Wharton real estate professor Benjamin Keys evaluates the U.S. housing market, which he says is in a deep freeze right now. This episode is part of a series on “The Economy & You.”


Current Challenges in Real Estate

Dan Loney: The housing sector is dealing with low supply, a wave of refinancing on mortgages from a couple of years ago that have changed the market, and the need to come up with new ideas to spur home sales. One recently announced was the decision by Zillow to provide a 1% down mortgage program for potential buyers.

Benjamin Keys: It’s an interesting business idea for Zillow to wade into this area and offer this type of subsidy for borrowers. I think this is reflecting a number of challenges in the housing market right now, but maybe the biggest one from Zillow’s perspective is that it’s a volume-based business. Zillow’s mortgage revenue is down about 17% year-over-year, and the visits to Zillow’s apps and websites are also down about 8% year over year. As we think about what the effect that these rate hikes are having on the housing market, the most obvious and dramatic one is on volume — the number of transactions that are occurring. Zillow is fundamentally a volume-based business, so they are looking for innovative solutions to increase some of that volume. I think of this down payment program as one potential direction for them to innovate.

Loney: We’re a little bit more than a decade from the housing crisis. The marker of that was all of the 0% down mortgages that occurred. Is the housing base strong enough at this point from where we were back in 2008 to handle this type of program?

Keys: I think it’s natural to feel some of the same echoes of the risky loans that we saw in the mid-2000s that were encouraging people to take on large amounts of debt that they couldn’t ultimately manage. Those kinds of loans had a number of characteristics in addition to just low down payments. They often had teaser rates, where the interest rate would jump after a couple of years, or negatively amortizing loans, where the loan balance would actually increase over time. This is just one margin along which we’re seeing this innovation to this point. I think it will be interesting to see if we see innovations on the other constraints on households.

If you look at the overall market right now, the 20% down payment for a house is actually a myth. The median down payment is about 7% right now, so loan-to-value ratio of about 93% is the median. This is because the FHA offers a 3.5% down program already. And Fannie and Freddie, in trying to compete — are offering a 5% down program for loans. Moving the needle from 5% to 3.5% to 1% certainly reduces that down payment constraint for households, but it doesn’t relax some of the other constraints that might be more binding for households at the moment.

Can Innovative Solutions Revitalize the Housing Market?

Loney: How important is innovation in the housing sector right now?

Keys: I think we’re going to see a lot of scrambling on the part of mortgage lenders, brokers, and Realtors to try to find some ways to juice volume from this incredible low point. And this is the challenge. The housing market is in a deep freeze because interest rates have risen so quickly. The rising rates have reduced demand, as buyers are going to be facing much larger monthly payments, and it has sharply reduced inventory. Few people want to sell their homes. They’re happy to stay put where they are right now, with their interest rates locked in at 3% or even lower. So, we’re going to see a lot of interesting efforts, I think. And the question is whether any of those efforts are going to really move the needle on the deep freeze or not.

We also have a housing market which I don’t think people fully appreciate. We nationalized the mortgage market between Fannie Mae, Freddie Mac, and the FHA. Those three entities dominate the types of mortgages that are issued, the flavor or the mortgages that are issued. They are almost all 30-year fixed rate mortgages, and they dominate the underwriting standards. So, credit scores are much higher than they were in the early 2000s for the average home borrower at the moment.

I think when we’re thinking about this question of innovation, we’re thinking about chiseling away at a giant iceberg that is the housing market right now. And right now, these feel like a very small chisel to me. It will be interesting to see whether there is more ambition coming forward.

Loney: When you think of the term “innovation,” is the housing sector one that has been innovative in general?

Keys: The innovation process in the housing market is extremely slow. If you think about the different margins along which you could innovate, mortgage contract design is one where there’s been a lot of discussion. In the aftermath of the foreclosure crisis in particular, there was a lot of concern among policymakers and academics: Could we design a better mortgage contract that helped people on the down side and avoided those kinds of costly foreclosure sales?

I think we’re seeing the effects of better policy. We didn’t have a foreclosure crisis curing COVID, and that was very much because of policy choices made by state and federal entities. We gave people forbearance. We allowed people to stay in their homes. We prevented evictions from occurring. And we supported people with a lot of fiscal support. All of those things prevented that big disruption to the housing market. The consequence of doing so is that now a lot of people are staying in place, so I think there’s kind of a trade-off there.

I would actually say that the way in which we helped people during COVID was the big policy innovation in the housing market, and now we have a new set of problems, and we’ll need to think of new ways to innovate.

Loney: What are some of the ideas out there?

Keys: I think first we have to diagnose what the problem is. This program by Zillow is really about increasing homebuyer demand. Homebuyers who struggle to save up for a large enough down payment, this program is going to help them out. The problem in the housing market right now isn’t just demand. It’s not a simple story of no one wanting to buy. That’s clearly not the story because inventory is so staggeringly low. Let me just give you a couple of numbers on the state of inventory in the housing market.

In the New York metro area at this time in 2016, there were about 70,000 active listings. In September, there were only 32,000. In Baltimore, there were 13,000 listings; in September, there were only 3,500. The number of homes for sale is far suppressed relative to where it was. And what we’re learning is that interest rate hikes seem to be affecting inventories even more than they’re affecting demand. That’s partly a function of demographics, partly a function of the kinds of options that different folks have.

If the problem is inventory, then how do we encourage more construction? How do we get more units built and made available for sale? And how do we get people to re-optimize, to shift out of a house that they may feel locked in with these low interest rates, and how do we get them to move? That’s a much trickier knot to untie.

Loney: Don’t you also have to factor in the types of properties that are being built? Have we placed the single family, $200,000 or $250,000, three bedroom, one-and-a-half bath house out of this marketplace right now?

Keys: Oh, for sure. The starter homes that we’ve seen built in the past are just not being built in the way that they used to be built. We are in the midst of a bit of a construction boom, and I’m cautiously optimistic in hearing from the home builders, especially this quarter. The home builders have, in their commentary, said that they are looking to acquire more land and to build more units. But I think you’re right. It’s very uneven. The housing market has never been one-size-fits-all, but it feels that much more idiosyncratic at the moment. I was referring to the East Coast markets of New York and Baltimore, where inventory is extremely low. In some other markets, you’re seeing a boom in inventory. New Orleans, for example, has inventory levels that have skyrocketed back up to their 2016 levels. And we’re seeing price softening occurring there.

I think one of the challenges for policymakers is thinking about what are some of the policies where we can relax the constraints in the places that need it? I think the challenge there is if you say, “We’re going to subsidize the homebuilders.” Where will they go? They’re going to go to some open tract in Texas, where it’s easy to acquire land, it’s easy to zone the land, and it’s easy to throw up housing. They’re not going to go into some of these cities in the Northeast that are much more dense, where there’s not a lot of land available, where the zoning is much tighter.

I think that’s one of the tensions that the housing market is facing right now. If you have a sort of over-simplified solution to our housing supply crisis, it’s going to be applied to the wrong markets.

What’s Next: Is the Real Estate Market Going to Crash?

Loney: How do online entities like Zillow shape what the industry is going to look like over the next couple of decades?

Keys: The industry has certainly shifted to having a much stronger online presence. As we’ve said before, housing markets move slowly. They’re extremely durable assets, and they use a lot of antiquated systems in the way in which transactions occur. We’re seeing the rise of fintech mortgage lenders. We’re seeing more innovation on the mortgage underwriting through some of the fintech tools. We’re seeing more certainly in terms of the way people shop for houses, shopping online, or in some cases during COVID, not even visiting the property before making an offer.

I think again it comes back to the size and scale of the U.S. housing market. The market is enormous, and thinking about a lot of these fintech players, right now they’re carving off relatively small slices of a giant market. It’s extremely profitable to do that. You can run a great business doing so, but it doesn’t shift the overall tenor of the market.

I think one of the myths that we’re hearing now is about the role of a few large institutional buyers sort of steering the overall U.S. housing market in one direction or another. They’re just not big enough players to have that kind of impact. They may have an impact on a subset of neighborhoods. Certainly the suburbs around Phoenix or the suburbs around Atlanta may have had some pretty big effects from the push towards single-family rentals, for instance. But I think at a national scale, they are just not there at the moment, and they might never get to that scale because of how big the market is.

Loney: The single-family house rental market has grown in the last couple of years. Is it beneficial longer term to see that fluctuation?

Keys: Coming out of the financial crisis of 2008, after the wave of foreclosures that we saw, a lot of these properties were scooped up to become single-family rentals. There was an expectation that that just wouldn’t last, that eventually those portfolios would be wound down by selling those homes to owner-occupied residents so that you’d see a rebound of homeownership. We haven’t gotten back to those levels of homeownership rates, where we were at their peak in 2005 or 2006. We’re still well below that point. There are so many more renters than homeowners at the moment, and a lot of those folks are in these single-family rental units. I think it’s an open question whether that’s a function of preferences or constraints.

I think it does add some flexibility, and it does lower some of the costs for households that don’t need to worry about some of the associated risks of homeownership. But at the same time, it doesn’t give them a potential tool for wealth-building or an asset to borrow against, or potentially another way in which they can build a deeper sense of community as a homeowner. I think all of those things point to some of the trade-offs, as we see certain communities becoming much more renter-oriented, rather than owner-oriented.

Loney: By having these types of low down payment programs, you’re obviously shortening up that window for the buyer because they don’t have to save as much money. Does it also potentially have an impact down the road in terms of that second house?

Keys: That’s a great question. It depends on what the path of house price appreciation looks like and how quickly they’re able to build up equity in the home. If they’re getting in at the right time, and this is a time when prices are going to continue to rise, then they’re going to see their equity build much faster than if they had to wait a few years to get into the market. So, it becomes really a market-timing story for that next asset.

Right now, Zillow has only rolled out this program in parts of Arizona, so it’s still small potatoes at a national scale. And I think that’s a market where you wouldn’t necessarily expect prices to be on a sharp upward trajectory in coming years because there is a lot of new supply coming online. Houses are still being built in those areas, and I wouldn’t expect that this would be a path to great dynastic wealth over getting in a couple of years earlier than you otherwise would. But for some households, that could make quite a difference.

Loney: With Zillow trying this in Arizona, I wonder whether or not this may end up being a market-specific idea?

Keys: We think of high-priced markets as places where there are more people constrained. But in every market in the country, there are renters who would love to buy right now. One of the themes that we haven’t brought up is just how much more expensive it has become to be a renter in the United States since 2010. Rents have outpaced inflation basically every year for almost 15 years now.

With the growth of rents, we have many more households that are constrained in terms of their monthly income going towards rent. The benefit of buying, even at a high interest rate right now, is that it fixes your housing costs in terms of the principal and the interest components that you’re paying in a given year. There is still a pool of renters that are out there who would love to own, and I think in the lower-priced markets, we may still see a group of people who would really benefit from relaxing this down payment constraint. I think they will still face challenges related to their credit scores and their debt-to-income ratios — whether they can make the monthly payments each month.

Loney: Realistically, we’re still looking like a process that’s going to take a few years for a lot of this to play out, partly because we’ve got mortgage rates that are above 7%. The expectation is they’re not going to come down significantly in the next year or two. And then you have that dynamic of supply that obviously can’t be fixed overnight.

Keys: That’s exactly right. I still think we’re in the early phase of a deep freeze of the housing market. There are so many homeowners who are sitting on 3% mortgages or below, and that’s a big financial friction if you want to give up that mortgage and move somewhere else. I think that’s going to have a big impact. Mortgage applications are down, basically cut in half since 2021, due to the effect of rate hikes. I think the market is going to struggle along for some time as it gradually works its way through these large financial frictions that we haven’t seen in the housing market in a long, long time.