With robust market strength and optimism comes greater risk as well
by Kate Seabaugh
The year 2018 is shaping up to be a strong year for housing. Builders are experiencing a robust spring lift, consumer confidence gauges keep trending higher, and we are having a hard time finding negative economic and housing market data in our monthly reports and analysis. Supply is very low, demand remains robust, and affordability is in check… for now. However, with all of this optimism and housing market strength, risks increase dramatically as well. Rising mortgage rates and risky mortgage lending are two of the big risks we see emerging that have the potential to derail housing market momentum.
For 2018, we expect six percent resale price gains and seven percent more single-family construction. We forecast healthy price appreciation and new home construction growth through 2019 with a modest housing ‘hiccup’ in 2020/2021. We anticipate this long (but relatively lackluster) economic expansion will last 11+ years, making it the longest on record.
Housing won’t trigger the next recession. We are constantly calling attention to the fact that 11 of the last 12 economic cycles came to a halt after one or more sectors grew too fast, often fueled by excessive debt. Public companies have borrowed heavily this cycle, which should ultimately lead to job cuts. Public healthcare and technology companies have grown their debt levels by over 300 percent since 2009! We’ve identified these two industries, along with automotive, as potentially overheated and over levered. These could be the sectors leading the next downturn.
Low construction should soften the next recession. This recovery, the Four Ls (Land, Laws, Labor, and Lending) limited growth and kept supply in check. Our builder and developer clients are constantly complaining about a shortage of desirable lots ready for development, higher regulatory costs, labor shortages that are rapidly increasing costs, and more conservative lending. All these items have constrained supply.
The next downturn should be more muted than the last. Very-well-capitalized homebuilders are positioned to drop prices, if needed, and the well-capitalized single-family rental industry should help soften home price declines. SFR operators will become early buyers in the next downturn.
Demand remains robust. Solid job and income growth and record-high consumer sentiment are still the backbone of strong housing demand. Leading economic indicators are also accelerating. Demand from young adults and solid household formations support long-term housing growth.
Flight traffic (a leading indicator of foreign buyer demand) jumped more than 20 percent YOY on flights from China to Los Angeles and San Francisco. Investor home sales are accelerating, up four percent YOY, exceeding growth in owner occupied purchases. Flippers are back, aided by new fintech lenders.
Affordability will be the story in the next recession. National affordability is now worse than average, despite historically low mortgage rates. Conventional 30-year fixed rates have spiked and are now hovering near five percent, the highest since 2011. While our builder clients report mostly little to no impact from rising rates, the rapid increase is a looming concern. Sales at upper price points have slowed in many markets due to higher supply levels and weakening affordability. Rising material and labor costs could squeeze builders if affordability finally hits a breaking point for consumers.
Risky mortgage lending returns. The credit box is expanding at a rapid pace as mortgage lenders search for growth. With rates no longer falling, the refinance business has essentially shut off. As such, mortgage lenders are pushing cash-out refinancing and expanding their underwriting guidelines on originations in order to continue growing. This all leads to short-term positives for housing and the economy, but raises our concerns for the longer term. In recent months, we have noticed a steady drumbeat of press articles mentioning creative low/ no down payment programs, lower FICO score requirements, creative “algorithmic” underwriting platforms, and even low documentation programs. We are alarmed that the percentage of loans considered high LTV and high DTI has reached an all-time high.
The mortgage market is now dominated by non-bank lenders, who are being funded by the large banks. Non-banks now account for 59 percent of agency Fannie/Freddie mortgages, more than double their 28 percent share in 2012 and 80 percent of FHA originations compared to just 32 percent in 2012. The concentration of mortgage activity within the non-banks (particularly entry-level home buyers) is concerning.
Many other risks are on our mind. Mortgage rates accelerating faster than forecasted would be detrimental to housing and our forecasts. Excessive debt burdens at the government, corporate, and consumer level could cause a steep crisis when these groups have trouble repaying debt. An overvalued stock market
is poised to correct at some point, reducing consumer confidence and creating job loss. And lastly, we always worry about black swan or geopolitical events triggering significant, unforeseen volatility in financial markets and the real economy.