The B.D. Interview: Robert Dietz, Chief Economist of NAHB

Robert Dietz shares important breakdowns of the current concerns in the homebuilding economy and what trends to expect for the market

Builder & Developer: What are your impressions on where the housing market will go in 2019? What are the headwinds?

Robert Dietz: We’re looking for continued slow growth conditions. The second half of 2018 saw a slowdown in the housing market that was primarily due to declines in housing affordability. The combination of higher interest rates, and the accumulation of home price gains over a number of years due to insufficient inventory and higher construction costs, represented a windfall for existing homeowners, but really priced out a lot of prospective homebuyers in the market.

B&D: There has been some slowing in the housing market, what underlying trends can you attribute to this downturn?

RD: Housing affordability. We’re at a 10-year low on the NAHB Wells Fargo Housing Opportunity Index, currently only 56 percent of new and existing home sales nationwide are affordable for a typical family based on income conditions. We’ve simulated it, in that index, and we’ve found it’s going to fall below a level 50, meaning less than half of home sales will be affordable for the typical family sometime in 2019.

We expect interest rates to continue to rise, although there will be some up and down periods. We’re in a down period right now. Interest rates will go below 5 percent so that should provide a little bit of a rebound for the December and January sales.

Overall, in 2019, that housing affordability issue is going to be a real headwind. Combine that with the ongoing lack of construction workers – we’re short about 300,000 construction workers nationwide – plus higher cost of other building materials, higher cost of land, and the ever-growing regulatory burdens associated with single-family and multi-family construction, and you have some real limits on the amount of volume growth that can take place in terms of residential construction.

B&D: And what do you think are some solutions to the affordability issues?

RD: Within the industry, I think builders can continue to try to recruit new workers into the industry. Increasing worker productivity is one way we can kind of bend the cost curve. That’s a real challenge for getting people into homeownership or into affordable rental housing. Some of that is going to have to be done collectively, which can be done by participating in your local homebuilding association. And local community leaders working with builders are really going to have to take the regulatory costs associated with construction seriously.

I think 2019 is going to be a key year of viewing housing affordability as an important advocacy issue for the industry. That can include things like looking at zoning laws, looking at impact fees, and looking at other costs; all these factors essentially get embedded into home prices and price out potential homebuyers from the market.

B&D: Historically, housing and employment rates have been intertwined, but we are currently at basically full employment. Can you speak to this divergence between employment and housing? Why aren’t people buying houses?

RD: Normally, you would expect, with job growth between 150,000-200,000 jobs a month and an unemployment rate that is well below 4 percent, that for-sale housing demand would be really strong. However, it’s the combination of the supply-side constraints over a number of years with the recent decline of housing affordability in 2018 keeping more households – especially younger households in the millennial generation – in rentership longer than in prior generations.

To be clear, our housing preference survey shows us that they still want the housing outcomes that prior generations have had. Two-thirds of them want homeownership; they want single-family, suburban aesthetic, a front door, and those types of things. The combination of slightly higher interest rates, insufficient wage growth, higher student loans, and higher car loans are holding back some of that demand. We think it will come, but we’re going to have to be patient about it.

Income growth is ultimately the way that we will counteract some of those challenges. Policy makers can help us on the supply side by trying to reduce the cost of construction so that we can add more affordable for-sale housing to the market.

B&D: Affordability has been the forefront of many conversations lately, what are your thoughts on the affordability crisis hitting the housing market? What are the factors? Are builders at the root of the problem or are there greater economic trends that are attributing to this slowdown?

RD: It’s curious, right? I think if you ask a lot of Baby Boomers or older Gen-X-ers, “Is a 5 percent 30-year fixed-rate mortgage really high,” most of them would instinctively say, “No,” because they remember mortgage rates well over 10 percent or even as high as 18 percent in the ‘90’s or the early ‘80’s.

What has combined with the growth in interest rates, admittedly to a historically still-low level, is the run-up in home prices. Home prices have gone up during that period. What is behind that is multiple years of insufficient inventory; we’re short a lot of housing units across the country, so that pushed up home prices. Then on the supply side, over the last three or four years, we’ve had limiting factors that have either limited the amount of production taking place, or acted as cost factors that really increased the cost of housing.

For years, I’ve been labeling these as the Five L’s: Labor, Lending for builders, Lack of lots, Lumber issues, and Laws – the growth and regulatory burden. Just to take one of them and look at the regulatory burdens – if communities could find ways to allow builders to build with density, townhouse construction for example, that is one way out of this affordability issue we find ourselves in. Townhouse construction has recently been growing at growth rates greater than 20 percent, so orders of magnitude faster than the […] single-family market.

B&D: Does NAHB have an ideal home ownership percentage? What is the target?

RD: We think the homeownership rate is going to settle in at somewhere between 64 and high 65 percent rate, just below 66. We’re at a little higher than 64 right now. We’ve had nine quarters of homeownership gains, and that was important because there were a fair amount of forecasters who were saying that homeownership would continue to fall as a result of “The Great Recession,” and the 10-year recovery that was really led by multifamily, so homeownership would fall [to] 60 percent or lower. Some forecasters had homeownership settling in in the high 50 percent range. We don’t think that will happen, but that said, with the housing market slowdown that we saw in the second half of 2018, it’s likely to cause some of the gains we saw in homeownership over the last nine quarters to either stabilize or even get some of it back. We think homeownership rates somewhere between 64 percent to 65 percent is where we’re heading, based on more millennials who, at their peak age, are in their late 20s. As they head into their early 30s, get married, and have kids, there is some upward demographic pressure that will help support homeownership. The downward pressure, of course, comes from housing affordability.

B&D: What sort of trends are you predicting for 2019?

RD: Townhouse construction, I think will continue to outpace the rest of the market. I think we’re going to see continued growth in entry-level housing in markets where it can be built affordably. We’re talking about single-family homes that are $300,000 or less. That can’t be built everywhere, but it can be built in places like Idaho, Utah, Montana, and places a lot easier than it can be built in San Francisco and L.A. and I think that will continue.

We’re probably going to see flat or declining conditions in the custom-building market, around larger homes. We already see that in the data and I think, from an advocacy point of view or a political point of view, I do think policy makers at the national and the local level are really zero in on housing affordability as a key economic challenge. We think the economy as a whole is going to slow down, reaching something resembling a growth recession by 2020. A lot of parts of the economy are doing quite well but it will be housing that will kind of be that leading indicator and, clearly, policy makers will target that as they look towards the 2020 elections.

B&D: What sort of things can builders do to have a successful 2019?

RD: Be sure that, in the markets that you’re building in, you don’t have too much holdings in land. Be cautious about land supplies, particularly if you need to dispose of that land; either build on it or sell it over a two-year period, because we do think macro conditions are going to weaken going into 2020.

Be careful with your home price points. We think growth is there in terms of the demographics at the entry level, but those are the buyers that are most sensitive in terms of increases in interest rates. Profit margins are likely to be smaller and builders are going to have to be cautious. Over the next 10 years, the prospects for homebuilding are really quite positive. Since we have underbuilt homes, and as more of the Millennials and Gen-X-ers move into their new home buying years – half of homebuyers specifically are aged 35 to 55 – there should be real uptick in single-family construction. However, next few years are going to be a little tougher because of the higher interest rates and the rise of regulatory burdens.

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