US new-home sales drop 9.4% in July

Uh oh! Is the new housing bubble beginning to deflate? My thought is yes, but let’s not move to hastily to that conclusion before walking through some facts:

1: Many lenders were / are offering mortgage down payments from 1-3% (sometimes as low as 0%). This means that even if a buyer is not able to save money such that they can make a reasonable down payment (or have money set aside if they lose their job, have to make a major repair, etc) they can still be granted a mortgage to buy a property that they make default on.

2: Home values have reached levels near or beyond the highs of 2007 (depending on which region one examines). This means that for most working people buying a home is not something that they can reasonably afford. And if they can they do so under extreme financial stress, making debtors who acquire a mortgage on a property more prone to defaulting.

3: The millennial student debt bubble has grown to over $1.4T. These poor souls who were overcharged for an education that may not lead to better income prospects have little chance of obtaining a mortgage for a home if they are hamstrung by so much debt, poor job prospects and potentially low credit scores. In addition, many millennials have opted to downsize and live in smaller spaces (micro apartments, studios, pods in the parents’ backyard, etc).

4: Many people whom are intending to buy a new house must also sell their existing property. It is more and more difficult to do so with prices on the rise. Somewhere either demand must rise to the higher prices or the supply must fall to more reasonable prices. I suspect the latter will happen given the current macroeconomic environment (final stages of current business cycle).

5: A lot of quasi-affordable housing stock is being leveled and replaced with gaudy, poor quality McMansions by rabid speculators. These housing units tend to have shorter lifespans before major repairs are necessary since builders prioritize quantity over quality. As a result, housing stock that is the most desirable to middle class buyers is being eviscerated while unaffordable, low quality and undesirable housing stock is growing. This is a large, and mostly unrealized problem as of yet.

Without near zero interest rates, and the Fed holding an enormous amount of defunct MBS (mortgage backed security) notes there would be no housing bubble right now. But because we are in an artificially low interest rate environment with massive stimulus in the mortgage market, there is likely a large bubble in real estate valuations that is extremely perilous.