In February, when the first case of COVID-19 was reported in the US, very few of us anticipated where we would be today. The novel coronavirus has sickened millions and tragically taken the lives of tens of thousands more. For those of us adhering to stay-at-home policies to reduce the spread of the virus, it has changed our daily lives more than any other event in recent history. Economically, it’s caused the fastest and most dramatic increase in unemployment in American history, destroyed businesses, and brought entire industries to a screeching halt.
In particular, housing, an industry that prior to COVID-19 was flying high, is at a standstill. Like many other industries, housing is in jeopardy of being changed forever. As we look towards the future of our world post-COVID-19, no one is sure what to expect, but we can be certain that things will be different.
In this article, I examine two potential outlooks for the housing market and what signs to look for that will indicate where it’s headed.
A "V-Shaped" Recovery
In March, the US economy plunged into a recession when investors realized the full force of the COVID-19 pandemic. Despite this sharp decline, some economists and business leaders believe the US economy will bounce back once it reopens for business. This type of recovery is referred to as “V-Shaped” because the charts of economic output take the shape of the letter “V”, showing a sharp decline followed by a rapid rise back to previous peaks.
Such a recovery is contingent upon employment rates returning to pre-COVID-19 levels. Assuming the majority of the people who lost their jobs during the pandemic are able to return to work and earn the same wage, then the Housing industry will be a sector that leads the recovery.
To begin, existing homeowners will be eligible to refinance into lower rate mortgages. Currently, interest rates are near historic lows, but many homeowners are not able to refinance because of job loss or lack of access to low rate mortgages. By lowering one’s monthly mortgage payment, borrowers have more money to put back into the economy. Many homeowners will use the extra cash and access to cheap financing for home improvements that increase the value of their home. For potential home buyers, low interest rates improve buying power, which in turn increases demand for housing.
With people investing in their homes and homebuyer demand improving, the value of homes will increase. Moreover, demand for housing, rising prices, and low interest rates will encourage home construction. An increase in home building is important because it not only leads to new home purchases, but it also increases employment and helps vendors who supply goods and services to home builders.
Signs of a V-Shaped Recovery
- Employment rates returning to pre-COVID-19 levels
- Improving housing sentiment indexes
- Increasing home values
- A rise in mortgage applications, especially for home purchases
- A growing number of home listings
- New housing starts
A Pandemic Induced Housing Crisis
While some economists are predicting a V-Shaped recovery, the prevailing belief is that we are headed for a prolonged recession with a slow recovery in the distant future. This outlook can be represented in economic charts by the letter “U” (a steep decline, followed by a bottoming and prolonged period of hardship before a rise back to previous peaks) or the letter “W” (a steep decline, followed by a sharp rise back upward, followed again by a steep decline and ending with another sharp rise). Regardless of the shape of the curve, the question ultimately is, how long will it take to return to pre-COVID-19 levels? While no one can be certain how the economy will recover, if a housing crisis develops to go along with the existing economic distress (think post 9/11 economy and the Great Recession combined into one), then we can be sure it will be a long time before we return to sustainable economic growth.
With the economy shut down and unemployment at an all-time high in the US, the Federal Government has responded with a series of stimulus packages that have included hundreds of billions of dollars for individuals and small businesses. One program, targeted at providing relief for homeowners, allows anyone negatively affected by COVID-19 to apply for mortgage forbearance for up to six months, with the potential to defer payments for up to 12 months. This program includes a government bailout of mortgage servicers who do not have enough capital to front the payments due by borrowers to investors of mortgage backed securities. Another program, targeted at small businesses and dubbed the Payroll Protection Program (PPP), has earmarked over $650B of aid for businesses negatively impacted by COVID-19 to keep their workforces intact.
While these actions have stemmed the tide thus far, the housing industry is still on shaky ground. To start, millions of homeowners have already entered into forbearance and the GSEs are predicting millions more will participate in the coming months. The hope for everyone in the program is that at the conclusion of the six month period they will be able to resume making payments, but there is no certainty that they will be in a position to do so after six or 12 months.
In addition, home sales have come to a standstill for obvious reasons. Sellers are not listing properties, no one is hosting or attending open houses, and the uncertainty about the economy is limiting major purchases. Consequently, the lack of sales will lead to a decrease in home values, which could become especially problematic for borrowers that are unable to make their payments once the forbearance period ends.
For example, consider a borrower who used an FHA loan to put 3.5% down when purchasing his first home. This person relies on his paycheck to make his monthly mortgage payment because he doesn’t have cash in reserve, which is permissible under FHA underwriting guidelines. Now what happens if he loses his job, the value of his home depreciates more than 3.5% and when forbearance is up, he needs to resume making his mortgage payments without any income? Similarly, what happens when a renter who loses his job stops paying rent to a landlord who still has a mortgage payment that she has to make? Now imagine this happening to millions of people around the same time. Is there any way to expect that the economy can withstand a systemwide failure to the housing industry such as this?
This doomsday scenario would lead to borrowers defaulting, lenders foreclosing, and property values dropping precipitously. Add this type of housing crisis to an already battered economy and the outlook is bleak.
Signs of a Housing Crisis
- Sustained high unemployment
- Tightening credit standards
- An increase in the number of homeowners in forbearance
- Mortgage applications being limited to refinances
- Decreasing home values
- An increase in the number of foreclosures
- Drop in new construction
The Housing industry is an integrated network of companies and individuals that spans the entire country. The Great Recession taught us the important role that housing plays in the broader economy and how impactful a downturn in this sector can be to the entire country. No one can be sure what to expect as we enter the next phase of the COVID-19, but by tracking the housing sector, you’ll know if we are headed for the recovery we’re all hoping for or one of the worst economic collapses in American history. The answer likely lies somewhere between these two extremes, but it’s important to recognize the potential for both.