The tail risk for US housing: An unlikely scenario
In my view, the worst-case tail risk for US housing would be a 2007–2011 type scenario, where supply increases significantly but with woefully insufficient demand from prospective homebuyers.
For this to materialize, there would need to be both “voluntary” and “forced” selling of homes. Voluntary selling is less problematic because it usually involves turnover where a sale is accompanied by a purchase of a different home, resulting in zero net supply. However, widespread forced selling caused by liquidation of “underwater” assets, which we saw during the 2008 global financial crisis (GFC), could prove challenging. But I see this as an extremely remote possibility amid the current cycle, for three main reasons:
1. US homeowners have built up record amounts of equity in their homes, thanks to brisk home price appreciation, which has helped to substantially reduce the loan-to-value ratios of many of their mortgages.
2. Mortgage underwriting criteria today are much more stringent than during the GFC era. And the credit risk posed by the average borrower is much lower now, making the rampant foreclosure sales seen in 2008 and 2009 very unlikely.
3. While interest rates are higher now, most borrowers are insulated from this risk of stiffer financing costs because the majority of their mortgages are 30-year fixed-rate loans. In fact, only about 2% of today’s mortgage loan origination is adjustable-rate mortgages, versus roughly 50% during 2004–2006!
Bottom line: In the absence of mass forced selling, I expect home prices to remain resilient.
Getting Real: China looks beyond real estate for economic success
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Johnny Yu, CFA
Han Sia Yeo