Housing & Rental Markets: Where do we go from here?

The housing market has been the talk of the town over the past year, with home prices rising faster than they did even during the 2000s era bubble. The rental market has now been following a similar path, seeing rental prices rise at the fastest pace in at least 20 years. As the Federal Reserve has embarked on a path to tighten financial conditions to combat inflation, mortgage rates have risen dramatically and are now above 5%. Just one year ago rates were at only 3%. Given these dynamics, what’s in store for housing, in terms of both homes prices and rental markets? While the outlook for home prices is a bit uncertain, the rental market seems poised for continued strength.

Market Dynamics – Home Prices

No doubt home prices have been on fire for the past year. Fueled by record low interest rates, the ability to work from home, young adults forming households and making first time home purchases, and a continuously dwindling supply, home prices have seen double digit year-over-year gains.

On the plus side for home prices, some of the tailwinds that have fueled the record run are still in place. Supply is still at historic lows. A decade of builder caution following the 2008 bust has left the single family home market woefully undersupplied. While builders have been ramping up home starts over the past year, labor and materials problems have hampered their ability to bring new supply online fast enough. Mortgage rates, while having ramped up significantly, are still relatively low from a historical perspective. Working from home seems to be a secular trend that may continue to play out, or at least isn’t about to fade away. And demographics still bode well for new household formation and the desire for families to buy their first homes.

Interestingly, over 90% of current homeowners would see a higher mortgage rate if they were to make a new purchase or refinance at current mortgage levels. This is a historically high level of owners effectively locked into their existing homes. This could further keep supply constrained as people opt to remain in their current properties.

However, these tailwinds come up against some significant headwinds. Despite being historically low, mortgage rates moving from 3% to 5% increase the payment on a same-priced house (if purchased at 5% instead of 3%) by nearly 30%. With home prices up double digits over the past year, the overall mortgage payment for purchasing the median-priced home in the US is up more than 40% vs one year ago. This is a big hurdle for new home buyers and will likely put a significant damper on demand as buyers are priced out. Further, the additional supply builders have been trying to bring to market should ultimately come online over the next year or so. And finally, home prices will likely struggle if the Fed causes a recession in its quest to cure inflation.

Market Dynamics – Rentals

The rental market has also been red hot. This began with eviction moratoriums during covid, which pushed occupancy rates up significantly. As home prices rose swiftly over the past year, would-be buyers turned to renting instead, further stretching already historically high occupancy rates.

The tailwinds in place for rentals seem unlikely to abate in the near term. Occupancy rates at all-time highs will continue to put pressure on rental prices. With the ramp-up in mortgage rates and home prices, even more potential homebuyers may instead look to renting. Moreover, as rental prices continue to increase, bigger rental payments will eat into potential homebuyers’ cash and savings, putting the downpayment for a purchase further out of reach and perpetuating the need to rent. And should a recession come, homeowners may be forced to sell and cash in on home equity, opting instead to rent to weather the storm. This will further bolster rental demand.

Of course, these tailwinds are not without headwinds. The eviction moratorium has rolled off, and a ramp-up in evictions could open up much needed occupancy. High rental prices measured against still relatively low mortgage rates could also mean buying still makes sense for many new would-be homebuyers.

Investment Implications

Home prices, and hence the homebuilding space, may be more susceptible to weakness going forward if demand surprises to the downside and/or supply comes online more rapidly. This could be exacerbated if we enter a recession. However, there is reason to believe there could be continued strength in this space, at least enough to suggest the recent selloff in homebuilding names (down 30% YTD) may be overdone.

The rental market, meanwhile, could well be a point of strength given the conditions in place. This may be particularly true for single family rental homes, which tend to historically have more stable tenants and can command premium rental prices.