By Brad Thomas, Editor, Intelligent Income Daily
I don’t know about you, but I’d like to move out of the “crisis” mode we’ve been in since 2020.
Over the past 18 months or so, interest rates – and therefore, mortgage rates – have soared.
Currently, the average 30-year fixed mortgage in the U.S. is 6.57%.
One year ago, that figure stood at 5.10%.
And at the start of 2022, the average 30-year mortgage was just 3.22%.
But this doesn’t show us the whole picture.
The way I see it, the strength of the U.S. housing market goes back to the simple, age-old forces that drive pricing across all markets: supply vs. demand.
Last week, Toll Brothers, one of the largest homebuilders in the country, reported earnings.
Toll Brothers focuses on “move up” properties for people leaving their starter homes and moving into their long-term residence. It’s also carved out solid market share in smaller luxury houses meant for “empty nesters” interested in downsizing.
It sold 2,492 homes during the last quarter… for an average $1 million each.
This was a record high for the company – signaling strong demand and pricing power even in the face of rising mortgage rates.
The CEO also noted there are roughly 75 million millennials looking for their forever homes right now.
But forever typically only lasts until the little ones have left the nest. This is what Baby Boomers are figuring out right now.
According to Toll Brothers’ CEO, another 75 million or so Boomers are looking to downsize. This is heightening demand across the square-footage spectrum.
This downsizing wave has been especially bullish for markets across the sunbelt as Boomers seek out better weather (and tax treatment) in retirement.
High Demand and Low Supply
So demand is growing – and will continue to grow.
But the main reason I’m bullish on home prices is that we’ve had 15 years of underbuilding in America.
Toll Brothers mentioned it takes 3-6 years to receive a green light for a new housing development these days, due to immense regulation across the construction industry. And labor shortages have slowed down the pace of new homes coming to market.
As a result, the National Association of Realtors last year noted that the average age homes for sale in the U.S. was 40 years old. That was a record high.
And it’ll continue to creep higher due to the lack of new developments.
This means there is a huge supply/demand imbalance in America right now.
These low supply issues are exacerbated by the fact that most (I estimate more than 90%) of homeowners have mortgage rates less than 5%.
Now that rates have shot up above that threshold, these people feel locked into their homes, knowing that if they move, they will receive less square-footage for the same dollar in terms of a new mortgage agreement.
Remember, when you buy and sell houses, you don’t get to trade your current rate to your new home.
So, not only are there not enough homes being built, but the market is stagnant because homeowners are hesitant to sell.
This is why there is no inventory in the market today.
This is why we’re still looking at a strong seller’s market, even though mortgage rates are at their highest levels in over a decade.
And this isn’t an issue anyone can solve soon.
Even if we see positive regulatory changes, it’s still going to take decades for builders to even out the supply/demand imbalance.
So what does this mean for the average homeowner?
A Good Rule of Thumb
If you’re a looking to purchase a home, there is a sweet spot you should look to hit before you make your next move.
For most homeowners, their house represents the single largest asset in their investment portfolio (by far).
And as a general rule of thumb, I recommend the value of one’s home versus their overall net worth should be ideally between 25% to 40%.
There are many people whose houses represent much higher percentages. But this could present big risks if that sector takes a hit.
If you’re looking to purchase and can’t hit that sweet spot, my recommendation for you is to hang tight.
Otherwise, your mortgage could represent more than 100% of your net worth if you’re a first-time homebuyer and have to allocate nearly all your savings toward a down payment.
When it comes to thinking about asset allocation and financial risk management in the stock market, I rarely recommend anyone dedicate more than 5% of their portfolio towards any one holding.
Obviously comparing the house that you live in to a stock in your portfolio is an apples to oranges comparison (your stocks can’t keep you warm or physically shelter you from storms).
Your home is likely to be your most meaningful and important asset and therefore, it makes sense for it to be your largest.
But it shouldn’t come at the risk of your entire portfolio.
If you want to sleep well at night, build up your income so that you can hit that sweet spot. You’ll thank yourself for it later.
And the best way to find income in the market is to focus on the most resilient businesses on the planet. I recently put together a presentation on the most compelling “royalty” I see in today’s market. To find out all about it – and how it can pay you reliable income for years – click here.
Happy SWAN (sleep well at night) investing,
Editor, Intelligent Income Dail