Record low inventory brings sales back to earth - Capital Economics
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Record low inventory brings sales back to earth

US Housing Market Chart Book
Written by Matthew Pointon
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Mortgage rates rose further in March, with the 30-year rate now up 50bps compared to the start of the year. Recent stability in the 10-year Treasury yield means mortgage rates are likely to move sideways over the next couple of weeks, but we expect they will soon resume their upward trend and end the year at around 4.0%. That, alongside record low inventory, will bring home sales back to earth. Indeed, the pending home sales index fell 10.6% m/m in February, pointing to a contraction in existing home sales in March. House prices saw another large rise in January, but even as house price expectations tick-up, higher mortgage rates should cool the market later this year. As the economy and offices reopen, apartment demand will recover this year, supported by the lack of homes for sale. We expect effective rental growth will rise from -2.9% y/y at end-2020 to 2.0% y/y by the end of this year.

  • Mortgage rates rose further in March, with the 30-year rate now up 50bps compared to the start of the year. Recent stability in the 10-year Treasury yield means mortgage rates are likely to move sideways over the next couple of weeks, but we expect they will soon resume their upward trend and end the year at around 4.0%. That, alongside record low inventory, will bring home sales back to earth. Indeed, the pending home sales index fell 10.6% m/m in February, pointing to a contraction in existing home sales in March. (See Chart 1.) House prices saw another large rise in January, but even as house price expectations tick-up, higher mortgage rates should cool the market later this year. As the economy and offices reopen, apartment demand will recover this year, supported by the lack of homes for sale. We expect effective rental growth will rise from -2.9% y/y at end-2020 to 2.0% y/y by the end of this year.
  • Economic indicators: Renewed lockdowns pushed GDP growth down to 4.0% q/q annualised in the fourth quarter. But the reopening of the economy, coupled with a boost to demand from substantial fiscal support, will help GDP growth accelerate to 6.5% this year.
  • Single-family: Higher mortgage rates will help cool home sales and house prices this year, but pent-up demand from buyers frustrated by a lack of inventory and an easing in lending standards argues against a sharp fall in either during the next few months. That will support housing starts, which have been hit by record high lumber prices and severe weather over the past couple of months.
  • Multifamily: As lockdowns have eased, apartment completions have gathered pace. That increased supply should be met by higher demand, as younger Americans and international migrants who had delayed moves last year begin to move closer to reopened offices. Vacancy rates are therefore set to fall back over the next couple of years, and total returns at the national level will rise from 1.7% at end-2020 to 4.3% by end-2021.

Chart 1: Existing Single-Family and Pending Home Sales

Source: NAR

Economic Backdrop

  • GDP growth slowed to 4.0% annualised in Q4, on the back of renewed lockdowns (2). But virus infections are significantly lower than at the start of the year, which has allowed restrictions to ease and economic activity to pick up (3). On top of this, we expect the boost to demand from fiscal support to help GDP growth reach 6.5% this year.
  • The easing of virus restrictions is driving a recovery in a range of services spending, including those worst-hit by the pandemic (4). This fed through to a 280,000 gain in leisure and hospitality sector employment in March which contributed to a better than expected 916,000 increase in non-farm payrolls. That said, this still left employment 8.4 million below its pre-pandemic peak (5).
  • Headline and core CPI inflation remained subdued in February, at 1.7% and 1.3%, respectively (6). But base effects will push headline inflation well above 2% in March. We expect the Fed will keep policy loose in the face of higher inflation and will only gradually increase the policy rate towards the end of our forecast horizon. 10-year Treasury yields have increased since the start of the year, and we expect them to reach 2.25% by the end of 2021 (7).

Chart 2: Real GDP

Chart 3: COVID-19 Infections & Deaths

Chart 4: Cons. Spending Indicators (% chg. from 2019)

Chart 5: Non-Farm Payroll Employment (Millions)

Chart 6: CPI Inflation (% y/y)

Chart 7: Fed Funds & 10-Year Treasury Yield

Sources: Refinitiv, C.E.

Single-Family Market

  • On the back of rising Treasury yields, the 30-year mortgage rate climbed to an average of 3.32% in March from 3.06% in February (8). That rise in mortgage rates has made it less attractive for borrowers to seek new deals, and demand for refinancing is down 35% since late January. Home purchase demand has held up better, with mortgage applications gaining 1.7% m/m in March (9).
  • Holding the debt-to-income (DTI) ratio constant, rising mortgage rates means that the average size of mortgages will need to decrease (10). But there is a good chance DTIs will rise, supporting house prices. After all, the economy is recovering, home equity levels are high and a surge in saving has supported down payments. Banks are therefore likely to ease lending standards over the next few months, which would help bring credit scores down from their recent highs (11).
  • Tight inventory and worsening affordability are weighing on housing market activity. In addition, severe weather in the South contributed to an 18.2% m/m decline in new home sales in February (12). Existing home sales also edged back in February, falling 6.6% m/m. And we are expecting a further decline in March as the impact of the winter storms feeds through to existing home sales (13).

Chart 8: 10-Yr Treasury Yield & 30-Yr Mtge Rate (%)

Chart 9: Mortgage Applications (Index)

Chart 10: 30-Yr Mtge Rate & Purchase Mtge Size

Chart 11: Purchase Credit Score & DTI (S. Adj.)

Chart 12: New Home Sales (000s Ann.)

Chart 13: Existing SF & Pending Home Sales

Sources: Refinitiv, MBA, NAR, ICE, C. Bureau, C.E.

Single-Family Market (Continued)

  • Recent declines in homebuying sentiment, driven by record low inventory, surging house prices and worsening affordability, point to a fall in home sales of over 20% y/y (14). But we don’t think that declines of this size will materialise. One reason is that the pandemic is forcing some households to find more space for homeworking. As a result, there is still a large share of households planning to buy a home despite the unfavourable conditions (15).
  • Winter storms and record high lumber prices forced homebuilders to delay housing starts in February. At 1.04m annualised, single-family starts were down 8.5% m/m. But an increase in the number of starts that have been authorised but are yet to commence points to a solid pipeline of projects, and starts will hold up even as demand starts to wane in the face of higher mortgage rates (16). Indeed, tight inventory is supporting homebuilder confidence, which points to stable starts this year (17).
  • House prices continued to surge higher in January, with Case-Shiller and FHFA reporting rises of 1.2% m/m and 1.0% m/m respectively, which pushed the annual growth rates up to 11.2% and 12.0% (18). That is now feeding through to higher house price expectations (19). That presents an upside risk, but for now we expect annual house price growth will slow to around 3% y/y by the end of 2021.

Chart 14: Good Time to Buy & Existing Home Sales

Chart 15: Buying Sentiment & Plans (%, 3-Mth Avg.)

Chart 16: SF Starts Authorised But Not Started (000s)

Chart 17: NAHB Homebuilder Conf. & SF Starts

Chart 18: House Prices (% y/y)

Chart 19: House Price Expectations Next 12-Mths (%)

Sources: Refinitiv, U.o.M, C. Board, C. Bureau, C-Shiller, FHFA, NAHB

Multifamily Market

  • An easing in restrictions in the Q3 2020 helped apartment completions rise to a record high 86,000 (20). But with new curbs introduced in the final quarter, a relatively low 49% of those had been rented by the end of the year. Since then, as restrictions have been relaxed, MF building permits have jumped, with February seeing the largest number since July 2015 (21). We doubt that surge in permits will last. There is a large pipeline of units in development, and steel prices have risen 110% in the year to March (22).
  • According to REIS, the apartment vacancy rate ended 2020 at 5.3%, up from 4.7% a year earlier (23). But with the economy reopening, and the number of homes for sale at record lows, we expect rental demand will recover and vacancy rates will fall back over 2021. Indeed, the monthly breakdown shows a fall in the vacancy rate from 5.4% in January to 5.3% in February.
  • In turn, that will support a recovery in rents. Effective rental growth had dropped to -2.9% y/y by end-2020 (24). But asking rent data from Apartment List is now showing a recovery, with growth rising from -1.2% y/y in December last year to just under zero by March of this year. For the country as a whole we expect effective rental growth will end this year at around 2.0% y/y and will reach 3.0% y/y by end-2022 (25).

Chart 20: SOMA Comp. & Absorption Rate (%)

Chart 21: MF Building Permits & Starts (000s Ann.)

Chart 22: HR Steel Price ($ per ton)

Chart 23: Apartment Rental Vacancy Rate (%)

Chart 24: Rental Growth (% y/y)

Chart 25: Effective Rental Growth F’cast (% y/y)

Sources: Refinitiv, REIS, C. Bureau, Apt. List, C.E.

Multifamily Market (Continued)

  • Within that national figure, NYC and D.C. are set to benefit the most from reopening, as they were amongst the hardest hit during the lockdowns (26). But given its high concentration of tech jobs, many of which can be done from home full time and therefore don’t require workers to live near the city, San Francisco will not make up the 14.6% drop in rents seen in 2020 over the next four years.
  • Rent arrears dropped back in March as the latest round of stimulus cheques supported incomes (27). Arrears will continue to fall as the economy and labour market improves. Alongside a fall in the vacancy rate, that will help boost apartment NOI, which dropped in the final quarter and pushed NOI yields down to just 3.8% (28). As that impact is reversed, NOI yields will recover, and total returns will rise from 1.7% at end-2020 to 4.3% by end-2021 (29).
  • In line with the recovery in rental growth, D.C. and NYC will see the best total returns over the next four years, while San Francisco will see average returns of around zero over that time (30). Apartment REIT prices are now only around 5% under where they were at the start of 2020 (31). But SFR REITS continue to outperform, with a 15% rise since early March.

Chart 26: Asking Rent F’Cast by City (% Cumulative)

Chart 27: Rent Paid by End-Mth (Diff. from Last Yr, pps.)

Chart 28: MSCI Apt. NOI Yield (%)

Chart 29: Total Returns (Year-End, %)

Chart 30: Total Returns p.a. Avg 21-25.

Chart 31: REIT Prices (Index, Jan-20=100)

Sources: Refinitiv, NMHC, REIS, MSCI, NAREIT, C.E.

Data Summary

Table: Single-Family Indicators

Previous Data

Latest Data

Published by

Data For

Level

% m/m

% y/y

% m/m

% y/y

Prices

Case-Shiller National (Index)

Case-Shiller

Jan

238

1.3

10.4

1.2

11.2

FHFA Purchase-Only (Index)

FHFA

Jan

317

1.2

11.4

1.0

12.0

Home Sales and Mortgages

Total SF Home Sales (000s Ann.)

CE Calc.

Feb

6,295

0.3

22.6

-8.2

8.1

New Home Sales

Census Bureau

Feb

775

3.2

22.5

-18.2

8.2

Existing Home Sales

NAR

Feb

5,520

-0.2

22.6

-6.6

8.0

Pending Home Sales (Index)

NAR

Feb

110

-2.4

13.5

-10.6

-0.5

Total Mortgage Applications (Index)

MBA

Mar

744

-10.1

24.6

-12.9

-23.2

For Home Purchase

MBA

Mar

293

-15.0

8.3

1.7

16.4

For Refinancing

MBA

Mar

3,360

-8.9

33.3

-19.0

-35.3

Mortgage Rate (30-Year Fixed, %)

MBA

Jan

3.06

3.32

Mortgage Delinquency (30+Days, %)

MBA

Q4

7.65

6.73

Mortgage Foreclosure Inventory (%)

MBA

Q4

0.59

0.56

Homebuilding and Supply

Single-Family Building Permits (000s Ann.)

Census Bureau

Feb

1,146

3.8

30.0

-9.8

15.3

Single-Family Starts (000s Ann.)

Census Bureau

Feb

1,040

-14.1

14.9

-8.5

0.6

NAHB Homebuilder Confidence (Index)

NAHB

Mar

82

1.2

13.5

-2.4

13.9

Total Months’ Supply of Homes

CE Calc.

Feb

2.4

2.5

Months’ Supply of New Homes

Census Bureau

Feb

3.8

4.8

Months’ Supply of Existing Homes

NAR

Feb

2.0

2.1

Table 2: Multifamily Indicators

Rents

CPI Rent of Primary Residence (Index)

BEA

Feb

345

0.1

2.1

0.2

2.0

Reis Effective Apartment Rent ($)

REIS

Q4

1,385

-1.8

-1.1

-1.4

-2.9

Zillow Observed Rent Index ($)

Zillow

Feb

1,750

0.1

0.5

0.1

0.5

Homebuilding and Supply

Multifamily Building Permits (000s Ann.)

Census Bureau

Feb

574

28.1

10.2

-6.8

29.3

Multifamily Starts (000s Ann.)

Census Bureau

Feb

381

28.7

-28.7

-15.0

-28.5

Multifamily Current Conditions (% Bal.)

NAHB

Q4

43

29.4

-0.9

-11.6

-13.2

Apartment Rental Vacancy Rate (%)

REIS

Q4

5.1

5.3

REIT

NAREIT Apartment Index ($)

NAREIT

Mar

453

5.1

-8.0

6.8

27.9


Matthew Pointon, Senior Property Economist, matthew.pointon@capitaleconomics.com