Focus
February 12, 2021 | 13:09
America’s Hot Housing to Stay Warm
Economics
Economics
Economics
Economics
Fixed Income Strategy
Economics
Economics
Economics
Economics
Economics
Fixed Income Strategy
Economics
America’s Hot Housing to Stay Warm |
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Some home price metrics are now running at double-digit growth rates, as the increase in housing demand, partly driven by pandemic-prodded changes in preferences, is running up against increasingly limited supply. Fed Chair Powell recently referred to the housing market’s state of excess demand and spiking prices as a “passing phenomenon”, arguing that as this increase in demand gets satisfied and elicits supply, “those price increases are unlikely to be sustained”. |
However, it’s uncertain how long these changes in preferences will exert their influence. Meanwhile, record-low mortgage rates are boosting housing demand among all would-be buyers, not just those motivated by COVID’s more-space, anti-density cry. It’s also uncertain how long it will take to adequately beef-up supply. As such, the housing market’s equilibrating path could last longer than what Mr. Powell posits, giving the growth in residential investment and prices at least a warm glow along the way. Home is Where the Price Hikes AreThe S&P CoreLogic Case-Shiller national home price index was up 9.5% y/y in November, the highest since early 2014 (Chart 1). The FHFA’s monthly metric was up 11.0% y/y, the highest since the series started in 1991. The average of the two measures is now growing at a double-digit rate for the first time since the 24-month run during the 2004-06 interval, a cadence that has more than doubled since the start of the year. This is bringing back memories of the housing bubble from some 15 years ago. However, before heading down memory lane, keep in mind that we no longer have the egregious mortgage market practices and lending standards that set the stage for the 2008 financial crisis. Remember NINJA mortgages… no income, no job, no assets required? Unlike then, this isn’t a credit-fuelled speculative bubble. Instead, the rapid run-up in prices reflects the since-COVID surge in housing demand that is butting up against increasingly limited supply. Mostly owing to the ‘work from home’ (WFH) phenomenon, folks have been looking for bigger abodes, often in less dense dwellings (favouring single-family properties over multi-family ones), located in less densely populated areas (favouring suburban, exurban, and rural addresses over urban ones). To a lesser extent, the motivation to move also reflects the fact that less crowded locales are less prone to virus spread, and the fact that city life’s close-at-hand amenities lost their lustre under lockdown. Augmented by the unwinding of demand pent-up during the spring lockdowns, existing home sales surged to 6.86 million (annualized) in October (Chart 2), the highest level ever apart from the above-7-million prints during 2005. Sales averaged 6.35 million for the remainder of the year, which, apart from October, was still the best result since early 2006. Meanwhile, before the pandemic, there were already record-low existing homes available for sale in absolute terms and relative to sales, as far back as 1982 for single-family units (Chart 3). The inventory shortage intensified as the year unfolded. As of December, the supply of single-family properties was only 2.1 months worth of sales, roughly one-third of the long-run norm. The paucity of existing properties pushed would-be homebuyers to the new home segment, making homebuilders giddy (Chart 4). The National Association of Home Builders (NAHB) Housing Market Index hit a record high of 90 in November (meaning 90% of respondents were ‘all good’), before ebbing in December and January to still historically-high readings above 80 (the survey started in 1985). New home sales surged to 979,000 (annualized) in July, the highest since 2006, before dropping and starting to stabilize in a still-decent 825,000-to-850,000 range by year end (Chart 2 again). In turn, housing starts rose 5.8% in December to 1.70 million (annualized), the most in more than 14 years (Chart 5). We reckon the underlying (12-month) trends for new and existing home sales along with housing starts will all continue to climb higher this year. Pandemic Spark, Mortgage Rates TinderApart from the pandemic’s more-space, anti-density impetus, housing demand is being boosted, broadly, by record-low mortgage rates (Chart 6). According to Freddie Mac’s since-1971 survey, 30-year tenors have been averaging under 3% since August—the lowest run ever—hitting a weekly low of 2.65% to start January and they’ve been hovering in a range that’s been only 10-to-15 bps higher since. The record-low borrowing costs were instrumental in improving housing affordability, initially, and then countering some of the impact of escalating home prices (Chart 7). The National Association of Realtors (NAR) metric hit its recent high in May, which represented the most affordable market in more than seven years. Even after being subsequently eroded by the rapid price appreciation, housing affordability remains well above its long-run average. Moreover, viewed from a wealth creation perspective, which can be proxied by the spread between the pace of house price appreciation and the level of borrowing costs, the current juxtaposition is the most attractive since 1975, aside from the June 2004-January 2006 interval. In November, the difference between the S&P CoreLogic Case-Shiller index (9.5% y/y) and the average 30-year rate (2.77%) was 6.8 percentage points. For a new purchase, this means the portion of the property value covered by a mortgage loan would be building equity at a roughly 6.8% y/y rate, with the remaining portion growing 9.5% y/y. Current well-above-average affordability and historically-attractive prospects for housing wealth creation should provide sustained support for housing demand, particularly since consumers seem keen on home buying and have lots of room to borrow. According to the Conference Board, consumers’ plans to buy a home within the next six months averaged their highest level since 2006 during the three months ending January, apart from September-October 2017 when looming reform was poised to erode some tax benefits of homeownership. Meanwhile, household finances, in aggregate, remain healthy. In 2020 Q3 (Chart 8), looking past the recent volatility in disposable personal income (DPI) caused by the recession’s job losses and subsequent gains, along with the introduction and conclusion of various income support measures, relative household debt levels look to be hovering at about 18-year lows with the debt service ratio running around 40-year-lows. And, relative to DPI, net worth looks to be flirting with record highs. Although households might have room to borrow, it matters whether mortgage lenders have adequate desire to lend. Here, enthusiasm was likely quelled by the deepest recession and highest jobless rate in the post-WWII period along with the number of existing customers taking advantage of loan forbearance programs. The Fed’s survey of lending practices showed that banks, on net, tightened mortgage lending standards during the last three quarters of 2020 including a huge spike in Q3. Encouragingly, banks began relaxing lending standards in 2021 Q1, particularly for GSE-eligible and other ‘qualifying’ mortgages. But, until these standards ease significantly further (which we expect will occur), the more restrictive credit environment will likely act as a constraint on housing demand, but not enough to stop or reverse the growth in home sales and prices. |
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Excess Demand ExtendedThe above-mentioned (non-pandemic-related) factors supporting housing demand appear pretty sturdy. There are even signs of increasing demand for urban properties now that the bulk of the COVID-catalyzed exodus is probably behind us. According to real estate brokerage Redfin, home prices in urban areas slightly outpaced suburbia in the three months through late January, even accounting for the still-weak pricing environments in the most expensive cities such as San Francisco, New York and Boston. And, there are other supportive factors to consider. First, more millennials might start buying properties. It was always assumed that this cohort would increase their homeownership rates as they aged, got married and had children, with the latter two milestones occurring later in life compared to previous generations. After initial pandemic-related prompts, perhaps this pending trend might now start unfolding in a meaningful manner. Second, the Biden Administration has proposed relaxing the rules limiting the deductibility of state and local government (property) taxes. When limits were introduced in 2018, they combined with rising mortgage rates (at the time) and other tax reform measures to weaken housing demand. Removing them now work to help strengthen demand. On balance, both housing demand and supply should continue increasing this year with the former well supported by the above-mentioned full array of factors and the latter gaining ground, but only enough to ameliorate (not completely eliminate) the housing market’s state of excess demand. This will likely lead to continued upward pressure on home prices, albeit less than before. In the meantime, this should permit residential investment to punch above its weight class in contributing to economic growth (last year, the sector weighed in at 4.2% of GDP). And then there's all the spending typically associated with home buying on the likes of furniture, appliances and related items. We suspect these housing and retail outlays, along with the direct influence of rising home prices, will be adding to the economy's expanding list of inflation risks. |