Welcome to Thoughts on the Market.
I'm James Egan, US housing strategist and co-head of securitized products research for Morgan Stanley.
And I'm Ellen Zentner, chief economic strategist and global head of thematic and macro investing at Morgan Stanley Wealth Management.
And today we dive into a topic that touches nearly every American household, quite literally the future of the US housing market.
It's Thursday, September 25th at 10 a.m. in New York.
So Ellen, this conversation couldn't be timelier.
Last week, the Fed cut interest rates by 25 basis points.
And our chief US economist, Mike Gapin, expects three more consecutive 25 basis point cuts through January of next year.
And that's going to be followed by two more 25 basis point cuts in April and July.
But mortgage rates, they're not tied to Fed funds.
So even if we do get six 25-bip cuts by the end of 2026, that in and of itself we don't think is going to be sufficient to bring down mortgage rates, though other factors could get us there.
Taking all that into account, the U.S. housing market appears to be a little stuck.
The big question on investors' minds is what's next for housing and what does that mean for the broader economy.
Well, I don't like the word stuck.
There's no churn in the housing market.
We want to see things moving and shaking.
We want to see sellers out there.
We want to see buyers out there.
And we've got a lot of buyers or would-be buyers, right, but not a lot of sellers.
And, you know...
The economy does well when things are moving and shaking, because there's a lot of home-related spending that goes on when we're selling and buying homes.
And so that helps boost consumer spending.
Housing is also a really interest rate-sensitive sector.
You know, I like to say as goes housing, so goes the business cycle.
And so you don't want to think that housing is sort of on the downhill slide or heading toward a downturn, because it would mean that the entire economy is headed toward a downturn.
So we want to see housing improve here.
We want to see it thaw out.
I don't like, again, the word stuck.
You know, I want to see some more churn.
As do we.
And one of the reasons that I wanted to talk to you today is that you're observing all of these pressures on the US housing market from your perspective in wealth management.
And that means your job is to advise retail clients who sometimes can have a longer investment time horizon.
So Ellen, when you look at the next decade, how do you estimate the need for new housing units in the United States?
And what happens if we fall short of these estimated targets?
Yeah.
So we always like to say demographics makes the world go round and especially it makes the housing market go round.
And we know that, if you just look at demographic drivers in the US, of those young millennials and Gen Z that are aging into their first time home buying years, whether they're able to immediately or at some point purchase a home, they will want to buy homes.
And if they can't afford the homes, then they will want to maybe rent those single-family homes.
But either way, if you're just looking at the sheer need For housing in any way, shape or form that it comes, we're going to need about 18 million units to meet all of that demand through 2030.
And so when I'm talking with our clients on the wealth management side, it's okay short term here.
Over the next couple of years there is a housing cycle.
And affordability is creating pressures there.
But if we look out beyond that, there are opportunities because of the demographic drivers single family rentals, multifamily.
We think modular housing can be something big here as well.
All of those solutions that can help everyone get into a home that wants to be.
Now you hit on something there that I think is really important, kind of the implications of affordability challenges.
One of the things that we've been seeing is it's been driving a shift toward rentership over ownership.
How does that specific trend affect economic multipliers and long term wealth creation?
In terms of whether you're going to buy a single family home or you're going to rent a single family home.
It tends to be more square footage and there's more spending that goes on with it.
But of course then, relatively speaking, if you're buying that single family home versus renting, you're also going to probably spend a lot more time and care on that home while you're there, which means more money into the economy.
In terms of wealth creation.
We'd love to get the single family home ownership rate as high as possible.
It's the key way that households build intergenerational wealth.
And the average American, or the average household, has four times the wealth in their home than they do in the stock market.
And so that's why it's very important that we've always created wealth that way through housing.
And we want people to own and they want to own and that's good news.
These affordability challenges.
Another thing that you've been highlighting is that they've led to an internal migration trend.
People moving from high cost to lower cost metro areas.
How is this playing out and what are the economic consequences of this migration?
Well, I think, first of all I think to the wonderful work that Mark Schmidt does on the Muniz team at MSCo.
It matters a great deal ownership rates in various regions because it can tell you something about the health of the metropolitan area where they are buying those homes and paying those property taxes.
It can create imbalances across the US where you've got Excess supply maybe in some areas, but very tight housing supply in others.
And eventually, to balance that out, you might even have some people that say post-COVID or during COVID moved to some parts of the country that have now become very expensive.
And so they leave those places and then go back to either try another locale or back to the locale they had moved from.
So understanding those flows within the US can help communities understand the needs of their community, the costs associated with filling those needs and also associated revenues that might be coming in.
So, Jim, I mentioned a couple of times here about single-family renting.
And so from your perch.
Given that growing number of single-family rentals, how is that going to influence housing strategy and pricing?
It is certainly another piece of the puzzle.
When we look at single-family homeownership, multi-unit rentership, multi-unit homeownership and then single-family rentership, over the past 15 years this has been the fastest growing way in which kind of US households exist.
And when we take a step back, looking at the housing market more holistically, something you hit on earlier supply has been low.
And that's played a key role in keeping prices high and affordability under pressure.
On top of that, credit availability has been constrained.
It's one of the pillars that we use when evaluating home prices and housing activity that we do think gets overlooked.
And so, even if you can find a home to buy in these tight inventory environments, it's pretty difficult to qualify for a mortgage.
Those lending standards have been tight.
That's pushed the homeownership rate down to 65%.
Now, it was a little bit lower than this. after the great financial crisis.
But prior to that point, this is the lowest that homeownership rates have been since 1995.
And so we do think that single-family rentership becomes another outlet and will continue to be an important pillar for the US housing market on a go-forward basis.
So the economic implications of that that you highlighted earlier.
We think that's going to continue to be something that we're living with, pun only half intended in the US housing market.
Only half intended.
But let me take you back to something that you said at the beginning of the podcast.
And you talked about Gapen's expectation for rate cuts and that that's going to bring the Fed funds rate down.
Those are interest rates, though, that don't impact mortgage rates.
So how do mortgage rates price interest?
And then how do you see those persistently higher mortgage rates continuing to weigh on affordability?
Or I guess really what we all want to know is when are mortgage rates going to get to a point where housing does become affordable again?
In our prior podcast, my co-head of Securitas Products Research, Jay Backow, and myself talked about how cutting Fed funds wasn't necessarily sufficient to bring down mortgage rates.
But the other piece of this is going to be how much lower do mortgage rates need to go?
And one of the things we highlighted there, a data point that we do think is important mortgage rates have come down recently, right.
Like we're at our lowest point of the year, but The effective rate on the outstanding market is still below 425.
Mortgage rates are still above 6.25%.
So the market's 200 basis points out of the money.
One of the things that we've been trying to do, looking at changes to affordability historically.
What we think you really need to see a sustainable growth in housing activity is about a 10 improvement in affordability.
How do we get there?
It's about a five and a half percent mortgage rate, as opposed to the six and an eighth to six and a quarter where we were when we walked into this recording studio today.
We think there will be a little bit response to the move in mortgage rates we've already seen.
Again, it's the lowest that rates have been this year.
And there have been some.
Are those fence sitters, what we call fence sitters, people that say, oh, gosh, it's coming down.
Let me go ahead and and jump in here.
Absolutely.
We'll see some of that.
And then from just other parts of the housing infrastructure, we'll see refinance rates pick up right.
Like.
There are borrowers who've seen originations over the course of the past couple of years whose rates are higher than this.
Morgan Stanley actually publishes a truly refinanceable index that measures what percentage of the housing market has at least a 25 basis point incentive to refinance.
Housing market holistically after this move.
17 mortgages originated in the last two years.
61 of them have that incentive.
So I think you'll see a little bit more purchase activity.
Again, we need to get to 55 for us to believe that will be sustainable.
But you'll also see some refinance activity as well.
Right.
It doesn't mean you get absolutely nothing and then all of a sudden the spigot opens when you get to 55.
Anecdotal evidence.
I have a 27 30-year mortgage and I've told my husband I'm going to die in this apartment.
I'm not moving anywhere.
So I'm part of the problem, Jim.
Well, congratulations to you on the mortgage.
I wasn't trying to brag.
But yes, it feels like you know your point.
On perspective, folks that are younger buyers, you know, looking at the prevailing mortgage rate right now and saying my gosh, that's really high.
But some of us that have been around for a lot longer are saying, really, this is fine.
But it's all relative speaking.
When you have over 60 of the mortgage market that has a rate below 45, below 4 yes, on a long-term basis, mortgage rates don't look particularly high.
They're very high relative to the past 15 years.
And to your point on a 27 mortgage rate.
There's no incentive for you, or there's limited incentive for you, to sell that home, pay off that 27 mortgage rate, buy a new home at higher prices at a much higher mortgage rate.
That has I know you don't like the word stuck, but it has been what's gotten this housing market kind of mired in its current situation.
Price is very protective, activity pretty low.
Jim, we've been talking about all the affordability issues.
And so let's set mortgage rates aside and talk about policy proposals.
Are there specific policies that could also help on the affordability front?
So there's a number of things that we get questions about on a pretty regular basis, things like GSE reform, first-time homebuyer tax credits, things that could potentially spur a supply.
And look, the devil is in the details here.
My colleague, Jay Backow, has done a lot of work on GSE reform, and what we're really focusing on there is the nature of the guarantee, as well as the future of regulation and capital charges.
For instance, US banks own approximately one-third of the agency mortgage-backed securities market.
Any changes to regulatory capital as a result of GSE reform that could have implications for their demand.
And that's going to have implications on mortgage rates, right?
First time home buyer tax credits.
We have seen those before, the spring of 2008 to 2010.
And if we use that as a case study, we did see a temporary rise in home sales and a pause in the pace with which home prices were falling.
But the effects there were temporary.
Sales and prices wouldn't hit their post-housing crisis lows until after those programs expired.
Right.
So you were incentivized to buy the house.
You get the credit, you buy the house, but then, unbeknownst to any economist out there, housing valuations continued to fall.
Could argue that it maybe pulled some demand forward.
And so you saw a lot of it concentrated and then the absence of that demand afterwards.
And then on the supply side, there are a number of different programs.
We have touched on some of them in these podcasts in the past.
And then some of those questions become what needs to go through Congress?
What is more kind of local municipality versus federal government?
But look, the devil's in the details.
It's an incredibly interesting housing market, probably one that's going to be the source of many podcasts to come.
So Ellen, given all these challenges facing the US housing market, where do you see the biggest opportunities for retail investors?
So in our recent note, housing in the next decade, we took a look at single family renting.
You and I have talked about how that's likely to still be in favor for some time.
REITs with exposure to select U.S. rental markets.
What about senior housing?
That is something that you've done deep research on as well senior and affordable housing providers, home construction and materials companies.
What about building more sustainable homes with a good deal of the climate change that we're seeing?
And financial technology firms that offer flexible financing solutions.
So these are some of the things that we think could be in play as we think about housing over the long term.
Ellen, thank you for all your insights.
It's been a pleasure to have you on the podcast.
And I guess there's a key takeaway for investors here.
Housing isn't just about where we live.
It's about where the economy is headed.
Exactly.
Always a pleasure to be on the show.
Thanks, Jim.
And thanks for listening.
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