Luck & Timing in the Housing Market

A little less than a year ago I asked Are US home prices becoming prohibitive?

At the time, the Case Shiller National Home Price Index had just hit a new all-time high with annual price increases of around 20%.

That meant monthly mortgage payments hit all-time highs for average single-family home prices:

But when you adjust those monthly payments for inflation, things didn’t look so bad:

Adjusted for low interest rates and inflation, mortgage payments were much higher in the 1980s and 1990s.

But it was low mortgage rates that really contributed to this affordability. Here’s what I said at the time:

The only variable that could shake this equation would be higher mortgage rates.

In my example above, a $308,000 house at a 5% mortgage rate would mean a monthly payment of $1,322. A $367,000 home would cost $1,576 per month. That’s increases of around $300/month over 3% mortgage rates.

Rising installments are even more powerful than increasing the price of your monthly payments.

If interest rates were to rise significantly, you would expect house prices to fall, at least in theory.

The worst-case scenario for would-be first-time buyers would be that mortgage rates go up while prices don’t go down. Demand would certainly ease if interest rates rose above a certain threshold, but I have no idea what that threshold is. And there’s no guarantee that house prices would fall immediately if interest rates rose.

Well, mortgage rates have gone up, more than doubling from that level to over 6%.

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Let’s look at these charts just a year later. The average mortgage payment is now off the charts due to a continued rise in house prices and much higher mortgage rates:

Look at this tee. Not good for anyone looking to buy their first home.

Now let’s see how things look when adjusted for inflation:

This is the worst level of unaffordability we’ve seen since the late 1980s, and it happened in the blink of an eye.1

The homeownership rate in the United States is about two-thirds:

If you’re one of the lucky ones in this group who bought a home before 2022 and locked in an interest rate of 3% or less, then these affordability numbers don’t matter to you (unless you plan to top up).

And it’s lucky if you happen to have bought or refinanced in the past few years.

Let’s say you’re an older millennial who bought a home between 2015 and 2020.

Your home has probably increased in value by 40-60%. Your mortgage rate is in the range of around 3%. That means the Fed’s short-term lending rate is now higher as your fixed rate mortgage, which happens to be one of the best inflation hedges you could ask for. Your payment is fixed and you are much wealthier thanks to the 2020 home price boom.

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But what if you’re a younger millennial or Generation Z person living in a big city or missed the window to buy a home?

Your rent is increasing rapidly. Buying a home is now significantly more expensive and for many young people more or less unaffordable. Your best bet is to buy a home with a high mortgage rate now and hope the Fed will cut rates after sending us into a recession so you can refinance. Choose your poison.

If you happen to have bought at lower rates with lower rates, you are not a genius. You were lucky.

And if you didn’t buy at lower rates with lower rates, you’re not an idiot. It was a case of bad luck.

Unfortunately, luck permeates much of your financial experience.

I calculated the numbers for a $10,000 annual investment in the S&P 500, adjusted for inflation, and the results are all over the place:

The difference between the best and the worst result had nothing to do with the individual being conscientious about saving money, but everything to do with when they were born and started saving.

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If you had the tailwinds of the 1950s, 1980s, 1990s, or 2010s bull markets, you did really well in the stock market.

If you happen to have started investing in the 1930s or lived through the 1970s or 2000s, not so much.

Unfortunately, much of what happens in your financial life is out of your control.

You have no control over what happens in the stock market, housing market, bond market or commodity market. You can’t control inflation, or interest rates, or tax rates, or the Fed, or the financial situation you were born into.

You can control your savings rate, asset allocation, diversification and work ethic.

It may not seem fair, but sometimes you just have to play the cards you’re dealt.

Michael and I talked about good and bad luck in the housing market in this week’s Animal Spirits video:

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Further reading:
How the Fed screwed up the housing market

Well, here’s what I’ve been reading lately:

1And it should be noted that I only have dates up to July 31, 2022. Mortgage rates have since gone up and house prices haven’t really come down yet, so it’s only gotten worse.

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