The Housing Market is Running on Fumes
Throughout the pandemic, housing has been one of the stalwarts of the economy along with the sustained level of consumer spending that was made possible by massive government stimulus. Not surprisingly, we believe this led to consumer confidence remaining higher than one might have predicted under the circumstances. In the previous four recessions, for example, the Consumer Confidence index dropped below 80 but only dropped to around 90 during the pandemic. It recently spiked to 109.7!!
In the latest Conference Board survey that is used for the index, the number of respondents planning to buy a home within 6 months reached an all-time high of 8.4%. Hence the focus on housing as a critical part of economic growth. Even during normal times – if we can remember what that is like – housing is a constant focus as a gauge of economic activity because a considerable amount of capital makes its way into the economy via housing. For example, Housing and utilities are the largest component of personal consumption expenditures (PCE), while PCE makes up around 70% of total GDP. When you add residential private domestic investment, the combined contribution of housing activity to GDP is between 16% and 18%.
Housing is also important because for the majority of Americans, their primary residence is their most valuable asset. When real estate prices are increasing, people feel better about their financial situation, which drives further consumption. The recent survey therefore, is a leading indicator of a potential spike in consumer spending. So, for both fiscal and psychological reasons, the housing market is an important component of our economy.
For Q42020, housing made up 17.7% of GDP and contributed 1.24% of the 4% GDP increase. Meanwhile, the homeownership rate continued to increase through 2020 – a trend that started back in 2016, after a steady decline that was caused by the housing collapse during the Great Financial Crisis.
Is the Housing Trend Slowing?
Towards the end of 2020, however, there was a considerable drop in homeownership without a proportional decrease in total occupied housing units. This reflects the possibility that some owners may be taking advantage of a red-hot market and selling their homes with the intention of renting, either temporarily or for the long-term. Unfortunately for those consumers looking to buy, there just aren’t enough of those houses for sale right now.
Spurred by strong demand, home prices for both new and existing homes have increased at double digit rates as inventory remains low and the pandemic led social distancing lifestyle accelerated the migration from dense urban areas to less-crowded suburbs – resulting in higher demand for single-family homes.
Lack of Supply Drives Housing Prices
Despite millions of lost jobs and uncertainty surrounding a path to normalcy, home price appreciation continued to rise in 2020 with new single family home prices gaining steam as low levels of inventory led to aggressive bidding wars. Both the median price of new and existing homes reached all-time records this past quarter and we expect new records when the data is reported for Q12021.
It is worth pointing out what could be an obvious answer to the question of why isn’t supply increasing to fill this demand. Well, builders are doing their best, but it is much easier to construct a multi-unit condo or apartment building to meet a certain level of demand for housing, than it is to build the number of single family units needed to meet the same demand. This shift from multi-unit construction to single unit construction is reflected in multi-unit housing starts as percent of single family starts. For years, multi-unit starts have far outpaced single unit starts as millennials and commuters sought living spaces that were closer to work. Not anymore.
The focus on urbanization caused a lull in single family homebuilding that has now become evident with the lack of supply of homes for sale. It doesn’t help potential homeowners that several large REITs and other institutional real estate companies bought up tens of thousands of homes after the housing collapse and now rent those out – essentially taking them out of the inventory of homes that may have potentially been offered up for sale.
Breakdown by Housing Price
The result of this lack of supply and overall price increases has led to a general upward trend towards pricier homes. This trend has been helped by historically low mortgage rates, but now builders are increasing their price points as well – even builders focused on the low-end market – as they confront rising input costs. For example, according to the National Association of Home Builders, the higher price of lumber alone is adding roughly $24,000 to the cost of a new home.
The proportion of new home sales priced below $150K has all but disappeared driven by improvement in affordability as well as the residual effects of rising input costs. Meanwhile, new homes priced above $400K make up around 30% of all new home sales.
But as rates rise, affordability starts to get impacted. Combined with strong demand driving up prices and the increase in costs just mentioned, either the trend will reverse towards lower priced homes or new home sales will slow – considerably.
New Home Sales
I mentioned earlier this year that some data was showing signs of an imminent slowdown in housing sales. The big miss this past month relative to the consensus forecast is a bit concerning but is likely a temporary blip caused by several factors, including the winter storms that decimated parts of the country. However, even if builders build faster, we still believe we could see a peak in sales relatively soon due to declining affordability.
We’re seeing it already – while the winter storm may have had an impact on sales, suggesting winter storms impacted new home sales would be valid if the decline in sales was especially acute in parts of the country that were hit hardest by the storm. But a uniform drop in sales figures across all regions suggest there was more going on. There was a consistent double digit drop across all regions in the U.S., including the West and South regions, where sales declined 16.45% and 14.7%, respectively, from the prior month.
Existing sales may also have peaked a few months ago – at least for the short-term. After accelerating throughout 2020, existing home sales have now declined 6.6% from the prior month and are up just 9.1% on a year over year basis – after 4 consecutive months of 20% plus Y/Y increases.
Throughout the year, both new and existing home sales surprised to the upside despite the supply of homes for sale sometimes reaching as low as just two months. Homes were selling in as little as a few hours and sometimes site unseen. In fact, a recent article highlighted that there are now more realtors in the US than houses for sale – likely a result of a greater number of laid off workers and the attractiveness of a red-hot market.
Income Required to Afford a Home
Affordability is measured by the combination of current mortgage rates, median incomes, and median home prices. As mortgage rates and prices rise, homes become less affordable without a proportional increase in income – and we just haven’t seen that yet. The headlines touting increases in Personal Income sometimes pass over the fact that the entire increase in personal income has been driven by government stimulus payments or extended unemployment benefits. Neither of these sources of income will continue indefinitely so the housing market will eventually depend on income from compensation to pick up in order for sales trends to continue.
Unfortunately, the median family income is well below where it was 12 months ago. Compared to new home prices and mortgage rates at year end 2020, the monthly payment on the principal and interest on the median priced home has increased roughly $160. For high income earners, this increase won’t make much of a difference but it does to lower income earners – that is, the ones currently dependent on stimulus.
Affordability can potentially increase as the job market improves and wages start rising, but it could be some time before we reach a level of employment that results in modest wage hikes.
There is also the issue of bank underwriting standards, which have continued to tighten and could make conforming mortgages available only to potential buyers with both adequate and predictable income as well as high credit scores. Anyone not meeting the criteria will have to accept less favorable terms, which would further limit a potential reacceleration of home sales. Already the value of mortgage originations is heavily skewed towards consumers with credit scores above 760 and this trend will likely persist as the bumpy transition from government payments to compensation occurs and credit scores get negatively impacted by defaults or delays in payments.
Will Building Permits Reverse Course
One important metric we are monitoring for a projection of future building activity is in the issuance of new building permits. Even during the worst of the pandemic, building permits were rising as builders tried to keep up with demand. Unfortunately, there was a sharp decrease recently, perhaps due to the winter storm or less optimistic builders – evidenced by the recent decline in the NAHB Wells Fargo Housing Market Index.
With the recent government stimulus payments sent out it wouldn’t be surprising to see further upside in consumer confidence followed by an uptick in spending. It has been the trend throughout the pandemic. In some cases, the combination of government stimulus and increased unemployment benefits is greater than many consumers would have earned from their jobs, so spending on some items may be a result of ‘splurging’ – even under the duress of a global pandemic. (See chart below)
As the labor market improves, we could see a stabilization of home affordability that could continue to drive sales. But there also needs to be a balance between supply and demand. The recent double digit price increases on new and existing home sales is not sustainable. That said, it seems the opportunities for homebuilders remain quite attractive despite their challenges and the market has recognized that. The SPDR Homebuilders ETF (XHB) is up 21% YTD, far outpacing the 6% return on the S&P 500. The question now is whether their favorable prospects are priced in or if their prospects end up being too optimistic.
I am very cautious about housing due to the huge supply/demand imbalance, temporarily inflated personal income, rising rates, tightening lending standards, and the end of deferred payments that combined should lead to slower activity.