One of the key indicators of U.S. economic health is housing - both the turnover of the existing housing stock and the construction of new units. Existing home sales, new home sales, and housing starts all peaked earlier this year. Given the health of the U.S. consumer, as vividly demonstrated in the employment and auto sales data, it is puzzling why the housing numbers now appear to be so anemic.
First Time Home Buyers
Pre-recession, it was normal for first time buyers to account for 40% of monthly existing home sales. These numbers have hovered around 30% in the post-recession period and were 31% in October. The normal demographic for first time buyers is the 25-34 age group. Over the past two years, this demographic has seen robust employment growth, with growth here faster than all of the other demographics combined. Household formation in this demographic, after languishing in the immediate post-recession period, has also been robust recently. Digging deeper, it is apparent that supply constraints are at least partly responsible for the first time home buyers' low participation rate in the existing home sales market:
- Homes available for sale currently represent about 5 months' supply, historically a very low level of inventory, with even tighter inventories of lower priced homes (those that first time buyers can afford).
- Distressed home sales (i.e., foreclosures or short-sales) are now back to 2006 levels, about one-third of the peak level of 2010. But because of the Fed's zero interest rate policy (ZIRP), investors who bargain hunted with cash during the peak of the foreclosure cycle remain heavily in the market, now looking for rental income to replace non-existent fixed income yield. In October, investors used cash to purchase a disproportionate share of October's sales (13%). First time home buyers are almost always cash constrained and are at a significant disadvantage to the cash investor in those lower end markets.
- Another anomaly arising from ZIRP is the unusual mix of new housing starts. In June, multifamily starts were 510 thousand (SAAR), a monthly level not seen since 1986. While total starts are anemic, the lack of supply of affordable starter homes is forcing many who would be first time buyers into the rental market which continues to be drum tight, and where rents are expected to continue to rise in 2016.
The Supply Issue
The above explains some of the demand dynamics in the home market itself, but doesn't explain languishing new supply (starts).
- In every market, there used to be both local and national developers. The recession took out countless numbers of small, local developers. Because many of those developers now have foreclosures or bankruptcies on their credit records, they simply can't return to the building business with any kind of volume.
- It takes many months, and in some markets years, for the "entitlements" to develop raw land to get through state and local government processes. In the run-up to the recession, there was significant overbuilding which resulted in excess supply. Thus, little new land development has occurred for several years. Now that affordable homes appear to be in short supply, the entitlement process may be a constraining factor.
- Recent new regulations, promulgated by Dodd-Frank's Consumer Czar, have added even more complexity, time, and expense to the mortgage process. Construction loans from small financial institutions to owner/builders have been virtually shut off by new regulations that went into effect on October 1. Large banks, which can deal more effectively with onerous regulations, have little interest in making loans to small businesses. Increased capital and liquidity requirements on the large banks have created a fragmented, inefficient lending environment. Funding has become scarce, and while new private sector entities are emerging, they are still in their infancy.
- Another issue is the time it now takes from application to close in a mortgage transaction. That has been lengthened significantly by the Czar's new regulations. The result is that the number of existing home sales (counted at closing) is likely to fall in Q4.
The recession did a lot of damage to the housing industry that we are still feeling today. Many local developers are gone; the oversupply of housing from the prior boom reduced the need for new land development, and now that there is a need, the entitlement dance significantly slows the process. New capital and liquidity regulations have muted large bank appetite for small business loans, and new consumer regulations have now taken small banks completely out of certain aspects of the construction game. At the same time, the Fed's ZIRP policy has brought cash investors into the market for low end (rental) homes, making it much harder for first time home buyers to successfully participate. So, when you hear how poorly the housing market is doing, you now know why. It is not for a lack of demand, but due to a significantly constrained supply and lack of available construction financing.
What does this mean for investors? The lack of supply for the existing demand means that national home builders, especially those that build entry level or move up homes, are likely to do well as long as the Fed's tightening moves don't significantly impact mortgage rates. It looks like those conditions will exist for much of 2016.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.