MICHELLE MEYER: Housing Affordability Has Peaked (ITB, XHB)

The recent surge in mortgage rates has hit mortgage refinance applications pretty hard.

The weekly MBA purchase applications announcement out Wednesday morning should give us more of an insight on the issue.

Bank of America's Michelle Meyer writes that with rising home prices and mortgage rates, housing affordability has peaked. She does however think that housing is a "better investment."

But this is just one of five hot housing topics that Meyer thinks investors need to watch.

2. Rising home prices and mortgage rates suggest that affordability has peaked.

Mortgage rates have pushed higher with the 30-year fixed rate up to 3.8%. "The combination of higher rates and rising home prices implies that affordability has peaked from the record highs reached earlier this year."

"If we assume no change in rates through the rest of the year, but account for an 8% rise in national home prices, the affordability index slips to early 2012 levels. If, however, we assume mortgage rates rise 100bp through the course of the year (with all else the same), the affordability index drops to early 2011 levels. In order to keep affordability constant with a 100bp rise in mortgage rates, home prices would have to fall 15% or income would have to rise 18%. Since neither of these scenarios seems likely, we think the affordability index will be heading lower."

The affordability index has peaked and there is concern that this could impact home sales. But Meyer thinks this would only really impact sales if interest rates continue to rise rapidly. 

Source: BAML

1. The collapse in lumber prices doesn't signal a collapse in housing starts.

Lumber prices have fallen recently and because its price reflects demand and supply dynamics some argue that it is forecasting a collapse in housing starts. 

But Meyer thinks this is unlikely for two key reasons. 1. Lumber prices are historically very noisy and the decline in prices is "consistent with the typical volatility in the data." 2. Lumber prices had far outpaced housing starts. "The decline in lumber prices actually brings it more inline with the trend in housing starts. We believe that prices had increased too rapidly and were divorced from fundamentals."

Meyer projects housing starts just shy of 1 million in 2013.

Source: BAML

3. Demographic trends suggest a decline in average household size.

"An aging population suggests a continued downward trend in the average household size due a greater share of 'empty nesters,'" writes Meyers. 

"This is reinforced by the decline in birth rates; the Census Bureau estimates the birth rate will fall from 2.0 to 1.91 by 2060. Moreover, marriage rates have been heading lower. The decline in household size should led to a reduction in the average size of the housing stock."

With millennials accounting for home purchases we could even see a move back towards cities.

Source: BAML