2016 Mid-Year Housing Market Report

The U.S. housing market continues to be an engine of economic growth in our country, even though many are not convinced that the engine is hitting on all cylinders. While sentiment may be mixed and muted, the overall mood of the industry is positive and optimistic, even as we wait for housing to get back to “normal” – but what will the “new normal” look like? Most analyst believe that even though housing data was relatively flat for the first half of 2016, new home production will ramp up in the second half, on the back of robust demand and tight inventories. The demand many forecasters sense will help propel the market forward is bolstered by the simple demographic tailwinds of new household formations. But can those demographics possibly return us to the housing heyday of 2007? 

The Demographics

According to Len Keifer, deputy chief economist with Freddie Mac, household formations are projected to accelerate over the next few years. Between 2008-2014, the slowdown resulted in 5.1 million fewer household formations than normal. In conjunction, U.S. homeownership rates receded to near half-century lows of 63.5%. Many see the fact that the rate has decreased less over the past year as a sign of stabilization. A high percentage of those household formations are entering the housing market as renter households rather than new owner households. In the first quarter of 2016 for instance, 540,000 new households formed in the U.S. Of those, some 363,000 were renters verses the 177,000 that bought homes. Of course, that’s not all bad news as the hope is that in the long-term, new renter households are likely to eventually turn into owners. But, those numbers certainly show why the multi-family construction market has performed so well during this housing recovery. They also reflect a decidedly different dynamic than any housing recovery in the past - when the sale of single-family entry level home buyers led every recovery. 

Who are these first-time home buyers sitting on the housing sideline? Collectively, they are known as the millennials. The millennial generation consist of people born in the 1980’s-90’s, and they have now eclipsed the massive generation known as “baby-boomers” in our society, formed by the tidal wave of births following WWII. Boomers are the generation that has controlled American politics and culture for decades. Millennials are a large and diverse age group consisting of everyone between 16 and 35 years of age. The 92 million Americans that fall into this category represent the largest generation of potential home buyers, or roughly 32% of the total home buying market. The U.S. census bureau’s latest population statistics show how millennials, especially those in their mid-20’s, are poised to have a disproportionate effect on the country in the decades to come. The most common age in the U.S. as of July 1, 2015 was 24, followed closely by 25 and 23, corresponding with births in the early 1990’s. So, millennials are currently set to enter the housing market as first-time homebuyers in increasing numbers but their housing preferences, along with their decision-making process of just when to do that, are different than the “boomers” that preceded them.  

Historically, homeownership became the norm in the 30-34 age group – raising well above a rate of 50%. But beginning in 2007, that rate went into a tailspin, eventually falling below 50% in 2011. The overall homeownership rate bottomed out in the first quarter of 2016 at 45.7%, with the rate of homeownership of those ages 25-29, dramatically lower, tumbling under 30%. These kind of stats may lead one to wonder if the age-old American dream of homeownership is still alive and well. But Julian Casto, secretary of Housing and Urban Development, sites recent surveys when claiming that, “The American Dream of Homeownership is as strong today as ever.” Casto said in a speech to the National Association of Realtors, “Millennials are showing that there generation is just as committed to homeownership as their parents and their grandparents.” So what are the dynamics delaying their entry into the housing market? Certainly there are multiple factors that are at play, including rising entry-level home prices, availability of inventory, student loan debt, delays in marriage and childbearing, and uncertainty about buying a home as an investment. These, and other factors, are weighing on younger households and motivating them to rent instead of buy, or even just stay with Mom & Dad. 

The Main Culprit…pricing and availability of entry level housing

One of the key factors delaying a higher number of first-time homebuyers from entering the market is simply the availability of entry level new home inventory. Trulia reported that 1st time buyer inventory declined nearly 44% over the last four years, plunging 10% in the last year. Across the country, starter homes are seeing the largest price increases because the supply of affordable homes on the market is so low and demand so high. This competitive environment at the bottom of the market is vaulting home prices in this segment to near double-digit increases. Builders are struggling to produce product at an affordable price point for this market for several reasons, the biggest being the financial squeeze from city hall. First-time home buyers are being disproportionally affected by impact fees levied by municipalities when builders get permits for new construction projects. These fees fund the local infrastructure needed to support a growing population, schools, transportation, environmental mitigation, and utilities. Cities boosted these fees after the downturn to make up for lost revenues they experienced during the housing bust. The combination of fewer building fees being collected and lost property tax receipts because of falling property values, put a strain on city budgets. According to NAHB researcher, Natalia Siniavskaia, regulations, impact fees, taxes and other government imposed costs add 24.3% - or an additional $84,000 to the cost of median priced home in 2015. That regulatory overload priced 14 million buyers out of the market, many of them potential entry level buyers. It’s a bigger issue for starter homes because builders face tighter margins to begin with. It’s easier for them to pass along these higher fees on luxury homes that have heftier margins because the fees represent a smaller share of the sales price. 

Financing is also an issue for entry-level buyers. Many builders rely on loans backed by the Federal Housing Administration (FHA), which allows buyers to make low down payments. As fees raise, builders are struggling to put a home on a lot that they can sell for prices below the loan-caps of FHA backed mortgages. This leaves builders with little incentive for the risk of selling entry-level homes. Boosting starter-home development density would help lower lot costs, driving down new home pricing, but municipalities are generally unwilling to budge on increased density requests from developers. Also plaguing first-time buyers is meeting the rigorous requirements of lending institutions, especially those with high college debt. The Department of Education confirmed that in the past decade, the level of outstanding college loans has more than doubled to $1.2 trillion. The average indebted grad has over $29,000 in student loans. And while the millennials are on track to be the nation’s most-educated generation according to the Pew Research Center, they may also prove to be the most financially obligated as well. Economists can argue on what, if anything, those financial obligations are doing to the housing market, but there is no doubt that first-time homebuyers have become scarce since the housing collapse, currently accounting for less than a third of purchases, a low last seen in the 1980’s according to the Realtor’s Association. 

What’s Driving the Housing Market Recovery?

So the under-performing segment of housing is well documented. But rising home values have a dual impact on the market. While some view the resurgence of home prices as a drag on housing, others see it as a vital component for housing’s healing. It is specifically these raising home values that have bolstered consumer’s confidence and rekindled single-family housing demand to its highest post-recession level. The bright spot in the single-family market has been at higher price points, spurred by solid job creation, wage growth, and low interest rates. The advantage that most of these buyers have over the millennial buyer is home equity and greater financing options. The demand for the luxury home market has led home builders to focus their development, design, construction, and marketing attention on the move-up market. Our entire housing industry is geared to go where the money is, so that is where companies are innovating – at the higher end - with materials, with processes, with installation, with manufactured products, with tools. The industry is simply reacting to opportunity and profit. Eventually, those innovations make their way across the housing divide and can be replicated to make lower-end housing more affordable, but that takes time. There are signs that the growth of the luxury home market is softening with home values of more expensive homes increasing at only half the rate they have over the past several years. That’s why attracting the entry level buyer is so important to the long-term strength and momentum of the housing recovery.

Multi-Family construction is the segment of the market that has driven the housing recovery the past few years. Of course, that is a direct reflection of soft entry-level home sales. Apartment construction has been churning along at above normal rates for some time now. The newest June statistics from the U.S. Commerce Department had multi-residential starts holding steady in June at 392,000 units and running over 16% ahead of what would be considered “normal” levels of production. But the booming multifamily market is expected to cool as single-family picks up, and a rebalancing of the housing mix takes place. David Crowe, NAHB Chief Economist, expects the multi-family sector to come in 9% higher than normal levels, not the 30+% the market has experienced in recent years. Apartment construction conditions remain favorable and demand is still very strong but banks are starting to become anxious about the flurry of production we have experienced, so expect headwinds to develop in that sector.

The general consensus is the outlook remains modestly optimistic for all sectors of the housing industry over the next few years. Using the 2000-2003 period as a healthy benchmark, when single family starts averaged 1.3 million starts, the market only stands at 58% of normal activity. NAHB projects new single family production will raise to 64% of normal by the 4th quarter, and climb to 77% by the end of 2017. The progress of the housing market recovery, according to NAHB senior economist, Robert Denk, is no longer a function of the boom-and-bust cycle marked by price bubbles, excess supply, and foreclosures. “The key driver of the housing recovery is now back to the underlying housing market fundamentals of population and job growth.” And even though the rental market will certainly cool, builders remain confident, yet cautious. They realize the industry is still not building enough homes to meet the demand that current demographics imply are needed, but they are concerned about three main obstacles – the three L’s – Labor, Lots, and Lending.  

What are the Barriers Facing Builders to a Full and Healthy Housing Recovery?

If solid job gains, including raising salaries and wages, pent up demand, low mortgage rates, and affordable home prices are the catalysts for the pace of housing’s upward trajectory so far, what are the key impediments facing this market to reach housing’s full potential? Builders face many hurdles in today’s dynamic construction environment but most agree the three L’s – access to labor, lots, and lending, offer the most significant challenges to production and profitability. Labor shortages have plagued the construction market for years and it will not be remedied any time soon. It is hard to grow much faster when you cannot find skilled tradesmen to construct your projects. Between 2006-2011, the construction industry eliminated more than 40% of its workforce, cutting nearly 2.3 million jobs. Most of these workers have not returned and there is currently a real struggle to find the right people to staff projects. According to the John Burns Real Estate Consulting firm, the politically-charged immigration debate is contributing to the existing labor shortage as an estimated three-quarters of a million Hispanic-born construction workers left the industry, and the country, during the housing crisis. A significant portion of these workers have not returned due to heightened immigration controls and more job opportunities south of the border. Eighty-six percent of construction companies reported they were experiencing significant problems finding trade labor and salaried professionals to staff projects, while 93% said these labor shortages will prevent them from meeting their growth goals this year. Most of them also agree that they expect the problem to get worse. What all builders can 100% agree upon, is that they have experienced substantial increases in their labor costs across all trades during this recovery.

The additional two “L’s” - Lots and Lending - are also affording builders considerable challenges. Demand for new homes may be strong but places to build these homes are getting harder to find and when you can, more expensive. “The lack of available buildable lots has quickly become one of our biggest problems,” says NAHB Chairman Ed Brady. “While labor shortages and regulatory burdens remain struggles as well, lot shortages are preventing our builders from responding to growing demand for housing.” Developers cite land use policy, geographic and regulatory constraints as major contributors to the development process, but most agree that access to acquisition, development & construction (AD & C) loans continue to hamper their ability to bring developments on line. A developer in Indianapolis (wishing to go unnamed), shared his frustration with the process. “Between the tight access to lending and the regulatory nightmares I have to contend with, I have never been more frustrated with the process than I am right now. You’d think that with the overall climate surrounding the recovery and the strong demand, that the players would be chomping-at-the-bit to move forward on land and development deals, but the process has become so stalled – so long and drawn-out, that the risk is just not worth the reward. The whole process is just so damn exasperating – so many obstacles.”    

Of course, builders are an ultra-adaptable lot, and are rolling with the punches like a professional prize fighter. They realize there is little they can do about high and rising costs of regulatory burden on home sites and code compliant vertical construction, lending, labor, and lot availability, so many are focusing efforts on things they can control – operational excellence. Builders and contractors who strategically align their companies with the best outsource partners will be able to create a significant competitive advantage. Price will become a secondary decision-making component to performance capabilities, especially in the short term. The dilution of a trained and experienced construction workforce is sure to add risk and vulnerability to the building process, and having a network of partners who you can trust to deliver the goods on a consistent basis and stand behind their work, will be critical to maintaining long-term success and reputation. Unseasoned workers not appropriately trained in the work itself, let alone safety procedures, will open builders to a whole host of potential perils – expensive perils. Builders are already practicing much more “project selectivity”, moving forward much more cautiously on projects they pursue. They are scrutinizing workloads and labor capabilities closer and shying away from projects they may have signed on for in past booms. And subcontractors are certainly doing the same. 

The current climate of the building industry reminds me of a famous Charles Dickens phrase from his 1859 book, A Tale of Two Cities - “It was the best of times, it was the worst of times.” There is no doubt that it a great time to be building the American Dream. Conversely, it may be one of the most difficult times to deliver on that Dream.