the inflation rate in order to get inflation under control. That would mean interest rates north of 8.5%.
The Fed Funds rate is currently at 2.5%.
Stan Druckenmiller, legendary investor and hedge fund billionaire who has been warning of a crash lately (and, full disclosure, for like the past 6 years now) recently said that once inflation gets over 5%, never before in history has the Fed been able to get inflation under control without lifting interest rates above the rate of inflation:
Wall Street and most retail investors believe the Fed is going to pivot and go back to easing.
They do not understand that the rules of the game have changed. Over the past 13 years, they could count on the Fed to bail them out anytime the market dropped 20%. That’s because inflation was under control and the labor market was in good shape (at least according to the Fed’s metrics that they use to justify their actions, which are in all likelihood cooked and manipulated simply to give the Fed the grounds to do whatever they want).
Inflation is now running rampant at the highest levels since the early 1980s.
People who blithely and confidently say the Fed will pivot do not know what they’re talking about. The vast majority of them were not around for the early 1980s during the Volcker era. You’d have to be currently pushing 70 to have been old enough to have worked in finance during the early 1980s.
Now we’ve got 25 year old HODLers and apes who are confidently predicting the Fed to pivot. They have no idea what they’re talking about.
They don’t even remember 2008, much less the Dot Com bubble.
So the point here is that the Fed will keep hiking. Why wouldn’t they? The official unemployment figure is 3.5%. The Fed can say that its hiking has not harmed the labor market at all. If unemployment remains low and inflation remains high, there is no reason for the Fed to pause its hiking.
The problem for prospective homebuyers now is that there is always a premium on mortgage rates when compared to the Fed Funds rate. Mortgage rates are 5.2% currently and the Fed Funds rate is 2.5%. This makes sense because obviously a prospective homebuyer is going to have to pay a higher interest rate than the US government–there’s a much greater risk that an average, middle-class homebuyer defaults on his debts than the US government defaulting, after all.
So if the Fed Funds rate moves up to 5%, 6% or even 7-8% and above, we can expect the average mortgage rate to be even higher than that. Probably over 10% if the Fed Funds rate hits 7%–minimum.
A $300k home at a 10% mortgage rate will end up costing $2,106 a month. In total, you’d end up paying $758k for that $300k home in principal and interest, plus your $60,000 down payment.
You can see just how devastating interest payments can get when mortgage rates start rising.
If your monthly budget for a mortgage payment is $1,100, then with mortgage rates at 10%, you can only afford a $155,000 home.
And keep in mind, too: lots of homebuyers are going to be paying mortgage rates above even what the average mortgage rate in the country is. After all, it is an average: some will pay more, some will pay less, depending on income, credit score, down payment size and preexisting debt burden.
If the Fed Funds rate goes to 8% or higher, there will be people out there paying 12%+ interest rates on their mortgage.
And so this is another extremely important factor when it comes to the idea of buying a home after a housing crash. A housing crash will likely be caused in large part by skyrocketing interest rates, and higher interest rates mean people will not be able to afford anywhere near as much house as they think they’ll be able to.
The 75% of Americans who think they’re going to buy a home if the market crashes will be in for a rude awakening. For one thing, if home prices do correct significantly, then it’s likely going to be accompanied by mass unemployment and layoffs.
Second, the main driver behind those mass layoffs will be rapidly rising interest rates, so even if you do manage to hang on to your job and your income level doesn’t drop, then you’re going to be looking at a much higher monthly mortgage payment than you could ever imagine.