In 1895, at the age of 60 and in some financial difficulties, Mark Twain embarked on a speaking tour of the British Empire to pay the bills. He later published an account of his travels in a book entitled Following the Equator. Among his many pithy observations is one that I’ve always felt was particularly relevant to investing:
“We should be careful to get out of an experience only the wisdom that is in it and stop there lest we be like the cat that sits down on a hot stove lid. She will never sit down on a hot stove lid again, and that is well, but also she will never sit down on a cold one anymore.”
As the economy recovers from the pandemic, the housing industry is booming. However many Americans remain wary of real estate, having been badly burnt in the first decade of this century when a U.S. housing bubble ultimately triggered the worst recession since the Great Depression.
However, the reality is more nuanced this time around. So far, the increase in home prices is more moderate than 15 years ago, particularly given current super-low mortgage rates. In addition, residential real estate could provide a hedge against now rising inflation.
In time, of course, the increase in prices and building may become more worrisome and, in the meantime, a housing boom is still a very mixed blessing as it tends to increase inequality and divert resources from more productive activities. However, for investors, as of now, the boom in U.S. housing looks like more of an individual investment opportunity than a general macro risk.
Tuesday’s new home sales and, particularly, housing price data should provide further evidence of the strength in housing. We estimate that new home sales only fell moderately in April from a nearly 15-year high in March while the Case-Shiller report on home prices should show a double-digit year-over-year gain in average prices, as did last Friday’s existing home sales report.
The strength in demand is easy to understand. The pandemic has, at least temporarily, enhanced the attractiveness of suburban housing relative to crowded city living. Equally important, strong stock market gains and very low mortgage rates have increased the pool of potential buyers. Indeed, with price appreciation running at 10% year-over-year and mortgage rates at just 3.00%, buyer enthusiasm is easy to understand.
However, it is important to recognize that the market overall still looks reasonably priced. The average price of an existing single family home sold in April was just under $365,000—roughly 2.6 times annual household disposable income. This is right in line with its average of the last 20 years and 21% lower than its peak in the summer of 2005 at the height of the early-2000’s housing bubble. Moreover, back then the average 30-year mortgage rate was 5.8%—almost double today’s level.
In addition, the mid-2000s was characterized by massive over-building with over 1.7 million single-family homes started in 2005. Today, single-family housing starts are running at a much more modest pace of less than 1.1 million units annualized in April.