House price growth surged to 8.4% y/y in October, as booming home sales have combined with record low inventory to boost values. But that rise in prices has already offset the improvement to affordability provided by record low mortgage rates. With mortgage rates now edging up, pent-up demand from the spring exhausted and buying sentiment falling back, home sales will cool over the next few months. The rapid growth in housing starts will also slow, but with homebuilder confidence close to record highs 2021 will be the best year for starts since 2006. Rental demand is starting to recover, driven in part by aggressive rent cuts. That will help stabilise vacancy rates over the next few months, and yields are set for a further small fall.
- House price growth surged to 8.4% y/y in October, as booming home sales have combined with record low inventory to boost values. But that rise in prices has already offset the improvement to affordability provided by record low mortgage rates. (See Chart 1.) With mortgage rates now edging up, pent-up demand from the spring exhausted and buying sentiment falling back, home sales will cool over the next few months. The rapid growth in housing starts will also slow, but with homebuilder confidence close to record highs 2021 will be the best year for starts since 2006. Rental demand is starting to recover, driven in part by aggressive rent cuts. That will help stabilise vacancy rates over the next few months, and yields are set for a further small fall.
- Economic indicators: The drop in employment in December was worse than expected, but was driven by a plunge in leisure and hospitality employment, as bars and restaurants across the country were forced to close. Other sectors saw a rise in employment, which bodes well for the recovery. Price pressure are mounting, and inflation is likely to rise to 3% y/y by the spring.
- Single-family: Mortgage rates edged up in early January, and with the 10-year Treasury yield now over 1% they are set to rise further. That has given a short-term boost to mortgage demand as borrowers rush to secure a loan before costs rise. But once that has passed through, home sales will gradually return to their pre-COVID trend.
- Multifamily: Rental demand is showing signs of recovery, and the overall rise in vacancy now looks to be lower than we first anticipated. In part, the rise in demand has been driven by aggressive rent cuts, particularly in New York, San Francisco and Boston. A surge in young Americans living with their parents during the pandemic is a good source of future demand, and that should help bring vacancy rates back down to 5.1% by the end of year.
Chart 1: NAR Affordability Index (S. Adj.)
Sources: NAR, Capital Economics
- COVID-19 infections and deaths have continued to rise, with the accompanying lockdowns depressing economic activity (2). Admittedly, both the manufacturing and services ISM activity indices rebounded in December (3). But in both cases the headline services reading received an artificial boost from a jump in the supplier deliveries component, which reflected virus-related disruption rather than stronger demand.
- The 140,000 drop in non-farm payrolls in December was worse than expected (4). But the fall was due to a plunge in leisure and hospitality employment, as bars and restaurants across the country were forced to close. Employment in most other sectors rose strongly, and while the headline unemployment rate was unchanged the rate of permanent job losers edged down and remained much lower than in 2008/09, suggesting there will be less scarring this time around (5).
- Inflation remained low at the end of last year (6). But survey evidence shows price pressures continue to mount (7). Indeed, strong base effects and rebounding energy prices will push CPI inflation briefly above 3% y/y in the spring, and, even once those effects fade in the summer, we expect it to remain at, or above, 2% y/y in the second half of this year.
Chart 2: COVID-19 Infections & Deaths
Chart 3: ISM Activity Surveys (Index)
Chart 4: Non-Farm Payroll Employment (Millions)
Chart 5: Unemployment Rate (%)
Chart 6: CPI Inflation (% y/y)
Chart 7: NFIB Price Plans & Core CPI Inflation
Sources: Refinitiv, NFIB, C.E.
- The 30-year mortgage rate averaged 2.88% in December, a record low. But a rise in the 10-year Treasury yield to over 1% pushed rates up in early January, and they may see further small gains. (8). The threat of higher rates drove a surge in both refinancing and home purchase demand at the start of the year (9).
- The boost to affordability provided by low interest rates has quickly been eroded by rising house prices. Indeed, the NAR affordability index has now fallen back to its pre-COVID level (10). And, with interest rates not set to drop further, we expect home demand will continue to fall back towards its pre-virus trend over the coming months. This is consistent with recent declines in homebuying sentiment. Indeed, Fannie Mae reported that just 52% of households in November thought now was a good time to buy, its lowest reading since April (11).
- The exhaustion of pent-up demand from mid-2020 is feeding through to home sales. Existing home sales fell for the first time in five months in November, and the downward trend in the pending home sales index points to further declines (12). Meanwhile, tight inventory helped new home sales to fall 11.0% m/m in November (13).
Chart 8: 10-Yr Treasury Yield & 30-Yr Mtge Rate (%)
Chart 9: Mortgage Applications (Index)
Chart 10: NAR Affordability Index (S. Adj.)
Chart 11: Fannie Mae Good Time to Buy (%)
Chart 12: Existing SF & Pending Home Sales
Chart 13: New Home Sales (000s Ann.)
Sources: Refinitiv, MBA, NAR, C. Bureau, F.Mae
Single-Family Market (Continued)
- Strong new home sales have pushed the months’ supply of new homes for sale to record lows. But a tighter inventory has boosted homebuilder confidence (14). The NAHB measure climbed to a record high of 90 in November, before edging back to 86 in December. The slight drop in confidence reflects both the recent moderation in new home sales and mounting constraints on production. Lots, labour and materials are in short supply, and lumber futures prices have been rising since November (15).
- Construction constraints will weigh on housing starts this year. Indeed, single-family starts rose just 0.4% m/m in November, after averaging 9.8% between May and October (16). November’s modest gain in building permits also suggests that an acceleration in starts is unlikely (17). That said, we think that starts will have a strong year, averaging around 1.2m annualised in 2021. (See our Update.)
- Surging home demand and low inventory have pushed house price growth to a 15-year high. In October, growth reached 8.4% y/y on the Case-Shiller index and 10.2% on the FHFA index (18). This was driven by particularly strong growth rates in Phoenix, San Diego and Seattle (19). But we expect house price growth to slow in the coming months as tight credit conditions and worsening affordability take their toll.
Chart 14: NAHB Homebuilder Conf. & Mths Supply
Chart 15: Lumber 1st. Pos. Futures ($ per 1,000 sq.ft.)
Chart 16: SF Starts (% m/m)
Chart 17: SF Starts & Building Permits (000s Ann.)
Chart 18: House Prices (% y/y)
Chart 19: C-Shiller 20-City House Prices (Oct-20, %y/y)
Sources: Refinitiv, C. Bureau, C-Shiller, FHFA, NAHB
- Apartment completions dropped sharply in 2020, as lockdowns shut down construction sites and some buildings were delayed (20). Given the high number of multifamily units started over the past 18-months, that implies a significant number of units could come on the market this year. After holding-up in recent months, that implies MF starts will drop back over the next year or so (21).
- The drop in completions has helped keep the rise in rental vacancy rates relatively low. At 5.0% in the third quarter, national vacancy rates are up only 0.4 ppts from a year ago (22). Some cities have seen lager gains, but the increase in NYC of 0.7 ppts over the past year only takes the vacancy rate back to where it was in early 2018 (23). We expect only a further small rise in national vacancy, to around 5.2%.
- Despite the modest rise in vacancy rates, rental growth has seen a sharp downturn. From 4.1% y/y in 2019 Q3, REIS reported that apartment rental growth dropped to -1.1% y/y by 2020 Q3 (24). The rent component of the CPI and Zillow have also shown large declines in growth, if not outright falls at the national level. Zillow data on the 20 largest metros showed that NYC, San Francisco and Boston saw the largest year-on-year declines in November, but rents in Riverside in California were up 6.8% y/y (25).
Chart 20: MF Starts for Rent & Apt. Comp. (000s Ann.)
Chart 21: MF Starts & Building Permits (000s Ann.)
Chart 22: Apartment Rental Vacancy Rate (%)
Chart 23: Selected Apartment Vacancy Rates by City (%)
Chart 24: Rental Growth (% y/y)
Chart 25: Zillow Rent Growth (Nov-20, % y/y)
Sources: Refinitiv, REIS, C. Bureau, Zillow
Multifamily Market (Continued)
- The new round of stimulus checks, plus the extension of enhanced unemployment benefits, will help prevent a significant rise in rent arrears. Indeed, at 76.6% in the first week of January, the share of rent fully or partially paid was down only marginally from the 78.3% recorded last year (26). Rental demand is set to pick-up this year as a recovering economy and the reopening of cities encourage some of those who moved in with parents during the pandemic to move back out (27).
- After a brief rise in the 2020 Q2, apartment NOI yields dropped back in the Q3 to just over 4% (28). We expect yields will fall back further over the next year, ending 2021 at around 3.9%. But, with risk-free interest rates also set to remain low, apartments will remain a desirable asset. Indeed, the Freddie Mac Apartment Investment Market Index increased in the third quarter, indicating investing in apartments was the most attractive it has been since mid-2016 (29).
- A decline in apartment capital values in the second and third quarter of last year weighed on total returns (30). But values will start to recover this year, helping to push total returns to around 7% by the end of 2021. The REIT market still views the single-family rental market more favourably, and the recovery in apartment REIT prices has stalled over the past month, with values 20% down over the year (31).
Chart 26: Rent Fully or Partially Paid by 6th (%)
Chart 27: 18-29 Yr-Olds Living with Parents (%)
Chart 28: MSCI Apt. NOI Yield (%)
Chart 29: Freddie Mac Apt. Invest. Mkt Index
Chart 30: Apartment Returns Breakdown (%)
Chart 31: REIT Prices (Index, Jan-20=100)
Sources: Refinitiv, NMHC, REIS, MSCI, NAREIT, F. Mac., Pew Research
Table: Single-Family Indicators
Case-Shiller National (Index)
FHFA Purchase-Only (Index)
Home Sales and Mortgages
Total SF Home Sales (000s Ann.)
New Home Sales
Existing Home Sales
Pending Home Sales (Index)
Total Mortgage Applications (Index)
For Home Purchase
Mortgage Rate (30-Year Fixed, %)
Mortgage Delinquency (30+Days, %)
Mortgage Foreclosure Inventory (%)
Homebuilding and Supply
Single-Family Building Permits (000s Ann.)
Single-Family Starts (000s Ann.)
NAHB Homebuilder Confidence (Index)
Total Months’ Supply of Homes
Months’ Supply of New Homes
Months’ Supply of Existing Homes
Table 2: Multifamily Indicators
CPI Rent of Primary Residence (Index)
Reis Effective Apartment Rent ($)
Zillow Observed Rent Index ($)
Homebuilding and Supply
Multifamily Building Permits (000s Ann.)
Multifamily Starts (000s Ann.)
Multifamily Current Conditions (% Bal.)
Apartment Rental Vacancy Rate (%)
NAREIT Apartment Index ($)