Landmines
This is About to Get Interesting (Maybe).
Demand: A Dull Thud
Supply: Less of the Usual
We’re in the midst of our summer buying season, and it feels a lot more like the fall. New listings and closed volume are both down ~30% year-over-year, so things are a bit weird with fewer deals happening on the Front Range. This is a direct effect of the “high plateau” market environment in which housing prices stay elevated, even at higher interest rates, because there’s less supply and no forced selling. All of that could change very quickly as the US grapples with another debt ceiling showdown, and while it appears that both sides left their negotiation on May 16th feeling much more constructive, there are still a lot of things that need to happen before we can call the “all clear.”
This is About to Get Interesting (Maybe).
If you haven’t heard of the debt ceiling, yet, then you should read up on what’s going on with Congress and the President right now. The short story is that there is a “debt limit” (or ceiling) that sets the maximum amount of money the US Treasury is authorized to borrow at any given time to pay the country’s bills. Since we operate with very large national deficits, the government is always borrowing more money to pay its current obligations, and that’s one of the main reasons why the legal limit needs to be raised from time to time. The US already hit the legal debt limit months ago, and the US Treasury has taken “extraordinary measures” to move money around without going over the legal limit. The Secretary of the Treasury (Janet Yellen, the former Fed Chair) has issued numerous warnings about running out of options in early June and set June 1st as the date by which Congress needs to pass an increase in the debt limit in order to avoid a potentially catastrophic result.
You might be asking yourself “Why is this an issue?” And that is a great question. Even though it’s Congress’ job to control the purse strings, they haven’t passed a budget in 27 years. Could you imagine maintaining a family’s or business’s financial health without agreeing on a budget for decades…? Instead, they’ve recently focused on spending bills that authorize spending without forcing Congress to actually do its job and pass a budget. It makes sense, then, that the only time the two political parties talk to each other about spending is whenever there is a fire drill happening, and that’s right now. President Biden is arguing that the debt ceiling is authorizing the government to pay bills that were previously incurred by Congress as a result of their spending bills and that Congress shouldn’t use the debt ceiling as a political weapon; he’s right. Speaker McCarthy is arguing that the US government is on an unsustainable path with its finances and is arguing for spending cuts in order to get the debt ceiling raised; he’s not wrong. This is why there is a lot of unease right now.
With falling tax receipts and higher interest rates, more and more of the government’s tax revenue is going to pay interest on debt that’s already been accumulated. If the country doesn’t change its spending habits then it logically follows there will eventually be a day when the market stops financing our debt and some really, really bad things would happen. Yes, there are other countries in much worse positions from a debt / GDP perspective and our day of reckoning is likely very, very far out in the future. We still shouldn’t wait until the last minute to get these issues resolved. But, at the same time, cutting spending will have a direct impact on the country’s GDP today… Given that the Democrats (1) have the President who is currently responsible for the economy and (2) are supported by voters who are twice as likely to have received government subsidies, it’s easy to see why Biden and the Democrats don’t want to chat about spending cuts.
This blog initially took a very different tone and needed to be rewritten after the “constructive” meeting on May 16th. It appears that both sides now recognize a need to negotiate and that the solution will likely involve some spending cuts in order to get the debt ceiling relief needed. That’s extremely constructive and the market’s reaction to the news on the 17th made a lot of sense: stocks up, Dollar up, longer-dated bonds down (slightly). There are still some details that need to get hammered out between the main negotiators, and it will be really interesting to see how the Republican caucus reacts to whatever deal gets presented. Given that each Republican in the House has a lot more individual power over the Speaker than in years past, there could be some noise over the next few weeks if certain members want to make a name for themselves.
After everything gets resolved, the market will quickly shift its focus from the debt ceiling debate to the June Fed meeting. There’s currently an overwhelming consensus that the Fed is not going to hike rates at this meeting, and it would be hard to see why the Fed would want to spook the market right now. At the same time, real-time inflation tracking systems do not show much progress in terms of core CPI nor PCE returning to the Fed’s 2.0% target, and it wouldn’t be unreasonable for the Fed to suggest future hikes will be needed if inflation doesn’t start going down more. (You can see this data in real-time for yourself on the Cleveland Fed’s website.)
Demand: A Dull Thud
Let’s check in on our trusty table summarizing the current conditions in Denver’s housing market within a 10-mile radius around downtown:
Summary of Denver’s residential market conditions over the past year. All data taken from REColorado from May 7-15, 2023.
Our anecdotal experiences are suggesting it’s harder to determine whether the market is slower because there’s nothing on the market or if affordability is now a major issue. We have a lot of clients who have been very interested in purchasing homes for a long time, and they continue to sit on the sidelines for a “better time.” This behavior is something that is also a result of the “high plateau.” With fewer homes on the market and significantly higher costs of homeownership through increased mortgage (and insurance) rates, the bulk of the buyer pool can’t afford homes that were affordable only 12-18 months ago. Clients are choosing to sit on the sidelines for when prices or affordability comes down, and that’s not something we think is going to happen quickly — as soon as it does, there will be so much competition that affordability will still be a problem for a lot of prospective buyers.
There are 41% more homes on the market right now versus the same time last year, and pending activity is still down 24% which suggests to us that affordability is the major issue and not lack of supply. If affordability wasn’t a major issue, we would expect pending activity to be up in line with increases in available supply. The opinion that affordability is starting to be a real problem is also evident in Avg Sold prices. This past month was the second month in a row when the price of the average sold unit in our market area was down year-over-year even while listing prices were up. Additionally, when we’ve experienced markets in which the median Days on Market (DOM) was < 10 days, we’ve tended to see bidding wars and hear anecdotal horror stories about buyers doing deals on crazy terms. There’s a lot less of that right now even with very low DOM in the market. Our best guess about what’s happening is that quality homes that are priced properly are selling extremely quickly and might get a bidding war. If the seller tries to push the price too much, the home will tend to stay on the market significantly longer, and we’ve tended to see these sellers chase the market down until a buyer is found. The next few months will be very telling as we tend to be in “peak demand” right now, so price behavior through July will set the tone for the fall and into next spring.
Supply: Less of the Usual
It would be really nice to see a few months when more homes are listed than the year prior, and that hasn’t happened in a while. The market statistics from 2019 are included as a comp to the current environment (at the bottom of the image), and I think it’s amazing that active supply is down 37% from 2019 when our population has increased massively since then. It’s no wonder that buyers are complaining about finding homes even when the market doesn’t feel that crazy…
We’ve seen materially less supply come on the market each month going back almost a year, and the main reason for this situation was the refinance boom and low mortgage rates through 2021. To recap, if you bought a $500k home with 20% down in 2021, your monthly payment was around $2,300 / month including interest, principal, property taxes, and hazard insurance. Now, based on price changes in the market, that $500k home is worth approximately $650,000, and it would cost you a little more than $4,000 / month to purchase that home with 20% down given changes in interest rates, property taxes, and insurance pricing. That’s a 74% increase in the monthly cost of homeownership in the last 18-24 months.
Even if you wanted to downsize that home and carry the same mortgage balance into the next, smaller property, the change in interest rates alone would increase the cost of your home by over $1,000 per month and that is something most people of retirement age can not afford. As a result, there is a whole generation of people with a lot of equity in their homes who will be less inclined to sell because they simply can’t qualify for a new purchase in the current interest rate environment. If you take our position that affordability probably is going to get worse before it gets better, then we should expect even fewer homes to be coming on the market than we’ve seen in the last year.
