Dissecting the Housing Turnaround Part 2
I left you last week contemplating the role consumer confidence plays in the fortunes of the U.S. housing market, specifically, the impact the government stalemate and subsequent shutdown may have on the recovering economic and housing landscape. Of course, Americans, in their infinite obsession to quantify any and everything possible, can turn to Gallup’s Economic Confidence Index if we want documentation of just how positive or negative consumers feel toward the current economic environment. Each day, Gallup conducts phone surveys of around 1,500 adults and assesses their perception of two components: the current economic conditions in the U.S., be they positive or negative, and whether the economy is getting better or worse. The difference between the percentage of positive verses negative respondents is then calculated into a positive or negative number and reported as a weekly average in Gallup’s Economic Confidence Index. Obviously, a negative number means that over half of respondents feel pessimistic about the economy. For perspective, there has not been a positive number posted since Gallup began daily tracking in January, 2008.
Consumer confidence has been improving slowly since July, 2011 when only 18% of respondents felt the economy was getting better verses 78% thought it was getting worse for a reading of minus 60. There had been times in 2008 when the index reached -78, respectively. Between July, 2011 and May, 2012 the index rose steadily topping out at -13. That’s when consumer confidence took another hit as Washington was mired in the last debt ceiling debate. But confidence rebounded quickly, even after receding when the sequester budget cuts took effect in early March, 2013. Then in May, after the index reached its highest level (-3) in over 5 years, fears over the looming budget battle and delayed debt ceiling fight started to deteriorate confidence. The more the debate heated up the greater the concern from consumers, culminating with a minus 39 rating during the partial government shutdown. Consumer sentiment did tick up last week after the fiscal deal was announced but it appears we are in for this type of roller-coaster reaction from consumers as long as economic turmoil prevails. The reason this matters to you and I in the building industry is that consumers historically do not make major purchases, like new homes, when their confidence in economic conditions is unenthusiastic. So, in order for the U.S. to continue building on our recent housing market strength, it is critical that consumer confidence remain at a high level.
In addition to the need for robust consumer confidence, I believe the single most important factor that will stimulate long-term real estate health is job creation. The drop in U.S. jobless claims has been slow but steady with September’s unemployment rate (7.3%) nearly a full percentage point below last year. Unfortunately, the problem for the labor market for some time now has not really been the pace of layoffs; it’s been the slow pace of hiring. Perhaps one of the most telling metrics of just how bad the Great Recession was for Americans relates to jobs, specifically, how many were lost and how slowly they are coming back. In fact, not only were more jobs wiped out in the Great Recession than any other post WWII downturn — 8.7 million, or 6.3 percent of the pre-recession peak payroll — but it is taking longer to regain them than it did in the previous two post-recession recoveries combined. From the late 1940’s until the 1990’s, the U.S. economy never took more than a year to regain all the jobs lost during a downturn. But the current pace of job creation stands at 6.8 million or 78 percent of the jobs lost; and that’s after 42 months. Until this country can create an atmosphere where employers feel compelled to hire more workers the housing market has the potential to stagnate, especially if you take a closer look at the complexion of this new real estate boom.
One of the most troubling aspects of the housing recovery so far relates to the uncharacteristic presence of big business stepping in to purchase homes, both new and existing. Deep-pocketed Wall Street investors including hedge funds, private equity firms, and real estate investment trusts (RIAT’s) have been rushing in to buy units with the intent to fix and flip or rent until positive equity growth dictates spinning the home to take profits. Indeed, it is a great paradox that the new real estate boom is taking place alongside a plunging rate of home ownership. The percentage of housing units occupied by their owner has fallen to 65 percent, the lowest level in nearly two decades. These “institutional buyers” have been most active in the hot markets we mentioned earlier where between 25-30 percent of purchases are being sold to investment buyers. Single-family starts built-for-rent are running at nearly double the pace of the historic average. The number one Wall Street U.S. house owner is Invitation Homes, a unit of Blackstone Group, which has purchased over 30,000 homes in the last two years.
It’s hard not to feel that this phenomenon has created an artificial layer of activity that has propped up housing statistics and prices. The math and strategy of the investment buyer is 180 degrees from individual homeownership. For instance, investors pay cash and the unit generally returns positive cash flow either through rent generation or by fixing and flipping the unit. They have real estate tax advantages, can allow for depreciation and will often avoid capital gains through some crafty bookkeeping. In contrast, homeowners usually borrow money for the purchase, which, even at today’s ultra-low interest rates, inflates the cost of the home by 70% above the purchase price over the life of a 30-year mortgage. Plus, all maintenance expenses must be covered with after-tax income.
The highest percentage of American young adults in four decades — 36 percent of those 18-31 years old — were living with their parents in 2012...
Of course, many argue that these institutional buyers have served a very important purpose by helping to infuse activity back into the housing market. Some feel they are fulfilling a void for those that want to live in a single-family home but are unable to meet today’s more stringent mortgage loan requirements and are forced into renting. In fact, the first time home buying cycle may very well be delayed coming out of the severe economic conditions of the Great Recession. The highest percentage of American young adults in four decades — 36 percent of those 18-31 years old — were living with their parents in 2012 according to the PEW Research Center. The main reason is considered to be unemployment and underemployment. According to a recent Gallup poll conducted in August, nearly 27 percent of workers between 18-29 years old were underemployed, meaning only working part-time when they were seeking full-time work. In many instances, heavy student loan burdens forced recent grads to move back in with parents as income that would have ideally gone toward a new home purchase or even rent, instead, goes toward student loan payments. Roughly two-thirds of college seniors now graduate with an average of $26,000 in student loan debt.
The final major component of a healthy housing market is availability to affordable home financing. Mortgage money is still at a remarkable bargain with today’s 30-year fixed rates cheaper than in 40 of the last 42 years. The only issue...can you qualify. Zillow, the online mortgage real estate research firm, claims that 30 percent of Americans cannot currently qualify for a mortgage loan because their credit score is below 620. Plus, lending standards are scheduled to tighten even further in early January, 2014. Issued by the Consumer Financial Protection Bureau (CFPB), the changes are designed to curb loose practices that triggered the real estate meltdown. Under these new regulations, lenders are encouraged to underwrite only “qualified mortgages” that meet the tougher standards or possibly face lawsuits from the borrowers if they default.
Photo courtesy flickr user woodleywonderworks
Borrowers, for their part, will face a higher bar for credit scores, loan-to-value ratios as well as debt-to-income ratios. Also, lenders that bundle and sell loans as mortgaged-backed securities to investors will be required to hold 5 percent of the mortgage value on their books for the term of the loan. This will certainly tighten scrutiny for those that spin loans to the secondary market since they are accepting more long-term risk. Jumbo loans, categorized as loans from $417,000-$625,000, are expected to especially be affected by the new rules as will self-employed entrepreneurs who may show income fluctuation on tax returns. Many welcome these higher standards and hope they add more stability into the primary and secondary mortgage industry but, without a doubt, the mortgage lending industry is in a state of flux and its’ impact to the housing industry cannot be ignored.
As positive and favorable as most indicators are trending, one recent signal from the Fed proves just how fragile the whole housing system is right now. Mortgaged rates surged beginning in May when the Federal Reserve gave indications that it was thinking of winding down a monthly $85 billion bond-buying stimulus program that has helped keep long-term interest rates at record low levels. Rates immediately started to climb and the Mortgage Bankers Association reported a 15 percent falloff in purchase loan applications that they attributed to the rate hike. But, the Fed surprised financial markets in September when it announced that it would put off reducing monthly bond purchases for now. Policymakers admitted that rising borrowing costs played a role in their decision and rates have been edging downward since the announcement. It appears recovery is walking a very tight rope.
Then there is the trillion dollar question that is on everybody’s mind...can America’s political leadership put aside their hidden agendas and come together to find long-term resolutions to Government budget and looming debt ceiling battles. If we retrace our missteps again next February when these issues come up again the result could have tremendous negative impact just as the building season is ramping up. It is safe to say that regardless of which side of the aisle your allegiances lie, frustration and anger is mounting as the impasse and gridlock that has become commonplace in our Nation’s Capital. Until we can create an atmosphere of unity to displace the divisiveness this country’s economy will never hit on all cylinders.
Certainly housing has turned the corner. Existing home sales and construction have rebounded nicely and this great house buyers’ market is likely to keep going as long as the economy can create jobs that pay well enough to buy and rent at today’s prices. Sure, current figures don’t come close to recent highs but I think that the current pace and controlled growth is probably best for the overall marketplace. Slow and steady improvement will be healthier and easier to manage and in the long run, will reduce risk, something everyone in the building industry is interested in achieving.
Don Dyson - Contract Lumber
30 Year industry veteran, Don Dyson serves as Business Development Director for Contract Lumber. Don maintains a keen interest and focus on educational efforts while getting to know each of our customer's businesses so we can better serve each one individually. He has become “affectionately” know as the chief “turd polisher” here at Contract Lumber.