Evaluating the current state of the market and potential risks at near-term, medium-term, and long-term horizons
By JOHN BURNS and KATE SEABAUGH
We expect another solid year in 2018.
• Shifting demand: While housing demand should soften due to the economy reaching full employment, we expect the softening to occur in the apartment market. Young renters will increasingly turn to homeownership. A rising percentage of older homeowners are turning to rentership. This mix shift creates opportunities for both homebuilders and landlords.
• Low supply: We expect low new home supply, as homebuilders have not increased community count at all YOY through October. Resale supply will also stay low. We forecast a 7 percent increase in single-family construction and a 1 percent decline in multifamily construction. The story of the year will be the increase in new homes built to rent.
• Affordability: Price appreciation should slow from 7 percent in 2017 to 5 percent in 2018, but we are keeping an eye on irrational exuberance that could make prices appreciate faster. Seattle appreciated 15 percent in 2017. Let’s hope the bitcoin and stock market euphoria do not spread to housing.
When evaluating the current state of the market and potential risks, we like to look at the near-term, medium-term, and long-term horizons:
• Near term (answers the question: “How are builders selling right now?”): We rate current sales and pricing trends as normal in 36 of the top 50 markets. Seattle, Portland, and Dallas are stronger, while markets like Cleveland and Chicago are still struggling to recover.
• Medium term (answers the question: “What are the underlying fundamentals, and what is my 2–4-year investment risk?”): In most markets, excess demand and a lack of supply continue to fuel price appreciation. However, the country is now priced 15 percent above what we calculate to be the long-term norm (per our Intrinsic Home Value Index). The more overpriced a market, the harder it will fall in the next recession.
• Long term (answers the question: “Which markets will likely depreciate the most in the next recession?”): Our calculation of a 15 percent overpriced national market assumes a return to the long-term norm 6 percent mortgage rate. Since we (and the bond market) do not expect this to happen, and we project incomes to rise due to the tight labor market, we expect good things in 2018. However, be careful of Miami (37 percent overpriced) and Dallas (34 percent overpriced) during the next recession.
Supportive Factors for Housing
Current housing cycle. Growth during this economic recovery has been very slow, which gives us reason to believe that the national economy can continue to grow for a few more years. That said, differences between markets can be staggering. Booming job markets like Austin, Nashville, Dallas, and Seattle have grown much faster than many Midwest markets like Chicago. For instance, Austin has 30 percent more jobs than in 2009, while Chicago employment is only 2 percent above 2009 levels. We have categorized the top 30 housing markets into four groups: new boomtowns, average growth, still recovering, and slow growth.
Government policies. In our book Big Shifts Ahead, we identified four major housing demand disruptors over time, including government policies. Recently, national policies have become more favorable, particularly mortgage policy. The FHA and FHFA have both announced increases to loan limits. This should help buyers afford more expensive homes. As the pain of the last credit boom/bust moves further in the rearview mirror, non-bank mortgage companies have expanded their low down payment offerings to target credit-constrained and entry-level buyers. Taken together, these policies and initiatives have begun to slowly open the mortgage credit box. New tax policy (not passed at the time of this writing) is the wild card. While a change to the mortgage interest deduction, state and local tax deductions, and the standard deduction have gotten all the attention, the most important impact of tax policy will be on economic growth.
Risks and Conclusions
Risks to the recovery. Our biggest concern is excessive debt that leads to layoffs when times get tough. 11 of the last 12 recessions have been preceded by excessive debt. We find excessive debts almost everywhere we look: governments at all levels, pensions, student loans, high-LTV mortgages, leveraged buyouts, public company mergers and acquisitions, and even stock market margin debt. Calling the timing of a debt bubble bursting is near impossible, so we are keeping our fingers crossed that there will be no major calamities in 2018. However, the risk is high and getting higher.
Economic Expansions. The next hiccup seems to be on all our clients’ minds. Of the last seven recessions, four were devastating housing downturns, and three were minor “hiccups.” Given today’s very low levels of construction, we believe the next recession is more likely to cause a hiccup than a downturn. Two of the three hiccups were caused by stock market corrections, which could certainly be in the cards, given that the stock market’s current price/ earnings ratio matches the ratio in 1929.
Conclusion. We have found the best strategy is to focus on the demand that the resale market cannot meet. We are helping builders focus on the demographic growth under age 45 and over age 65. The older buyers need to be enticed to buy with new designs and great prices, eight of which we feature in our DesignLens™ subscription each month. The younger buyers have gravitated toward smaller homes on smaller lots closer to work and retail. Some of these homes are surban™, a term we coined to describe urban-like homes and amenities built in the suburbs.
John Burns is CEO of John Burns Real Estate Consulting. Kate Seabaugh is a Manager in the Research Group at John Burns Real Estate Consulting. They may be reached at www.realestateconsulting.com.