Financial Investment — Know the Housing Cycle

(Updated on 07/25/2018)

For now, although #MortgageRates are rising, mortgage payments as % of disposable personal income remain at record low—Liz Ann Sonders

2017 was the best year since 2007 for new and existing home sales. However, there are headwinds looming.  Based on two sources that I'm following, here are analysts' concerns:^[1,2]

• Declining household formation 
• Unaffordable mortgages
• Mortgage rates are based on mortgage-backed securities (MBS), which are essentially bonds that correlate quite well with US Treasuries.  
• New tax bills

No matter you are a house buyer or seller, you should know about Housing Market Cycle because house price will not rise forever without falling.  The last housing bubble burst in 2008 should be a painful reminder of this fact.  In [3], it sums it up clearly:

It’s important to remember that the Great Recession was not caused by an unexpected event. To those who study the real estate cycle, the crash happened precisely on schedule. It was painful, but it inaugurated the next iteration of the real estate cycle.

Housing Cycle

To explain the cyclicality of  housing, I'll show you from six sources:


Source #1

As early as 1876, Henry George observed the curious cycle through which real estate markets inexorably move. His findings can be illustrated by below diagram:

Source #2

Below chart was published on realestateconsulting.com by Rick Palacios Jr (09/22/2016) and here are Rick's comments on the locality characteristics of housing cycle:^[3]

Every market has its own unique set of industry influences, supply impediments (or lack thereof), and demographic drivers. While some markets took it on the chin during the last cycle, many others were left relatively unscathed. To better answer the cycle question, we examined all of these influences across the 20 largest new home volume markets. I break down our findings below.

Note that Houston was in Phase 5 (or recession) phase in 2016 because the falling oil price.  However, the oil price has recovered and new tax-cut bills has been signed since then.  Both seems to have delayed or slowed Houston's housing downturn.

Source #3

For a comparison, Doug Short has overlaid the HPI (FHFA House Price Index) and Owners' Equivalent Rent of Residences (OER).  Below is his comments on the chart:

HPI and OER moved in close parallel from the 1991 inception date of the former until early 1999, when the two parted company and HPI began accelerating into the housing bubble. HPI then fell 20.7% over the next 48 months to its March 2007 trough. Confirmation of the "bubble" designation for house prices is the 40.1% spread between HPI and OER in January 2006. 

Is another housing bubble forming? The current spread is 22.8%.

Source #4

In [6], John Rubino think the housing bubble is back and he describes it as echo-bubble.  He attributes this housing bubble as a global phenomenon.  Here is the Case-Shiller Index of San Francisco from his article:

Alarmingly, he has also commented that:

When bubbles are followed by echo-bubbles, the bursting of the second bubble tends to signal the end of the speculative cycle in that asset class. There is no fundamental reason why housing could not round-trip to levels below the 2011 post-bubble #1 trough.

Source #5

In [7], Ironman at Political Calculations compares Median New Home Sale Price and Median Household Income.  It shows an interesting loop when housing bubble burst in 2008.

Source #6

In a podcast, Ross Kay of The Wealthy Homeowner has commented on Canadian Housing Market.  He said that it has started the correction phase in Jan 2018.  He describes there are three phases of housing cycle: contraction (already happened for over 13 months), correction (just happened) and collapse.  Once the correction phase has started, it normally lasts for 4-5 years.  And, the housing market is like an ocean liner.  When it changes speed or direction, it slows or turns gradually.  After 5 years in the future, Canadian Housing Market should have taken  26% off its current Average National House Price (current: $509 K CAD), which is equivalent to a 40% correction if the collapse happened overnight.

As for affordability, the radio show host has asked him if it could be assisted by government's building more affordable housing.  He said NO and it can only be improved by the correction of house price.

You can listen to the podcast here for details.

References

1. Outlook For New Home Construction May Be Excellent - Or Not
2. Financial Sense News Hour 01/20/2018 (audio)
3. How to Use Real Estate Trends to Predict the Next Housing Bubble
4. The Housing Cycle: Market by Market
5. FHFA House Price Index: Index Up 0.4% In November
• For an explanation of OER, see this PDF commentary from the Bureau of Labor Statistics.
6. The Housing Bubble Is Back
7. Median New Home Sale Prices Resume Slow Climb
8. Ross Kay on Canadian Housing Market
9. Housing Affordability and Growth:  Draw or Drawback?
10. Housing Affordability Index in the United States
11. THE PRICKING OF THE CANADIAN REAL ESTATE BUBBLE?
12. Trends For New Home Sale Prices At The Beginning Of 2018
13. Making Sense of Rising Rates And The Risks Ahead
14. Investment—Housing Affordability (06/27/2022)
15. The Macro Update (Q1 2023) With Eric Basmajian (EPB Macro Research; 02/23/2023)