By Varshika Prasanna
In 2020, the sale of previously owned U.S. homes surged to their highest levels in 14 years, and many economists forecast sales to rise again this year. Considering the previous global recession occurred due to housing prices, people and businesses are anxious about the potential consequences of this housing boom.
In the mid 2000s, loose mortgage lending standards enabled borrowers with flawed credit histories to purchase homes beyond their means while some mortgages had lower interest rates in the early years of the loan. Financial institutions converted these mortgages into tradable securities, and sold them off to investors. When an increasing number of homeowners started defaulting on their mortgages, the lenders suffered from huge losses which triggered a financial crisis. Between 2006 and 2014, homeowners paid the price: around 9.3 million households went through foreclosure, surrendered their home to the lender or sold in a distressed state.
Some analysts observe that the ongoing housing market boom occurred as a result of a severe shortage of single family houses due to the slower pace of housing construction after the last recession. The plummeting interest rates also make purchasing a home with a chapter mortgage attractive. However, mortgage lenders are also maintaining tight standards. Buyers are drawn to the housing market right now due to the low interest rates and high barriers of access to credit. This short supply coupled with growing demand has caused housing prices to soar. With rising home values, if homeowners cannot make the mortgage payments then they can sell their homes for a profit instead of facing foreclosure. Although financial firms continue to trade mortgage backed securities, most of them have government backing now. Thus, the current housing boom is far more stable than the previous one.
Real estate analysts acknowledge that the pandemic has played an important role as a catalyst to the housing market boom, as residents of bustling cities like New York and San Francisco are choosing to move to cheaper cities, or live in the suburbs while working remotely from home. When the lockdown was lifted, home sales surged: June sales were almost 21% more than May sales while July sales increased 25% compared to June. According to Rich Barton, the chief executive of online real estate company Zillow Group, “Covid has catalyzed a rethinking of where we live, and why we live there, and where we work, and how we work.” Market watchers claim that long term trends will keep the housing market steady even after COVID-19 fueled demand subsides in the future.
Existing homeowners have benefitted the most from this housing boom, as they collectively gained $1.5 Trillion in equity in 2020 from the previous year. They also restructured their mortgages with record low interest rates to save money. Real-estate brokers, home builders and mortgage lenders are also riding the wave. The S&P Homebuilders Select Industry index is up 96% in the last year, outperforming S&P’s 500 59% gain.
On the other hand, first time home buyers are finding it very difficult to buy despite the housing boom. This is partly because less expensive homes are harder to find, and they are struggling to afford the down payments. Interestingly, home prices and rents are going in completely opposite directions. While the demand for purchasing homes continues to rise in the middle of the pandemic, rent prices are falling by double digit percentages in some of the richest cities in the US. For example in San Jose, home prices rose by 14% in 2020 while rent prices declined by 7%.
However, the divergence between the rental market and the housing market is best attributed to the ‘K-shaped’ recovery of the economy from the COVID-19 recession. While hourly workers in jobs that require physical presence have been hard hit by the pandemic, employees in the white-collar industries have prospered. A large number of middle and high income households have used the pandemic to their advantage by speeding up their timeline of purchasing first, second and vacation homes.
However, the recession also caused urban rents to plummet as most activities nearly came to a standstill. Most businesses that depend on physical location like restaurants and bars have had to shut down. Work from home has made living close to the office less and less valuable. Typically, big cities have a lot of new entrants which constitute an important part of the rental markets. However, city residents who have the option to reside in the suburbs have chosen to do so. Therefore, the housing rental markets have taken a serious hit.
Millennials have also contributed to the housing and rental market disparity. Most 30 to 39 year olds have taken the opportunity put forth by the pandemic to purchase their new home. According to StreetEasy (a real estate website), rents in New York City are somewhat increasing in the low-income parts of the city, while they are plummeting in richer neighborhoods. This supports the theory that high income millennials are trading urban apartments for quiet urban and suburban homes. It also suggests that the housing and rental market disparity is definitely attributed to the inequality in the economic recovery of the rich and the poor after the pandemic.
Although the housing markets are in a complicated situation right now, something good could come of it in the years to come. The imbalance between rents and house prices could prompt an ‘urban renaissance’ where young and middle class residents lead the rental markets. It’s possible that millennial consumers shifting from the rental market to the housing market could have fueled the divergence between rents and housing prices. However the first evidence of a housing bubble – where the price of an asset rises way above its fundamental value – is when there is a significant difference between the trends observed in the housing market and the rental markets. Thus, investors and financial institutions need to be cautious and prevent consumer behaviors from causing history to repeat itself. □
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