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High demand for housing combined with low inventory has heated up the market – boosting property values and leading some to wonder if we’re in bubble territory.
But Morgan Stanley analysts say no.
“We have strong conviction that we are not experiencing a bubble in US housing,” Morgan Stanley strategist Vishwanath Tirupattur wrote in a note to clients this week.
Tirupattur and the Morgan Stanley team admit that the “US housing is on a hot streak,” pointing out that prices have increased 12.2% over the past year based on the S&P Case-Shiller index.
"That amounts to an increase of $35,000 in the median selling price for homes from just a year ago and marks the fastest pace of increase since 2006," Tirupattur wrote.
The hot real estate market and hot stock market may be evoking memories of bubbles for some. Even Treasury Secretary Janet Yellen said this week that interest rates might have to rise from the current near-zero level to prevent overheating. And even uttering “2006,” Tirapattur writes, carries a lot of baggage when it comes to housing, as that was the trigger that imploded the economy 15 years ago.
But Tirapattur says it’s not a bubble and not really like 2006 at all, and there’s a good reason to think so based on the data. This time is different, the bank says.
Today’s hot market is based off of one key thing after all – big demand and little supply – which puts the sector on “a sustainably sturdy foundation,” in Morgan Stanley’s view. “We are not at all suggesting that home price appreciation will maintain its current torrid pace. Home prices will continue to rise, but more gradually.”
Two different types of risk
According to Tirapattur, there's a misunderstanding about the cause of the financial crisis, and that it wasn't just about lending to people with low credit scores. "We think it was more about the type of credit they had access to,” he wrote.
There are two types of risk, borrower risk and product risk; borrower risk is based on a consumer’s creditworthiness – using metrics like credit score and debt-to-income ratio. Product risk, on the other hand, is more about providing mortgages with higher risks of default, "even controlling for those borrower characteristics."
Some of the mortgages that have product risk are ones structured in ways that can make payments vary significantly, like mortgages with introductory periods, teaser rates, and balloon payments – which have a higher risk of default. “Product risk increased significantly more than borrower risk during the pre-GFC housing boom,” the analysts write.
“The affordability products were inherently risky because they effectively required home prices to keep rising and lending standards to remain accommodative so that homeowners could refinance before their monthly payment became unaffordable,” Tirapattur explains. “When home prices stopped climbing, these mortgages reset to payments that borrowers could not make, leading to delinquency and foreclosure. As foreclosures and the subsequent distressed sales piled up, home prices fell further, creating a vicious cycle.”
Back in the lead-up to the Global Financial Crisis, product risk was rising far more than borrower risk, Morgan Stanley analysts say, with affordability products comprising around 40% of the mortgage market between 2004 and 2006. "Today their share is down to 2%,” Tirapattur notes.
On top of that, other metrics like credit requirements and leverage are improved. Before the crisis, the US housing market value was around $26 trillion in 2006 with mortgages equalling around $11 trillion. Today, the mortgage debt is only $1 trillion more and the value of the market has jumped to $33 trillion. For Morgan Stanley, "these changes give us confidence that the current system of housing finance is healthy and on a sustainable footing."