From Boom to Balance: The U.S. Housing Market’s Transition Phase

Over the last few years, the US housing market has defied expectations as prices, helped by constrained supply, have remained resilient—despite high mortgage rates and affordability challenges for homebuyers. But the outlook appears to be darkening, with recent headlines seizing on potentially adverse trends. We think these fears are overblown, as market fundamentals suggest a more nuanced and less fraught outlook than headlines imply.

We regard signs of slowing home-price appreciation (Display, left) and an increase in supply (Display, right) as noteworthy but expect their impact to be muted and that home prices at a national level will remain flat to slightly positive over the coming year.

Fundamentals Remain Strong

A key factor in home-price resilience to date has been a supply constraint caused by the so-called lock-in effect. US home loans are mostly fixed rate, and homeowners who locked in cheap mortgages before rates began to rise in 2021 are reluctant to sell, as selling would mean financing their next property at a higher cost. Since rates rose, market activity, as measured by applications to purchase properties or refinance loans, has fallen significantly.

It's against this background that the rising supply trend needs to be understood. The real-estate industry measures supply in terms of “months of supply”—that is, today’s estimate of the number of months it would take to clear current for-sale inventory. Thus, the metric reflects the overall level of market activity, not just the rate at which new supply is becoming available.

The increase in new-home months of supply relative to existing homes also needs to be put in perspective. New homes are a small portion of the US housing universe and currently represent only 12% of all transactions. Overall supply, measured as the number of new and existing homes for sale, is still well below the average for the market prior to the Global Financial Crisis. The prevalence of locked-in borrowers in the mortgage market suggests that this is unlikely to change soon.

The low supply is mostly the result, in our view, of caution among homebuilders since the financial crisis. Before 2007, in a boom that helped trigger the crisis, housing completions ran significantly ahead of household formations, a key driver of housing demand (Display, left). But recently, the opposite has happened, with housing completions running well below household formations (Display, right). 

When we factor in the obsolescence rate of existing US housing stock, we estimate that there has been a shortage of five million homes during the last 30 years, even taking into account the excess building that took place before the crisis.

Supply Stays Tight, Demand Depends on Rates

We expect supply to remain tight for the foreseeable future. Obsolence—60% of US houses were built before 1980—should create shortages in coming years. Homebuilders, meanwhile, have responded to rising supply trends by scaling back construction of single-family and multifamily homes, a move that should help ease any build-up in supply.

Homebuilders also face deteriorating business conditions that may dampen their activities. The Trump administration’s immigration policies, for example, have led to more construction job openings (immigrants make up about 30% of the industry workforce), creating the potential for slower home completions and wage inflation. Tariffs are pushing up building-material costs, putting further pressure on margins.

On the demand side, affordability remains a challenge. A fall in mortgage rates should lead to an upturn in housing activity as more locked-in borrowers sell and buy elsewhere. But a key question concerns how much new demand there would be.

Two long-term trends are positive in this respect. Despite the large affordability advantage of renting over housing, the proportion of people renting has changed little since rates rose, pointing to the strong appeal of home ownership, even in difficult conditions (Display, left). Population trends also support the demand side, with millennials—those aged between 29 and 44—now entering prime home-buying age (Display, right).

As rates fall and affordability improves, we expect these psychological and structural dynamics to help drive demand.

Home Prices at National Level to Stay Steady

We expect home prices at a national level (as per national home-price index data) to stay flat to slightly positive this year. At a regional level, the picture is more varied. In parts of the South and West, median sale prices have fallen as boom conditions—fueled by a surge of state-to-state migrants during COVID—begin to abate. Homebuilders rushed to meet demand, resulting in high housing supply in these areas. Conversely, in the Northeast, supply is light, and sale prices have been rising.

We think these trends will even out as homebuilders respond to regional dynamics. In our view, well-seasoned assets supported by years of home-price gains should provide a degree of security against regional price strains.

Implications for Investors

With respect to credit risk–transfer (CRT) securities, we expect below-average issuance, solid fundamentals and years of home-price appreciation—which has allowed seasoned mortgages’ loan-to-value ratios to decrease—to remain supportive. Today’s higher prices have significantly increased homeowners’ equity, which provides an incentive for them to stay current on their mortgages.

Even if we see higher unemployment and a weaker consumer, mortgage borrowers are more likely to sell their homes at higher-than-purchased prices and use the proceeds to pay off the debt rather than to default on their mortgage. Tight underwriting standards have also limited borrowers to a very high-quality pool, with average credit scores at origination meaningfully higher than before the Global Financial Crisis.

We also find agency mortgage-backed securities (MBS) compelling. We expect the sector to continue to perform well as growth slows and interest-rate volatility continues to stabilize, now that Fed policy has crystallized. In addition, moderating supply should help offset the effect of lighter demand from banks and overseas investors. That said, we think bank demand could pick up now that the Fed is easing, and if capital regulations are loosened.

Overall, prepayments will remain contained, in our view, given most borrowers have locked in lower rates than are currently available. Thus, while refinancing of the higher-rate mortgages of the past few years should persist, refinancing of lower-rate mortgages—which represent the lion’s share of MBS outstanding—will likely be muted. Regardless, we don’t expect mortgage rates to fall much from here, as they’re more correlated with the 10-year Treasury yield than with Fed policy.

We are closely watching the possible privatization of government-sponsored enterprises Fannie Mae and Freddie Mac. The effect on the agency MBS market will depend, in our view, on the details. Ensuring a continued government guarantee is an important step to maintaining stability.

Overall, we see recent trends in the US housing market as part of a nuanced pattern of normalization from historically favorable conditions. To the extent that they serve as a warning light for possible risks, we continue to assess those risks as mild.

The views expressed herein do not constitute research, investment advice or trade recommendations, do not necessarily represent the views of all AB portfolio-management teams and are subject to change over time.