When it comes to the residential real estate market in the United States there is more or less consensus on one theory, which is that there is no reason to worry about rising interest rates because after all rates are still incredibly low compared to historical trends. Most people see a continued recovery based on interest rates that are still considered low, even though they are rising, as well as the pent-up demand effect given that for years now far fewer houses have been built than in the years prior to the sub-prime mortgage meltdown.
State of recovery:
(Data)
In 2011 it took 6.7 months on average to sell a new home, while according to latest data, in the last months of 2013 it took only about 3 months on average (link). The lowest average price for a new home since the sub-prime meltdown was recorded in January, 2009, at $245,000 while currently the average sale price of a new home is $311,000. While the days of selling over a million new homes in a year are gone for the time being, sales are picking up. In 2011 only 306,000 homes were sold, while for 2013 we have 430,000 total sales of new residential homes (link). Bottom line for homebuilders is that they have more sales and at a higher price. It is a good trend, thus homebuilder stocks have been doing alright.
SPDR S&P Homebuilders ETF (XHB)
iShares Dow Jones US Home Construction Index Fund (ITB)
As we can see from both ETF charts, as things started to improve in 2011, so did the value of home builders. Since talk of Federal Reserve wishing to gradually disengage from policy of monetary stimulus sent mortgage rates up by roughly one percentage point last summer, homebuilders are no longer doing as well. Reason for homebuilder stocks stagnating is that new home sales volume and selling price are coming under pressure as well. Despite all the reassurances we have been getting that rising rates will not stall the housing recovery, because interest rates are still at historic lows despite the relatively small interest rate uptick, it seems buyers have become very sensitive to even a small increase in rates.
Long term affordability is the problem:
Note: US median income data as well as new house average price data are adjusted for inflation (2013 dollars). Data for average new home price was not inflation adjusted, so did the adjustment myself.
Since 1999, when median household income adjusted for inflation peaked, average inflation adjusted new home prices increased by roughly 25%, while median household incomes are down by almost 10%. Before 1999 average home prices more or less kept pace with income growth, but that is no longer the case. The only reason people were able to afford this increase since 1999 is because interest rates went down significantly since then.
Aside from house prices increasing even though median household income decreased, we also had a large increase in many other goods, which tend to squeeze the household budget. Gasoline prices adjusted for inflation have more than doubled since 1999, food prices are up significantly as well. Bottom line is that without the lower interest rates, most families would not be able to cope with the higher price of housing and other things.
Given that historically speaking real median household income has been on a rising trend for many decades until the peak in 1999, it is important to understand that interest rates may be low by historical standards, but they need to be in order to keep the consumer afloat. If interest rates will continue to rise, somehow home prices will have to re-adjust in order to maintain the historical trend of rising in line with people's incomes. Since incomes have not been rising for over one and a half decades already and there is little hope of ever surpassing the 1999 peak again, house prices might be in for another major stumble if we ever get back to interest rates which will reflect the historical average. It will be a needed correction in order to bring house prices back within historical affordability rates again. That is unless the current low interest rates become the new historical normal.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. (More...)
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