US Housing: recovery revisited

After a sustained period of strong job creation, an uptick in household formation, and the return of very low interest rates, US housing appears to be making a comeback once again.

19th October 2015

Continue to the other two articles in this edition of the Global Outlook....

Headwinds to the global economic recovery

The world economy has remained subpar in 2015.  Are recent concerns about the fragility of global demand and price stability justified? Brian Biggs, Research Analyst, Grosvenor Group, shares his views.  Click here to read more.

What are the recent trends in global real estate investment?

Global commercial real estate volumes were up 17% in the first half of 2015 and cross-border flows have also been on the rise. Which investors have been active and in which locations and sectors?
In this month’s ‘Questions & Answers’ , Simon Chinn, Research Analyst, Grosvenor Group, offers his insight.   Click here to read more.

 

After a severe and prolonged downturn, the US housing market began to show signs of life during 2012.  The Fed’s highly accommodative monetary policies were effective in reducing market interest rates; in response, home sales and prices escalated, and residential construction activity began to pick up from historically low levels.  This incipient upturn stalled after May 2013, however, when interest rates spiked by more than 100 bps in response to Fed comments about the future phase-out of quantitative easing – the so-called “taper tantrum”. 

After a sustained period of strong job creation, an uptick in household formation, and the return of very low interest rates, US housing appears to be making a comeback once again.

Rising sales.  Total home sales in July 2015 exceeded 6 million annualised units, 11.4% up year on year (yoy) and the highest volume in eight years (Chart 1).  Sales of existing single-family homes, the market’s largest segment, approached 5 million annualised units (+11% yoy), while condo/coop sales rose more modestly (+5% yoy).  New home sales cooled briefly after a robust Q1 performance; however, 20% more new homes were sold in the first half of 2015 than between January and June 2014.  July’s 507,000 new home sales represent a 26% yoy increase.

Lean inventories.  Nearly 2.5 million existing homes are currently being marketed for sale nationwide, 14% below the July 2014 total and a low 4.8 months’ supply (6 months inventory is considered a balanced market). There were 218,000 new homes on the market, a 5.2-month supply and, despite expanding construction activity, 11.3% fewer than in July 2014.

Acceleration of existing home price gains.  Home price appreciation is beginning to pick up in response to competitive market conditions.  Case-Shiller’s widely-quoted 20-City Index has shown modest acceleration thus far in 2015; however, it is a three-month moving average, and so responds to changing conditions with a lag. The CoreLogic Index, a monthly “repeat-sales” index which excludes distressed transactions, provides a more timely view of developing price trends.  By June 2015, it was rising at a 6.4% yoy pace, up from 4.5% in December 2014.

New home prices healthy.  US new home prices are much more volatile than price trends for the much larger existing home category.  Despite considerable choppiness, new home prices are posting solid growth.  Between August 2014 and July 2015, monthly price growth has ranged from -3.5% to 14.5% yoy, and averaged 6.0%. The median price paid for a new home in July was $288,305.  Although only 2% above its year-ago level, this is more than 30% above the median price for an existing home – double the typical premium. 

Although the cyclically strong summer home buying season is now drawing to a close, the market’s forward-looking measures indicate that year-to-date gains should continue.

Robust pending home sales.  Because sales of existing homes are recorded at closing, they are a lagging indicator of activity.  However, the pending home sales index tracks sales contracts for existing homes, and therefore acts as a leading indicator for this dominant segment of the US residential market.  The pending home sales index has averaged 10% yoy growth through July 2015, and is currently near a post-recession high – all positive signals for sustained strength in purchase activity into the autumn months.

Accelerating residential construction.  Homebuilding activity has accelerated into mid-year.  In July, almost 1.25 million permits were issued, and developers broke ground on 1.16 million units (Chart 2) – 20% and 16%, respectively, above year-ago levels.  Almost two-thirds of residential starts are single-family homes (up 15% yoy).  Trends in this category are particularly important, as single-family construction has the greatest multiplier effect; each new single-family home supports four jobs in construction, manufacturing, transportation, and other services.  Permits continue to exceed starts by a healthy margin, an indication that residential construction will continue to expand in coming months.

Strong homebuilder confidence. The positive message conveyed by the permits and starts data is echoed in the National Association of Homebuilders (NAHB) Housing Market Index.  The composite index reached 61 in August, its highest level since November 2005. Top-line improvement was driven by a robust six-month forecast for single-family home sales.

The return of very low interest rates has aided this year’s housing market recovery. Plummeting oil prices, renewed geopolitical tensions, and stepped-up monetary easing by other countries began to pull capital into US Treasuries in late 2014.  In response, the ten-year bond rate fell to ~2.0% and FHLMC’s benchmark 30-year mortgage rate dropped below 4.0%.  The average mortgage rate has remained at or below 4.0% for eleven consecutive months. The Fed is preparing to begin normalisation of monetary policy by raising interest rates.  Most economists expected the first increase before the end of 2015; however, timing is now uncertain due to recent volatility of global financial markets.  Once begun, rate increases will be small and the pace slow as the Fed gauges their impact on the domestic economy – in particular, the housing sector.  

There is concern that higher interest rates could again short circuit the housing recovery.  Moderate price appreciation, coupled with the mid-year spike in rates, eroded affordability somewhat in 2013.  The average mortgage payment as a share of average household income rose from a low of 8.2% in Q4 2012 to 10.2% in Q1 2014.  Declining interest rates then reversed the trend again: by Q2 2015, the average cost of home ownership had fallen 60 bps to 9.6% (Chart 3).  This is very low from a historical perspective; over the last 17 years, the average cost of homeownership was 13.1%.

Homeownership became more affordable than renting during the 2008-09 recession.  Several years of strong rental demand has kept apartment vacancy at very low levels and resulted in steep rent increases.  As of Q2 2015, the average cost to rent in the US was 11.3%, 170 bps above the cost to own but slightly below its long-term average level of of 11.5%.

Although interest rates are set to move higher, easier underwriting standards, a robust labor market, rising income gains, and stronger household formation will all support demand for housing.  Household growth was moribund for several years after the 2008-09 recession, despite favorable demographics.  It began to accelerate in late 2014.  The large “millennials” cohort should conservatively generate ~1.5 million new households per year.  As they age, their tenure preference will shift from rental toward ownership housing.  Low down payment programs recently introduced by the GSEs will also encourage first-time purchases.

For-sale housing demand will be further augmented by so-called “boomerang buyers” – people that lost a home to foreclosure during the downturn but have since repaired their credit and are again eligible for a government-insured mortgage.  This group could represent 7.0 - 7.5 million units of additional purchase demand over the next six to seven years.

So long as interest rate increases occur in tandem with solid economic expansion, buyers should be able to accommodate higher financing costs.  The gradual increase in rates that the Fed will soon initiate should not derail the housing sector recovery.  It will continue to unfold at a measured pace, though rising interest rates will lead to more modest gains in home sales, construction, and price appreciation.  

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