One of the key indicators of U.S. economic health is housing – both the turnover of the existing housing stock and the construction of new units. Existing home sales, new home sales, and housing starts all peaked earlier this year. Given the health of the U.S. consumer, as vividly demonstrated in the employment and auto sales data, it is puzzling why the housing numbers now appear to be so anemic.
Pre-recession, it was normal for first-time buyers to account for 40 percent of monthly existing home sales. These numbers have hovered around 30 percent in the post-recession period, and were 31 percent in October. The normal demographic for first-time buyers is the 25-34 age group. Over the past two years, this demographic has seen robust employment growth, with growth here faster than all other demographics combined. Household formation in this demographic, after languishing in the immediate post-recession period, has also been robust recently. Digging deeper, it is apparent that supply constraints are at least partly responsible for the first time homebuyers’ low participation rate in the existing home sales market:
- Homes available for sale currently represent about five months’ supply, historically a very low level of inventory, with even tighter inventories of lower-priced homes (those that first time buyers can afford).
- Distressed home sales (i.e., foreclosures or short-sales) are now back to ’05 levels, about one-third of the peak level of 2010, but because of the Fed’s zero interest rate policy (ZIRP), investors, who bargain-hunted with cash during the peak of the foreclosure cycle, remain heavily in the market, now looking for rental income to replace nonexistent fixed income yield. In October, investors used cash to purchase a disproportionate share of October’s sales (13 percent). First time homebuyers are almost always cash-constrained, and are at a significant disadvantage to the cash investor in those lower end markets.
- Another anomaly arising from ZIRP is the unusual mix of new housing starts. In June, multifamily starts were 510,000 (SAAR), a monthly level not seen since 1986. While total starts are anemic, the lack of supply of affordable starter homes is forcing many who would be first-time buyers into the rental market, which continues to be drum-tight, and where rents are expected to continue to rise in 2016.
One of the key indicators of U.S. economic health is housing, but several factors are holding the housing sector back, says Barone. (Photo: RGJ file photo )
The supply issue
The above explains some of the demand dynamics in the home market itself, but doesn’t explain languishing new supply (starts).
- In every market, there used to be both local and national developers. The recession took out countless numbers of small, local developers. Because many of those developers now have foreclosures or bankruptcies on their credit records, they simply can’t return to the building business with any kind of volume.
- It takes many months, and in some markets years, for the “entitlements” to develop raw land to get through state and local government processes. In the run-up to the recession, there was significant overbuilding which resulted in excess supply. Thus, little new land development has occurred for several years. Now that affordable homes appear to be in short supply, the entitlement process may be a constraining factor.
- Recent new regulations, promulgated by Dodd-Frank’s consumer czar, have added even more complexity, time, and expense to the mortgage process. Construction loans from small financial institutions to owner/builders virtually have been shut off by new regulations that went into effect on Oct. 1. Large banks, which can deal more effectively with onerous regulations, have little interest in making loans to small businesses. Increased capital and liquidity requirements on the large banks have created a fragmented, inefficient lending environment. Funding has become scarce, and while new private sector entities are emerging, they are still in their infancy.
- Another issue is the time it now takes from application to close in a mortgage transaction. That has been lengthened significantly by the czar’s new regulations. The result is that the number of existing home sales (counted at closing) is likely to fall significantly in Q4.
The recession did a lot of damage to the housing industry that we are still feeling today. Many local developers are gone; the oversupply of housing from the prior boom reduced the need for new land development, and now that there is a need, the entitlement dance significantly slows the process. New capital and liquidity regulations have muted large-bank appetite for small business loans, and new consumer regulations have now taken small banks completely out of certain aspects of the construction game. At the same time, the Fed’s ZIRP policy has brought cash investors into the market for low-end (rental) homes, making it much harder for first time homebuyers to successfully participate. So, when you hear how poorly the housing market is doing, you now know why. It isn’t for a lack of demand, but due to a significantly constrained supply and lack of available construction financing.
Robert Barone (Ph.D., Economics, Georgetown University), an adviser representative of Concert Wealth Management, is a Principal of Universal Value Advisors (UVA), Reno, NV, a business entity. Advisory services are offered through Concert Wealth Management, a Registered Investment Advisor. Robert is available to discuss client investment needs. Call him at (775) 284-7778.
Statistics and other information have been compiled from various sources. Universal Value Advisors believes the facts and information to be accurate and credible but makes no guarantee to the complete accuracy of this information. A more detailed description of Concert Wealth Management, its management and practices is contained in its “Firm Brochure” (Form ADV, Part 2A) which may be obtained by contacting UVA at: 9222 Prototype Dr., Reno, NV 89521. Ph: (775) 284-7778.