U.S. mortgage rates are up again, threatening to push the housing sector back into a recession, and a new report is warning that the weakness in the housing market has implications for the rest of the world.
In the report by the Dallas Federal Reserve Bank, researchers called out the possibility of a “deep global housing slide.” Weaknesses in the U.S. and German housing markets in particular “pose a vulnerability to the global outlook” due to the size of the countries’ economies as well as their “significant cross-border financial spillovers,” the report said.
In comparing home prices with rents, which is akin to comparing the price-to-earnings ratio for stocks, the researchers at the Dallas Fed tried to measure the profitability of housing as an investment opportunity.
They found that if the price-to-rent ratio grows “at an explosive rate” as compared with its fundamental-based ratio, which is estimated using long-term interest-rate and rent growth data, then it’s worth considering whether the sector is in a bubble.
“Exponential growth in key housing market indicators — such as real house prices and the price-to-income ratio — are a symptom of exuberance during a FOMO-driven housing bubble,” they explained.
Looking at the chart below and the area in pink, it’s clear that the price-to-rent ratios in the U.S. and Germany have risen far more than the fundamental ratios, meaning that “evidence of exuberance is apparent,” the researchers said.
The gap for the U.S. in particular “signals exuberance in the early 2000s as well as the pandemic,” the researchers said.
They also called for a “correction” to bring that line back down closer to the fundamentals — which would be a 19.5% decline.
And that has implications for the rest of the world, they added.
“The possibility of a domino effect, where investors pull out of international housing seeking safety and liquidity elsewhere, also raises concerns of spillovers beyond Germany or the U.S. to the global economy,” the researchers said.
The housing market is in a state of flux as buyers anticipate that the U.S. Federal Reserve will raise its benchmark interest rate further to dampen inflation and cool the economy and that mortgage rates will continue to rise as a result.
High mortgage rates affect demand, as the higher cost of interest can add hundreds of dollars a month to mortgage payments for home buyers. Home sales have plummeted as a result, except in the new-home sales arena, where builders have enough financial firepower to buy points on a mortgage rate to bring it down for buyers.
Source: www.marketwatch.com
