How Does Housing Volatility Affect Non-Agency Lenders?

How Housing Volatility Affects Non-Agency Lenders 


Volatility is a key component of the broader market conversation. The lasting effects of COVID-19, inflation, the War in Ukraine, lockdowns in China, and a whole host of other variables contribute to a substantial rise in volatility across markets and sectors. At the same time, the Federal Reserve is taking steps to calm the markets — including raising interest rates — which is having a knock-around effect on the housing markets. Housing and property lenders are seeing significantly more risk, which has led to slowing housing price growth in many markets, and increased housing volatility. 


What causes housing volatility?


Several different factors cause housing volatility. The sector as a whole is sensitive to problems and contagions in the broader markets. Economic issues outside real estate’s scope can affect housing prices, loan interest rates, days on the market, new construction starts, and other housing-related concerns. For example, you can look at the 2008 housing crash, the price run-up during the height of COVID-19, and the current drawdown in housing sales caused by the Federal Reserve’s recent rate hikes; all of which happened in response to wider issues in the American and global economies.  


The Standard & Poor’s CoreLogic Case–Shiller Home Price Indices track repeat-sales home prices for the U.S. real estate market. Within the broader context of Case-Shiller, there are several different indices, including a 20-city composite index, a 10-city composite index, a national home price index, and an index that tracks 20 individual metro areas throughout the United States. If you follow these market-tracking baskets, you’ll see that real estate goes through periods of instability and volatility, but always regains its footing.  


Keep in mind that current market conditions are not necessarily indicative of longer-term trends in the housing markets. The return on capital for housing assets is relatively consistent over time, as long as you adjust for inflation. For instance, the average homeowner who sold their home in 2014 after living there since 2001 saw a 33.59% return on capital — the lowest point in the range since 1989. Conversely, the highest point — between 1989 and 2002 — saw a remarkable 46.24% return.   


As long as the U.S. has an inflationary currency, it is likely that real estate will continue to grow in price indefinitely. Because people will always need a place to live, demand for housing is inelastic, and home values will therefore keep pace with inflation for this reason alone.  


How Interest Rates and Government Policy Affect Housing Volatility


Despite their long-term growth and stability, housing markets do exhibit excess volatility relative to other asset classes. Home prices are more volatile than both aggregate income and rental prices. Additionally, prices and transaction volumes tend to move in concert and are negatively correlated to the average time sellers spend on the market before sale.  


While there is no academic consensus on why housing markets remain so volatile, economists have offered several possible explanations. These include down payment effects, financial constraints, and departures from rational expectations (e.g., people are less “rational” as consumers when choosing a place to live).  


A recent paper published by the World Economic Forum concluded that homeowners’ “search behavior” can create significant housing market volatility. For example, the simple decision between whether to buy a new house, or sell their current property first, can affect the ratios of buyers and sellers within a market, and that market’s liquidity. This can tremendously impact the housing market’s total transaction volume and home/property prices.  


How Housing Volatility is Affecting Lenders 


Much of the volatility in the market is created as a result of government policy. Housing in the United States is far from a “free market,” with countless programs, initiatives, and policies that shape the housing landscape. For example, one of the major contributing factors to the 2008 housing crisis was the fact that the federal government took concrete steps to incentivize homeownership. Lenders took interpreted this as a green light to start offering mortgages to anyone who applied, regardless of the applicant’s financial qualifications or ability to repay.  This blanket loan approval policy resulted in catastrophic defaults and systemic risks in the housing market; issues that may not have existed without interference from the government, or the loosening of private lender standards.  


Right now, we’re seeing a similar effect, though the trend is moving in the other direction. Lending standards are significantly tighter than in 2008, but beyond that, there has been a general tightening of lending standards in response to Federal Rate hikes. As interest rates rise, the cost to borrow gets higher. This can cool off a given market and introduce volatility in the form of declining prices, declining sales, and a smaller buyer pool. When faced with significant housing market fluctuations, many lenders leave money on the table and reduce their total balance sheets, rather than deal with the potential negative repercussions of too much participation in a volatile market. With that said, there are several ways lenders can mitigate volatility-related issues, including using AXY Wrap


The Last Word


Volatility is a feature of every single investment or asset class. As an investor, it is not something you can or should want to completely avoid. Without volatility, markets don’t function; and growth is, by definition, impossible. With that said, it is also prudent to understand the effects of volatility on a given market, like real estate. Too much of anything can hurt you — a glass of water is great on a hot day, but drinking 15 gallons all at once will hurt, or even kill you. Volatility is no different.  While some volatility is necessary for growth, excess volatility can cause headaches across the real estate sector; from the inability to accurately map profitable cap rates, to causing a murky economic forecast that stops development projects from getting off the ground, and so on. 


If you’re interested in learning how you can survive, or even thrive, during a volatile period in the housing markets, click here to see how AXY Wrap™ can help you protect your lending portfolio.   

Legal Disclaimer:

This article does not constitute an offer to sell, or the solicitation of an offer to buy, any security interest in any jurisdiction. This material is distributed for informational purposes only and should not be construed as investment, legal, tax, regulatory, financial, or other advice. No assurance can be given that any investment objective will be achieved, or that an investor will avoid losses or obtain a return on an investment. While the information contained in this article is believed to be reliable, its accuracy is not guaranteed. Individuals should consult with their own professional advisors with respect to the legal, tax, regulatory, financial, and accounting consequences of any potential investment.

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