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2 Red Flags for the Hot US Housing Sector

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- By Panos Mourdoukoutas

The U.S. housing sector has been hot in a cold economy. Sales of previously owned houses rose by 0.6% month over month to 6.69 million units in January, ahead of market expectations. The median existing home price increased by 14.1% year over year to $303,900 in January as home inventory dropped by 26% to 1.04 million homes, the lowest on record.

Homebuilder stocks have been hot, too. Over the past 12 months, D.R. Horton (NYSE:DHI) is up 27% and Lennar (NYSE:LEN) has gained 23%, beating the S&P500, which gained 16% over the same period.

The run-up in both home sales and home prices may have come as a surprise to some. The housing sector is cyclical, faltering in recessions. But the pandemic recession wasn't the typical recession for a couple of reasons. One of them is the unprecedented monetary and fiscal stimulus launched early on in the Covid-19 pandemic, which helped maintain American households' purchasing power. Then there's citizens' urgency to move away from cities to suburbs, where housing markets have been hot.

But there are a couple of red flags signaling that things could eventually cool off. One of them is rising long-term interest rates. According to the Mortgage Bankers Association of America, fixed 30-year mortgage rates in the United States averaged 2.98% in the week ending Feb. 12, up from 2.80% in December.

Meanwhile, the yield on the benchmark 10-year Treasury note was hovering around 1.30% last week, double the level it was last summer and reflecting inflationary concerns arising from a recovering economy and additional fiscal stimulus.

Another red flag is the deterioration of the Housing Affordability Index, which measures whether a typical family makes enough income to qualify for a mortgage loan on a typical home at the national and regional levels.

According to data published by ATTOM Data Solutions at the end of December, the median home prices of single-family homes and condos in the fourth quarter of 2020 were less affordable than historical averages in 55% of counties with enough data to analyze, up from 43% a year ago and 33% three years ago.

Simply put, the average wage growth has lagged far below the increase in home prices, making it more difficult for buyers to afford to purchase a home. And the situation could worsen as long-term interest rates climb, raising the cost of financing home purchases.

We all know what happens when housing affordability declines: banks scale back on giving loans and the housing sector cools off.

Disclosure: No positions.

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This article first appeared on GuruFocus.