Mortgage rates have continued to fall, hitting a record low 3.14% at the end of July. Alongside the reopening of parts of the economy, and pent-up demand from the spring, that has helped home sales bounce back strongly from their COVID-related dip. Indeed, the June pending home sales index implies existing home sales will reach a 13-year high in July. However, tighter credit conditions, a lack of inventory and elevated unemployment mean sales will soon hit a ceiling. The recovery in demand is good news for homebuilders and starts are set for a decent rise over the coming months. With so few people moving, apartment vacancy rates have seen only a small rise. But net absorption rates have fallen to 11-year lows, and we expect rental growth will continue to fall back.
- Mortgage rates have continued to fall, hitting a record low 3.14% at the end of July. Alongside the reopening of parts of the economy, and pent-up demand from the spring, that has helped home sales bounce back strongly from their COVID-related dip. Indeed, the June pending home sales index implies existing home sales will reach a 13-year high in July. (See Chart 1.) However, tighter credit conditions, a lack of inventory and elevated unemployment mean sales will soon hit a ceiling. The recovery in demand is good news for homebuilders and starts are set for a decent rise over the coming months. With so few people moving, apartment vacancy rates have seen only a small rise. But net absorption rates have fallen to 11-year lows, and we expect rental growth will continue to fall back.
- Economic indicators: GDP contracted by three times the previous record in the second quarter, but activity has rebounded strongly since then. The labour market continues to recover. Although the total unemployment rate was still a very high 10.2% in July, at 1.8% the rate of workers with a permanent job loss is a long way below what was seen during the financial crisis.
- Single-family: Despite a further fall in mortgage rates, mortgage applications for home purchase edged down over July. Record low inventory may be putting some buyers off, but that will support housing starts. Indeed, homebuilder confidence has reversed its COVID-related dip, and building permits have returned to mid-2019 levels. House price growth has slowed, and while we expect it will see a further dip, outright falls in house prices should be avoided.
- Multifamily: The coronavirus has weighed on rental demand, and net absorption of apartments dropped to an 11-year low in the second quarter. But, with no one able to move, vacancy rates have to date seen only a small rise. Effective rental growth slowed from 3.5% y/y in the first to 1.6% y/y in the second quarter, and we expect it will drop to around -1% y/y by the end of the year.
Chart 1: Existing & Pending Home Sales
- The 32.9% annualised decline in GDP in the second quarter, more than three times larger than the previous record quarterly contraction, underscores the unprecedented hit to the economy from the pandemic (2). That said, the second-quarter data are to some extent old news as we already know that activity rebounded strongly in May and June. Both the manufacturing and non-manufacturing ISM indices increased in July, which implies renewed lockdowns have not derailed the national economic recovery (3).
- Indeed, non-farm payrolls increased by 1,763,000 in July, and we expect that employment will continue to rebound (4). Unemployment dropped back to 10.2%, from 11.1%. And most of the unemployed continued to report themselves as on temporary layoff, with the 1.8% of workers permanently losing their jobs unchanged from June and well below the peak of 4.4% seen after the Global Financial Crisis (5).
- Headline CPI rebounded to 0.6% y/y in June, driven by a 12% m/m rise in gasoline prices (6). Headline inflation is also being pushed up by the continued surge in food prices, as grocery stores adjust to higher demand. But even in bars and restaurants, where demand remains well below pre-pandemic levels, there are tentative signs that supply constraints are beginning to push up prices (7).
Chart 2: Real GDP ($bn, 2012 Prices)
Chart 3: ISM Activity Indices
Chart 4: Non-Farm Payroll Employment (Millions)
Chart 5: Unemployment Rate by Reason (%)
Chart 6: CPI Inflation (%)
Chart 7: CPI Food (% y/y)
Sources: Refinitiv, C.E.
- Mortgage rates have continued to trend down, reaching a record low 3.06% by the first week of August (8). That drop has been driven by a decline in the 10-year Treasury yield, which recently hit a record low. Indeed, if the spread between yields and mortgage rates was closer to its pre-COVID level of around 200bps, mortgage rates today would under 2.7% (9).
- Despite the further fall in financing costs, mortgage applications for home purchase edged down over July, to a 10-week low by the end of the month (10). That might reflect the working through of pent-up demand from the spring, and the impact of tighter credit conditions. Indeed, Ellie Mae reported that the closing rate for conventional home purchase loans fell to a two-year low of 74.9% in July, as credit scores have risen, and debt-to-income ratios have edged down (11).
- The moderation in housing demand, and fall in the closing rate, argues against a strong rise in home sales over the next few months. That said, the rise in the pending home sales index implies existing home sales will reverse all their COVID-related drop in July (12). Based on reports of homebuyer traffic, new home sales are also set for a strong July (13).
Chart 8: 10-Yr Treasury Yield & 30-Yr Mtge Rate (%)
Chart 9: Spread Between 10-Year & 30-Yr Rate (%)
Chart 10: Mortgage Applications (Index)
Chart 11: Home Purchase Credit Score & DTI (S. Adj.)
Chart 12: Existing & Pending Home Sales
Chart 13: New Home Sales & Buyer Traffic
Sources: Refinitiv, MBA, NAR, C. Bureau, E. Mae, NAHB
Single-Family Market (Continued)
- Low inventory will also act as a constraint on sales. The existing home inventory has been close to record lows for a few months now, but the recent strength in new home sales has also tightened that market (14). Renewed lockdowns also pose a small risk to sales – the first round pushed sales in the Northeast down by more in comparison to the South (15). But, with home buyers and sellers now more comfortable with lockdowns, we doubt sales in the South will match the Northeast decline. (See Update.)
- The tightening in the new home market is good news for housing starts. Indeed, single-family building permits have already returned to mid-2019 levels (16). With inventory set to stay low, and solid demand for single-family homes, starts are set for a decent rise over the next couple of years. Homebuilders feel the same way, with the NAHB measure of confidence recovering to close to pre-COVID levels (17).
- House price growth has slowed. Annual growth on the Case-Shiller and FHFA indices slowed to 4.5% and 4.9% respectively in May. Price growth is set to slow further, but house price falls should be avoided (18). The reported homeownership rate surged to 68.2% in the second quarter (19). But the virus disrupted data collection, and we suspect the true rate saw no increase. (See Update.)
Chart 14: Months’ Supply Homes for Sale
Chart 15: Total Home Sales (Index, Jan-19=100)
Chart 16: SF Starts & Building Permits (000s Ann.)
Chart 17: NAHB Conf. & Housing Starts
Chart 18: House Prices (% y/y)
Chart 19: Homeownership Rate (S. Adj., %)
Sources: Refinitiv, C. Bureau, C-Shiller, FHFA, NAR, NAHB
- The hit to employment from the coronavirus has, not surprisingly, impacted younger Americans to a greater extent. Employment for 20 to 34-year olds has fallen 13% since February, compared to an 10% fall in employment for all age groups (20). That will weigh on rental demand. That said, issues with data collection means we don’t believe the Census Bureau data that the number of rental households collapsed by 3 million in the year to the second quarter (21).
- That also means we don’t accept the MF rental vacancy rate dropped to a five-year low of 7.2%. Indeed, alternative data from REIS has shown a small rise since the arrival of the coronavirus (22). That is mainly a reflection of the fact that no one could move. Indeed, the net absorption rate saw a sharp drop in the second quarter, and that implies vacancy rates will edge up over the remainder of the year (23).
- Lower rental demand, and increased demand for homes in the suburbs suggest multifamily starts will fall back over the next few years. That said, multifamily building permits have held-up over the past couple of months (24). The sharp rise in unemployment and fall in absorption have also started to put downward pressure on rental growth. Growth on the CPI measure fell to a six-year low 3.2% y/y in June (25).
Chart 20: Employment by Age (Index, Jan-15=100)
Chart 21: Rental Households (Change y/y, Millions)
Chart 22: Rental Vacancy Rates (%)
Chart 23: REIS Net Absorption Rate (%)
Chart 24: MF Building Permits & Starts (000s)
Chart 25: Rental Growth (% y/y)
Sources: Refinitiv, REIS, C. Bureau, Zillow, C.E.
Multifamily Market (Continued)
- Based on the Zillow Observed Rent Index, rents in the major metros are still higher than they were at the start of the year (26). But a move away from cities may pose a risk to rents in large cities. As yet, COVID has not led to an appreciable rise in rental arrears (27). But, if not replaced by additional support, the recent expiration of enhanced unemployment insurance at the end of last week poses a risk to arrears.
- As the economy has recovered, rent expectations have ticked-up (28). Nevertheless, they are still low by past standards, which implies rent negotiations will remain challenging. Record low risk-free interest rates will provide some support to valuations, which helps explain the relatively small rise in the NOI yield on the MSCI measure to 4.19% in the second quarter of 2020 (29).
- We expect yields will rise further in the third quarter, to around 4.4%, which implies a drop in capital values of around 8% y/y (30). Apartment REIT valuations have fared poorly compared to single-family REITs and homebuilder share prices (31). That may be a sign that investors are wary about COVIDs impact on the attractiveness of city living.
Chart 26: Zillow Rent Growth (% Chg. Jan-20 to Jun-20)
Chart 27: Rent Fully or Partially Paid by Month End (%)
Chart 28: Rent Growth Expectations Next 12-Mths (%)
Chart 29: MSCI Apt. NOI Yield (%)
Chart 30: Apartment Returns Breakdown (%)
Chart 31: REIT & Builder Price (Index, Jan-20=100)
Sources: Refinitiv, NMHC, F.Mae, MSCI, NAREIT, C.E.
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 ($)
Homebuilding and Supply
Multifamily Building Permits (000s Ann.)
Multifamily Starts (000s Ann.)
Multifamily Current Conditions (% Bal.)
Apartment Rental Vacancy Rate (%)
NAREIT Apartment Index ($)
Matthew Pointon, Property Economist, firstname.lastname@example.org