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Procida’s Take on The Economy “It’s Not Housing This Time”

Procida’s Take on The Economy
“It’s Not Housing This Time”

Billy Procida & Kent Michels

Procida Funding

July 15, 2022

With contributions from Dorian Clark, Bruce Doyle, Alex Gottlieb, and Adam Kochman

So here we are in July of 2022. We just lived through a 2-year pandemic and global supply chain crisis as well as the nastiest election in living memory. Just when it seemed like the situation couldn’t get any worse, an unexpected war in Ukraine came out of nowhere, worsening global supply chain bottlenecks and adding fuel to the inflation firestorm. Not only in the New York metro area but across the county and the wider world, mother nature seems persistent in kicking our ass. But the USA and mankind, just like football and baseball (and soccer in Europe), always seem to continue to move on. Now, we are left to figure out how the current environment is likely to impact us given our exposure to real estate, and how we can best navigate the landmines that surround us.

It’s Not Housing This Time

When we last had a “real” recession (more than 13 years ago now), the housing market was at the epicenter of it. To briefly recap: Weak lending standards allowed borrowers with poor credit and insufficient income to purchase homes with adjustable-rate mortgages, fueling significant increases in home prices. At the same time, homebuilding increased significantly to meet rising demand. But ultimately, a supply glut emerged when borrowers could not make their mortgage payments and foreclosures spiked just as homebuilders’ new deliveries were peaking. Banks, investors, and homeowners alike suffered massive losses – and the Great Recession ensued.

With this recession being the freshest one in our collective memory, investors are understandably nervous about the current state of the U.S. housing market. At first glance, there are some eerie similarities between the current environment and the one preceding the last housing-fueled recession. Home prices have increased at a faster rate than at any other time in post-war history, including the period preceding the last housing crisis. As of May 2022, the median sales price of a new home was 40% higher than it was only two years ago. While historically low interest rates softened the impact to overall housing affordability, the extremely rapid increase in mortgage interest rates during the last 90 days has started to derail this dynamic. Many investors are concerned that the significant run-up in housing prices is, like last year’s rising stock market, ultimately unjustified and that declining home prices are inevitable as a result.

Not so fast…

Rising interest rates may dampen the number of home sales and the frequency of out-of-control bidding wars. But the housing market of today appears to be starkly different from the bubble that burst in 2008 in several key respects. We have identified no fewer than 7 reasons to remain optimistic about the staying power of current housing prices:

Reason #1: The housing market is not oversupplied.

There is a potentially significant shortage of housing units in the U.S. according to several metrics. In a report released in 2021, the National Association of Relators reported an “underbuilding gap” of 5.5 million units during the last 20 years, based on the cumulative shortfall between annual housing unit completions and their long-term average going back to 1968. Their report points out that an average of 1.5 million housing units were built annually between 1968 and 2000, but housing completions have dwindled to an average of less than 1 million units per year since 2010. Although housing completions have increased during recent years, they remain below their pre-2000 long-term average. Based on this methodology, the NAR estimated a cumulative housing deficit of 5.5 million units for the period since 2000 – a level that has grown further to 5.7 million units since the NAR’s report was released.

Procidas Take on The Economy “It’s Not Housing Time”

Billy Procida & Kent Michels

Procida Funding

July 15, 2022

With contributions from Dorian Clark, Bruce Doyle, Alex Gottlieb, and Adam Kochman

So here we are in July of 2022. We just lived through a 2-year pandemic and global supply chain crisis as well as the nastiest election in living memory. Just when it seemed like the situation couldn’t get any worse, an unexpected war in Ukraine came out of nowhere, worsening global supply chain bottlenecks and adding fuel to the inflation firestorm. Not only in the New York metro area but across the county and the wider world, mother nature seems persistent in kicking our ass. But the USA and mankind, just like football and baseball (and soccer in Europe), always seem to continue to move on. Now, we are left to figure out how the current environment is likely to impact us given our exposure to real estate, and how we can best navigate the landmines that surround us.

It’s Not Housing This Time

When we last had a “real” recession (more than 13 years ago now), the housing market was at the epicenter of it. To briefly recap: Weak lending standards allowed borrowers with poor credit and insufficient income to purchase homes with adjustable-rate mortgages, fueling significant increases in home prices. At the same time, homebuilding increased significantly to meet rising demand. But ultimately, a supply glut emerged when borrowers could not make their mortgage payments and foreclosures spiked just as homebuilders’ new deliveries were peaking. Banks, investors, and homeowners alike suffered massive losses – and the Great Recession ensued.

With this recession being the freshest one in our collective memory, investors are understandably nervous about the current state of the U.S. housing market. At first glance, there are some eerie similarities between the current environment and the one preceding the last housing-fueled recession. Home prices have increased at a faster rate than at any other time in post-war history, including the period preceding the last housing crisis. As of May 2022, the median sales price of a new home was 40% higher than it was only two years ago. While historically low interest rates softened the impact to overall housing affordability, the extremely rapid increase in mortgage interest rates during the last 90 days has started to derail this dynamic. Many investors are concerned that the significant run-up in housing prices is, like last year’s rising stock market, ultimately unjustified and that declining home prices are inevitable as a result.

Not so fast…

Rising interest rates may dampen the number of home sales and the frequency of out-of-control bidding wars. But the housing market of today appears to be starkly different from the bubble that burst in 2008 in several key respects. We have identified no fewer than 7 reasons to remain optimistic about the staying power of current housing prices:

Reason #1: The housing market is not oversupplied.

There is a potentially significant shortage of housing units in the U.S. according to several metrics. In a report released in 2021, the National Association of Relators reported an “underbuilding gap” of 5.5 million units during the last 20 years, based on the cumulative shortfall between annual housing unit completions and their long-term average going back to 1968. Their report points out that an average of 1.5 million housing units were built annually between 1968 and 2000, but housing completions have dwindled to an average of less than 1 million units per year since 2010. Although housing completions have increased during recent years, they remain below their pre-2000 long-term average. Based on this methodology, the NAR estimated a cumulative housing deficit of 5.5 million units for the period since 2000 – a level that has grown further to 5.7 million units since the NAR’s report was released.

Cognizant of the potential for bias in a housing research report from the NAR, we have also conducted our own analysis, measuring the cumulative housing deficit based on the difference between household formation and housing completions during recent years. This approach suggests that new housing supply is closer to equilibrium, but still not oversupplied. Since 2010, the country gained 12.4 million households but realized a net increase in housing inventory of only 10.1 million units, suggesting a cumulative deficit of as many as 2.3 million units. A similar analysis, which measures the cumulative housing deficit as the difference between household formation and housing completions during the preceding 5-year period only, also reveals a significant deficit throughout most of the 2010s.

Notably, the pandemic’s severe impact on household formation, which was negative for the first time ever in 2020, resulted in a noticeable “surplus” for 2020 and 2021. However, housing completions and household formation are expected to return to equilibrium based on the current level of housing starts and the likelihood of a return to pre-pandemic rates of household formation. In stark contrast, housing surpluses persisted for many years prior to past housing downturns in 1990-1991 and 2007-2009.

Even if the total housing supply is aligned with the number of U.S. households, the number of homeowners willing to sell is not commensurate with the pool of willing buyers. This dynamic is not likely to change anytime soon. Since 2000, the number of existing homes available for sale has averaged 2.3 million units, a figure that peaked at more than 3.7 million housing units before home prices began to plummet in 2008. Since then, the number of existing homes available for sale has steadily declined and reached an all-time low in May 2022 of 1.1 million units.[1] Rising mortgage rates are likely to further dampen the supply of existing homes for sale, as existing homeowners will be less likely to move if that means consigning themselves to a much higher interest rate. At the same time, rising inflation and stock market turbulence may dissuade homeowners from selling given the difficulty of maintaining the real value of their sales proceeds once a sale is consummated.


[1] Specifically, we refer to the 12-month moving average of the number of existing homes available for sale given monthly seasonality in the data.

Reason #2: Mortgage borrowers have much stronger balance sheets than they did in 2008.

Mortgage borrowers’ creditworthiness is much stronger now than it was during the housing bubble preceding the Great Recession. Whereas borrowers with credit scores below 660 accounted for more than 25% of mortgage originations in late 2006 and early 2007, this cohort of borrowers accounted for only 8% of mortgage originations since 2009. And their share of mortgage originations declined to less than 6% since the pandemic began fueling significant home price increases in mid-2020. Lending standards tightened significantly after the housing bubble burst the last time, and they have not let up in the years since.

Similarly, mortgage borrowers’ home equity balances have never been stronger than they are today, suggesting that foreclosure activity is likely to remain subdued. Households’ real estate debt as a percent of market value is at a 35-year low of 30.1% as of Q1 2022. By comparison, real estate debt was above 40% of market value in the years preceding the last housing downturn and peaked at 54% in 2012 after home prices crashed. Moreover, the improvement in owners’ equity balances is only partly driven by rising home prices during the last several years. The share of homes purchased with marginal down payments has also declined very significantly since the last downturn. The share of new mortgages with equity below 3% of the home’s purchase price surpassed 31% in late 2006 but has since fallen to 8.7% as of September 2021, marking the lowest level in the 20 years since data collections began.[2]


[2] Data through September 2021 were released on June 29, 2022, and reflect the most recent figures available

Existing homeowners are also much less susceptible to rising mortgage interest rates than they were in the mid-2000s, as adjustable-rate mortgages have been rarely utilized during the last 10 years. Whereas adjustable-rate mortgages accounted for more than 40% of mortgage originations in early 2005, they have accounted for less than 3.5% of mortgages originated since 2009 and only 0.8% of mortgage originations in September 2021, the latest month for which data are available. While adjustable-rate mortgages are quickly becoming more popular as fixed-rate mortgage rates rise, these products pose significantly less risk to borrowers than they did during the run-up to last housing crisis. Interest rate changes for adjustable-rate mortgages are typically subject to both annual and lifetime caps, and unlike during the housing bubble, lending regulations require that adjustable-rate mortgages be underwritten to their fully-indexed interest rate.

Reason #3: Mortgage rates and housing affordability remain in line with historic norms, so far.

Despite the media rhetoric surrounding the recent run-up in home prices and mortgage rates, neither housing affordability nor mortgage rates compare unfavorably with their long-term averages. In fact, interest rates remain low by historical standards. Even after three interest rate hikes this year, the current WSJ Prime Rate of 4.75% remains significantly below its 50-year average of 7.35%. The 30-year mortgage rate, which has risen to 5.30% (as of July 7th), likewise remains well below its 50-year average of 7.77%.

Housing affordability also remains near its historical norm, even after the significant run-up in housing prices during the last two years and the substantial increase in mortgage rates during the last 90 days. The cost of purchasing a median-priced new home, assuming a 20% down payment and the prevailing 30-year fixed mortgage rate, amounts to an estimated 27% of median family income, just slightly above the 50-year average of 24%. Home prices are not out of whack with family incomes at the national level.

Reason #4: Homebuyers have other financing options that are still remarkably cheap.

Although 30-year fixed-rate mortgages are the most popular mortgage product, it is worth noting that other less costly financing options are available to prospective home purchasers. Despite their stigma, adjustable-rate products are not necessarily bad options for large cohorts of homebuyers, and their availability may continue to support the housing market as 30-year mortgage rates increase. As shown in the table below, the average interest rate for a 5-year adjustable-rate mortgage was 4.2% as of July 7th, more than a full percentage point lower than the interest rate for a 30-year fixed rate mortgage. Notably, home sellers’ homeownership tenure averaged only 6 years as of late 2021, and adjustable-rate products lock in a lower interest rate for at least 5-10 years and afford some protection in the form of interest rate caps. As a result, adjustable-rate mortgages are a smart option for many buyers, especially given their improved underwriting standards.

Reason #5: Real estate is usually a “safe” haven from inflation.

Housing has historically proved to be a relatively safe store of value during periods with high interest rates and inflation. In many respects, the current environment is like the one that persisted during the 1970s and early 1980s, when gas prices soared, the economy soured, and the Federal Reserve was forced to increase interest rates significantly to combat high inflation. After 40 years of subdued inflation, the consumer price index registered a year-over-year increase of 9.1% as of June 2022, the highest rate observed since 1981. Based on these similarities, the performance of the housing market during the 1970s and early 1980s may provide some guidance regarding the likely trajectory of home prices in the current high-inflation, rising interest-rate environment.

That guidance is surprisingly encouraging. Between 1972 and 1982, during which time inflation averaged 8.2% per year and the 30-year mortgage rate averaged 10.8%, home prices and commercial real estate appreciated at average annual rates of 9.8% and 9.4%, respectively. By comparison, the stock market achieved an average nominal return of only 2.5% per year, which equated to a negative real return. To the extent that inflation and higher interest rates cause turbulence in the stock market, these factors may even bolster the housing market as investors appreciate its intrinsic value and relative lack of volatility.

Reason #6: Housing-centric recessions are the exception, not the rule.

Housing prices have historically been remarkably resilient, even during recessionary periods. There have been seven recessions during the last 50 years, and new home prices have only noticeably declined during two of those recessions, in 1990-91 and in 2007-2009. Both episodes were caused by risky lending practices and loose banking regulations, which have been substantially addressed in the years since then. The savings and loan crisis gradually unfolded between the mid-1980s and early 1990s, when deregulation allowed savings and loan institutions to increase their exposure to risky, speculative real estate loans. Risky speculation and outright fraud ultimately ended in massive taxpayer-funded losses, prompting new regulations to curtail the role of savings and loan institutions in real estate lending. The decline in credit availability contributed significantly to the decline in home prices in 1990-1991. The more recent decline in home prices in 2007-2009 was precipitated by the infamous proliferation of subprime mortgages to borrowers with weak credit and razor-thin down payments. There is no evidence that lending practices have loosened once again, which should reduce the likelihood of a renewed downturn in home prices.

Reason #7: It’s less subject to emotion and volatility than the stock market…

During the last 50 years, there have been 7 recessions and 3 periods (2 of them during recessions) when home prices declined. Home price declines only surpassed 10% from peak to trough in 2007-2009, when home prices declined 11.3%. (Home prices declined only 3.6% in 1990-1991 and 2.9% in 2018-2019.)[3] In contrast, during that time the stock market has had a total of 26 corrections during which its value declined 10% or more.

At Procida Funding, we’ve made this argument in the past, and frankly, it’s more obvious today than perhaps ever before: the way the stock market fluctuates is nonsensical. It’s not based on cash flow analysis, it’s not based on profit and loss statement analysis, it’s not based on anything except emotion. Nobody can underwrite the value of a company by the hour, or even by the week, leaving emotion as the predominant market mover – and emotions are fickle. Stockbrokers and financial advisors will be quick to tell you that, “since the beginning of time, the stock market always goes up,” while leaving out that it crashes once every 7 or 8 years and can take


[3] Note that the data referenced refer to the 12-month moving average of the median sales price for new homes. We have concentrated on the 12-month moving average given monthly seasonality in the data.

years to recover. Real estate, on the other hand, has intrinsic value based on its cash flow, square feet, number of bedrooms, and market demand. You can sleep in it, work in it, and shop in it. It’s real!

Conclusion: We’ll stick with real estate.

Today’s investment landscape is undoubtedly littered with land mines. Inflation is now at a 40-year high, and we’ve yet to see any clear signs that it is abating, or even decelerating. Interest rate increases have been rapid, and rates may continue to climb steeply for a long time yet. Even after its recent 20% decline, the stock market remains nearly 12% above its pre-pandemic level (as of June 30th) despite a laundry list of economic risks that have accumulated since then.

In this environment, real estate is the best bet by a long shot, and we’re sticking with it. The country’s housing supply is constrained, mortgage borrowers have strong balance sheets, housing remains relatively affordable, real estate is a good hedge against inflation, and home prices have historically been very stable. Of course, certain areas of the country and certain segments of the housing market carry greater risk. Areas where land is more plentiful, new construction is more abundant, and housing prices have more significantly outpaced local income levels are more susceptible significant price declines. The same is likely the case for luxury housing and other niche segments that have smaller buyer pools to leverage. But significant price declines for middle-class “apple pie” housing (our specialty at Procida Funding) are much less likely based on the factors that we have outlined.

Moreover, unlike stocks, real estate has intrinsic value. You can sleep in it, eat in it, shop in it, and have medical procedures performed in it; you can feel it, kick it, and smell it! Moreover, its supply is constrained, and its versatile – you can reposition it and breathe new life into it if need be. Corporate boards can dilute common shareholders by creating more shares, and the Federal Reserve can unilaterally lower prices for paper securities by ceasing to provide liquidity for them. But nobody is creating more land. It’s only becoming scarcer and more valuable, and this is especially true in Procida Funding’s home state of New Jersey, which ranks as the most developed state in the country with less than 15% of its total land area still available for future development.

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