You might have learned that supply and demand dictates price before you graduated from high school. There’s a less-discussed variable within—the capacity to pay.
Say that you and I are crawling through the hot desert, penniless and dying of thirst. We have a high demand for a drink of water.
Next, we’re lucky enough to find a trekker with a water canteen. Ah! Demand just meets supply. A market is about to be created and we will live, right?
No. They charge just one penny for a drink. We can “demand it” all that we want. But since we’re penniless, we’re dead. We lacked the capacity to pay.
Now that the median monthly mortgage payment is 56 percent higher than a year ago due to higher home prices and higher interest rates, many renters who wanted to buy a home feel like the dehydrated and penniless desert crawler.
They can demand to be a homeowner all that they want, but lack the capacity to pay. Today’s wannabe first-time homeowner is in worse shape than Texas’s power grid.
American housing supply remains so scarce that we need the current available inventory units of ~600,000 to increase to 1.5 million (chart). This means that we need a 250 percent increase in supply just to have reached a supply–demand equilibrium.
Last year on NTD Television and my podcast, I stated that home prices should keep rising this year. But if more wannabe buyers lack the capacity to pay, then what should keep supporting these ever-higher housing prices that I expect to continue?
Higher Mortgage Rates
C’mon now. In what twisted, upside-down era and place would higher rates correlate with higher property prices? Today, and right where you are as you read this now. Prices have risen alongside interest rates for the past 18 months.
Let’s look at recent history. Mortgage rates have increased substantially nine times since 1994. Home prices rose seven out of those nine times (chart). Are you surprised?
Although there is broad disagreement on the state of today’s economy, rate increases are, historically, often a confirmation that the economy is strong. Conversely, when the Federal Reserve lowers rates, it often means that the economy is doing poorly and needs support. People make homebuyer decisions based primarily on the stability of their job and income, not the mortgage interest rate.
But homebuilders expect these higher rates to slow buyer appetite. This has made homebuilder confidence and sentiment sink. Builders build less. This crimps supply even more.
Existing homeowners are reluctant to sell because their replacement home would have a higher rate. This means that their property often does not come onto the market at all, further crimping supply.
The most populous age cohort in America are 28–34-year-olds. It’s prime “household formation” age.
When a 51-year-old buys a home, they typically sell their old one. This balances supply and demand. But see, when these more numerous 29-year-olds buy a home, they often don’t have one to sell. Their transaction absorbs one unit of supply.
Existing Homeowner Strength
A housing price crash is fueled by distressed homeowners who cannot make their mortgage payments and have no equity, so they walk away (like in 2008). Today, 40 percent of homeowners have no mortgage.
Among those with mortgages, the national loan-to-value ratio is 30 percent. For example, that’s a $500,000 home with a $150,000 mortgage. The delinquency rate on residential mortgages keeps descending (chart).
The Fed Factor
Fed rate increases support rents. Sure, their higher rates are primarily an attempt to slow inflation.
But in the context of real estate, the Fed is trying to fight a supply issue by dampening homebuyer demand. Eventually, policy makers will have a chance to stomp out demand if today’s mortgage rate doubles. The effect is that higher home prices push droves of people into renting property. They can’t afford to buy a drink in the desert.
Two big variables are as rigid and bulletproof as Kevlar: high demographic demand and low housing supply. They cannot change in the next few years.
Today’s losers are renters and first-time homebuyers. Today’s winners are existing homeowners and rental-property owners.
I discuss the housing market’s future and how to profit with rental property every week on the Get Rich Education podcast.
Views expressed in this article are the opinions of the author and do not necessarily reflect the views of The Epoch Times.