Don’t Discount Structural Housing Trends

The recent surge in interest rates and inflation has put the record strength in housing under a microscope. How does record-high inflation impact the housing sector and how will the Federal Reserve’s prospective tightening affect the supply and demand for shelter? We believe that while the rise in interest rates will certainly slow the sector from its recent heights, long-term structural trends in the sector will not be so easily swayed. Here’s why.

Structural trend #1 – Demographics sustaining demand

The baby boomer generation[1] remains the driving force in US national demographics. Therefore, its demand preferences and consumption patterns will continue to have an outsized impact on all market segments—especially housing. This is not a new phenomenon. Older demographic tiers have traditionally had higher rates of homeownership.

There is another age group contributing to favorable housing demand. The size of the 35 to 44 year old cohort, a key home buying and household formation segment, is rebounding after an approximately 25-year decline. An environment of higher interest rates and inflation could somewhat temper this rise.

Structural trend #2 – Lack of supply

Baby boomers are holding on to their homes longer. The general increases in life expectancy and availability of at-home care, along with the significant size of the boomer generation, have resulted in a concentration of real estate ownership in the older generations.

On the supply side, demographic shifts have exacerbated tight supply conditions. In the US, the marginal first-time-homebuyer segment is growing in size and competing for a share of the declining housing stock. Adjusted for population, inventory remains at structural lows.

One window into the ongoing lack of housing supply is to measure the contribution to GDP from residential investment. The chart below makes clear the excess in the run up to the global financial crisis (GFC), and the substantial, decade-plus long deficiency in investment. The substantial destruction in capacity caused by the GFC has not yet been made whole.

 The pandemic’s accelerating effect?

For homeowners, these positive tailwinds have been in place since 2016. What is driving the dramatic move in prices currently, and how sustainable is the move? Our thesis is that the pandemic accelerated a broadening preference shift in the key home buying population cohorts—spurring an increase in household formation and pulling forward demand for detached housing. This was, and continues to be, confounded by the structural deficiency in available housing.

Finally, the demand shock, and supply deficiency has been further compounded in some of the fastest-growing markets by the significant increase in participation of investors.

Conclusion

The housing sector’s exceptionally strong performance in 2021 and recent dramatic rise in interest rate somewhat tempers our optimistic outlook. We expect that the record rise, on a proportional basis, of housing costs will significantly slow transaction volume, as well as the pace of future price appreciation. However, despite the ongoing volatility in both macroeconomic events and interest rates, we are fundamentally positive on the US housing based on its long-term structural trends.

[1] People born 1946 – 1964.

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Past performance or market experience is no guarantee of future results.