Nearing Peak, U.S. Home Price Gains to Slow, by Jonathan R. Laing, April 18, 2015
The three-year rally in housing prices is losing a little
steam but should continue for another year or two. Go figure. Just as several measures of U.S. economic growth
appear poised to accelerate, the three-year residential real estate market
recovery is showing signs of slowing.
Strong job growth, falling unemployment, ultralow mortgage
rates, and encouraging consumer confidence figures haven’t been enough to boost
monthly sales of existing homes, as tracked by the National Association of
Realtors. They’ve been running below their previous annual pace of around five
million transactions in recent months, much to the surprise of most experts.
Of course, some slowing is to be expected, following their
stellar climb from the depths of the financial crisis, when home prices
nationally fell 35%, subtracting nearly $8 trillion from Americans’ home
equity. More recently, prices rose 8% in 2012, 11% in 2013, and 5% in 2014,
much as Barron’s had predicted they would in each of those years. Rising sales
in Dallas and Denver, for example, mean houses now cost more than they did back
in 2006; and other markets, such as Boston, Charlotte, Portland, and San
Francisco, are very close to their peaks, according to figures from Standard
& Poor’s/Case-Shiller.
Various housing experts, including Mark Zandi, chief
economist at Moody’s Analytics, and Lawrence Yun, chief economist at NAR, see
solid growth continuing, albeit at a more languid pace of 4% or so this year
and next. That would be a little more in line with an expected increase of 2.7%
in U.S. output in 2015 and 2016 and rising average wage rates.
Helping sustain the recent healthy pace of growth is the
strength in housing prices in major cities that don’t include outlying,
poorer-performing blue-collar counties and exurbs. For instance, another realty
data cruncher, Local Market Monitor, which takes into account an area’s income
and employment figures, as well as job and population growth and
building-permit activity, sees more boom areas than S&P/Case-Shiller. The
company’s founder, Ingo Winzer, says San Francisco, Dallas, Houston, and Denver
have all moved to peak valuations, while Honolulu, Nashville, Raleigh, Salt
Lake City, Portland, and Seattle also are near or at all-time highs.
We think 4% growth in prices is a reasonable expectation
over the next year or two, particularly in light of the strange dichotomy
between economic and housing data that could prevent more rapid increases.
While the split between a gradually rising rate of economic growth and a
gradually slowing housing market is unlikely to result in a dramatic immediate
change in housing prices in the next couple of years, it’s enough to raise
questions about whether a more important, longer-term shift is under way.
Looking out a little further, say to 2017-2019, Bank of
America Merrill Lynch mortgage-backed securities strategist Chris Flanagan sees
the possibility that home prices could start to decline. By then, he says,
prices will be subject to slowing growth in buyers’ disposable income and the
inevitable end in speculative purchases by professional investors.
Among other causes for concern: Housing starts, as reported
by the Commerce Department, have been in a deep funk ever since the U.S.
housing bust and Great Recession hit with such ferocity in 2007. They sank from
an annual pace of more than two million in the 2004-2006 period to around
500,000 in 2009. They’ve bounced back since, but can’t seem to get much over
the hump of one million a year, even though population growth and immigration
alone would seemingly dictate construction of at least 1.4 million homes
annually. And much of the revival owes to multifamily construction, largely for
rentals, rather than single-family housing. In fact, multifamily construction,
at around 350,000 homes a year, is now at the pre-bust level.
“There’s no question the housing recovery is beginning to
falter some,” observes David Blitzer, chairman of the index committee of
S&P Dow Jones Indices and the keeper of the all-important
S&P/Case-Shiller Home Price family of indexes. “Anytime in the past, when
housing starts came in at the current annual pace of one million new homes, the
economy was in recession.”
Obviously, the U.S. is not in recession today. Adds Blitzer:
“One wonders whether these days something has changed in Americans’ attitude
towards homeownership—the dream house in the suburbs with a white picket
fence.”
RESEARCHERS AT REAL-ESTATE data keeper CoreLogic estimate
that, through February, prices in 26 states and the District of Columbia had
rallied within 10% of their all-time highs, and New York, North Dakota,
Oklahoma, Wyoming, Texas, and Colorado had hit new peaks. But as impressive as
the rebound was through February, the signs of a slowing pace in residential
housing now are equally apparent.
One theory holds that growing income inequality has stymied
the millennial generation (folks born between 1982 and 2000) from playing the
same role in energizing the housing market as did their parents and
grandparents. This is the most populous generation of potential home buyers.
Yet the millennials have largely been missing in action in the home market,
forced by college-debt burdens and sketchy incomes to double up in apartments
or remain in their parents’ basements rather than form and head new households.
Nor is much inventory available for the first-time home
buyer, even if he or she has the wherewithal. New-home construction since the
bust has largely been concentrated in the “move-up” or luxury segments of the
market, rather than in the starter strata, according to Sterne Agee
home-building analyst Jay McCanless. This is only underlined by the latest
Commerce Department figures, which show that the median new home in February
sold for $275,500, compared with $202,600 for the median existing home.
Likewise, not much is available for the first-time buyer in
the existing-home market. There’s less distressed merchandise—homes in
foreclosure or late-stage delinquency—than there was a few years back, now that
opportunistic private-equity firms have scarfed up much of this excess
inventory. In addition, 27% of the owners of the lowest-priced third of U.S.
homes remain in negative equity (owing more on their mortgage than the value of
the dwelling), making them reluctant to do anything, according to a recent
Zillow report.
As a consequence, says NAR economist Yun, first-time
buyers—millennial or otherwise—have sunk to 28% of purchasers of existing
homes; the normal historical level is 40%. Without a strong cadre of first-time
buyers, the entire residential real estate ecosystem stagnates. Move-up
activity languishes because not enough people are buying their first homes,
allowing others to purchase more expensive digs.
Likewise, future home price growth figures to be tempered by
continuing tightness in mortgage credit. True, the government in recent months
has tried to entice more lending to first-timers. For example, for folks with
strong credit, it has cut mortgage down-payment requirements, to just 3% from
20%, on loans that Fannie Mae and Freddie Mac guarantee.
But lenders aren’t loosening credit standards much, either
to mortgage borrowers or smaller home builders, who in the past supplied much
of the starter-home inventory. And who can blame them? Moody’s Zandi estimates
that lenders suffered catastrophic losses approaching $150 billion in the wake
of the housing bust from mortgage putbacks, government fines, and legal costs
arising from their allegedly defective mortgages.
Affordability will be a growing problem for housing.
Existing and new-home prices have been rising faster than average U.S. incomes
for the past three years, effectively pricing lots of buyers out of the market.
Rents also have been going up sharply in recent years—more than 3% annually in
the U.S. and over 7% in especially desirable locations, such as San Francisco
or the boroughs of Manhattan and Brooklyn in New York City.
STILL, RENTING REMAINS the more attractive alternative for many,
even with the tax breaks that homeowners garner through the deductibility of
mortgage interest and property taxes. According to Sam Khater, deputy chief
economist at CoreLogic, the ratio of home prices to rent (the owner’s
equivalent rent number used in the consumer price index) indicates that homes
are still about 30% over-valued, compared with the more normal markets of the
1990s—an era before prices went into the stratosphere.
Also negatively affecting affordability will be the rising
mortgage rates that will inevitably follow the Federal Reserve’s
“normalization” of short-term interest rates, probably beginning later this
year. By 2017, mortgage rates may well be two full percentage points higher
than the current 30-year fixed-rate average of about 3.7%, predicts Zandi.
“That would still be a bargain, assuming that the economy continues to
strengthen and U.S. incomes rise briskly,” he contends. We can only wonder on
the latter score.
Many potential buyers could be priced out of existing
markets unless construction of new homes picks up markedly. New construction of
about a half-million single-family units annually is dwarfed by yearly sales of
around five million existing single-family houses, town homes, condominiums,
and co-ops, according to NAR. However, unsold inventories of existing homes
will remain constrained unless new construction cranks up.
Inventories expand only when sellers of existing homes buy
newly built homes, or rent while putting their own dwellings on the market. If
they buy another existing home, there’s no change in inventory. In the latest
monthly NAR report, inventories stood at an unhealthily low 4.6 months at
current sales levels. At least six months is considered a healthy inventory.
ALTHOUGH CUMULATIVE PRICE GAINS are expected to top 20% in
many big cities over the next three years, some observers see a secular change
in Americans’ attitude toward homeownership. This new meme is possibly
reflected in the latest government report showing that ownership has fallen to
a 20-year low of 64% of the nation’s roughly 120 million households; the rest
rent. The peak was 69.4% in the bubble year of 2004, when any American who
wanted a mortgage could find financing with no inconvenient questions asked
about net worth or income. Since then, the rental market has grown by eight
million households, while homeownership has dropped by two million.
Of course, much of this shift to rentals was a matter of
necessity. Folks who lost their homes to foreclosure had little alternative but
to rent. Yet, clearly, not all renters lack the resources to make a 20% down
payment and carry a mortgage. The decision to rent can be a lifestyle choice
that affords many a millennial or empty nester easy access to attractive,
culturally vibrant city centers, for example.
Chicago real-estate mogul Sam Zell long ago made a big bet
on the U.S. rental market. When his real-estate investment trust Equity
Residential (EQR) went public in 1993, it owned garden-apartment complexes in
suburban areas. But over the succeeding two decades, it shifted to central-city
apartment buildings to exploit the tidal wave of young professionals moving
from the suburbs into the “bright lights, big cities” environment. Equity
Residential now boasts some 400 apartment buildings with more than 100,000
residential units, in Boston, Miami, New York, Washington, San Francisco, and
Seattle.
“The American Dream for the under-40 crowd today isn’t so
much the house in the suburbs, but more the convenience of city living, where
commutes are short and cultural and entertainment amenities are nearby,” he
tells Barron’s. “Renting is a heck of a bargain, with homeowner property taxes
soaring in both the ’burbs and central cities. Likewise, the proliferation of
private schools in various cities makes the move to homes in the suburbs for
families with school-age kids less of a necessity,” says Zell.
Louis Conforti, a principal with the global real-estate
investment firm Colony Capital, claims that a change in the zeitgeist has
developed among younger adults, driving them to rentals. He dubs the change
“Uberization.” Conforti explains: “Just as many feel it’s silly to own a car
when you can have a fleet at your disposal with the click of the computer, why
pinch pennies to save for a mortgage down payment, rather than rent an abode,
when you have no idea where you may be working in five years’ time.”
To some extent, he’s talking his book. Colony, like
Blackstone Group (BX), was an avid buyer of distressed properties during the
downturn and then put them out to rent. The firm now owns 20,000 homes in
Phoenix, Las Vegas, Atlanta, and Denver and has enjoyed strong financial
results in its portfolio.
FEW OBSERVERS HAVE as acute an understanding of the
residential market as Yale economist and Nobel Laureate Robert Shiller. He was
co-creator of the Case Shiller home price indexes and has done extensive
academic research on housing prices in the U.S. and abroad. When we chatted
recently by phone, Shiller evinced concern about the prospects for
homeownership in the U.S.
First, he said, many buyers during the boom years, aided and
abetted by real estate industry cheerleaders, made the mistake of regarding
homes as an asset class, like stocks or bonds. This is clearly not the case.
Homes, in fact, are a consumption item that depreciates, albeit at a much
slower pace than, say, cars, requiring much upkeep spending to hold value. In
fact, about the best one can expect in home appreciation over the long term is
to match inflation. That’s what a study of U.S. home prices from 1890 to 1990
showed. Actually, Shiller found that prices outpaced inflation by a trivial 10
basis points (a tenth of a percentage point) annually.
As a behavioral economist, Shiller puts much stock in the
annual surveys he does of American attitudes toward homeownership. And these
surveys betray growing levels of anxiety. Americans no longer expect lush
annual gains in home values. And reading between the lines of the survey
responses, Shiller detects reluctance on the part of many to shoulder the long-term
commitment that a home requires. “People are clearly beset by insecurity over
their careers, both as a result of globalization and job displacement by
computers,” he observes. “We live in a world of first-mover advantage and a
winner-take-all economy that makes people fearful.”
The future course of home prices is immensely important to
the U.S.
Residential real estate accounted for $23 trillion of
Americans’ total 2014 year-end net worth of $83 trillion, according to the Fed,
affecting people across the entire income scale. That wealth looks likely to
rise in the next year or two, but its longer-term prospects are much less
assured.
Comments
Home ownership is still viable in most places
and home equity is one of the safer investments given the bubbles everywhere in
other investment options. The well paid
40-somethings are still moving to the nice subdivisions and finding workable
public schools. New college grads are
not inundated with job offers, so there may be a dearth of home buyers later.
It all depends on whether or not we can stop excessive immigration and improve
job availability. It’s hard for me to imagine why the housing industry has
joined the Chamber of Communists to champion excessive immigration. Most of the immigrants we are getting are
going on welfare.
Norb Leahy, Dunwoody GA Tea Party Leader
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