Headwinds for Housing Overall, but Some Markets are Hot -Freddie Mac

As a rule, it isn't good when economists use words like "sluggish" and "lackluster," the very terms that crept into the opening paragraph of Freddie Mac's June 2014 U.S. Economic & Housing Market Outlook.  Billed as a "mid-year assessment" the report by Freddie Mac's chief economist Frank E. Nothaft and deputy chief Leonard Kiefer said that the year had started out as far more sluggish than they had anticipated.  Existing home sales have slipped 7 percent compared to the same period in 2013 and new home sales are off 3 percent.  They first applied the word lackluster to housing construction although it wasn't the only time they used it.  Building permits and housing starts were both lower in the first four months of this year than last.

There was a bright spot in construction, multifamily rentals.  Starts for units in buildings with five or more jumped 15 percent in the first four months of the year compared to 2013 and vacancies dipped to 4.0 percent, a decline of 4 basis points from the first quarter of 2013 and the lowest recorded by the Reis survey since 2000.

While the economists expect a 3 percent growth in the GDP over the next few quarters the dismal showing in the first quarter will probably bring the year overall down to 2.0 to 2.5 percent, partially because of the "lackluster" housing activity.  Residential fixed investment declined by an annualized 5.0 percent in the first quarter compared to 2013 when it contributed 0.33 percent to overall GDP growth.

Employment news is a bit better with unemployment down from 6.7 percent in January to 6.3 percent.  Non-farm payrolls increased by 217,000 in May, exceeding the pre-recession peak for the first time construction jobs are picking up, especially in the residential building and specialty trade sector. Increased job growth will help to boost household formation, which has been lagging throughout the recovery. In the long run, household formations are almost entirely driven by demographics, but in the short run job and income growth are critical.

Home price and rent increases have moderated and Nothaft and Kiefer view that as good news, a move toward more stable and sustainable gains.  The 9.3 percent growth of the Freddie Mac House Price Index in 2013 is expected to slow to 5.0 percent this year.  Rents will likely continue to rise by about 3.0 to 3.5 percent over the next year.

The economists are lowering their overall home sales forecast for the year from 5.5 million to 5.4 million, 0.1 million below the 2013 pace.  Inventories of available homes remain limited in some markets because existing homes remain underwater or because potential sellers are unwilling to give up the low interest rates they gained through recent refinancing.  Purchase mortgage applications have increased a bit recently but are running 13 percent below the pace last year.

The year-over-year decline in mortgage applications was primarily the result of interest rates which spiked last June and triggered a rapid drop in refinance originations and stunted the purchase market.  Rates have gradually come down from the high of 4.58 percent reached in late August and Freddie Mac sees them likely to remain near current levels of 4.25 percent but not for long.  As the Fed tapers its purchases of long-term mortgage-backed securities and economic growth picks up, fixed-rates may approach 5 percent by this time next year.  

Home sales are likely to be slightly lower this year. Inventory of for-sale homes remains limited in some markets as many sellers remain underwater or prefer to keep the very low-rate mortgage they refinanced into, holding back a full recovery in the overall sales market. Home purchase applications have picked-up a bit recently yet they're still currently 13 percent below last year and Freddie Mac is lowering its overall homes sales forecast from the same 5.5 million sales as last year to 5.4 million.

The limited inventory in many markets will help sustain house price and rent growth but affordability may suffer.   The inventory is extremely tight on the west coast and Texas and Louisiana but the market is not as tight in the southeast.

(bigger circles = more homes for sale.  The color of the circle corresponds to the percentage of homes for sale per total in the area.  In other words, the RED side of the spectrum connotes tight inventory.  The BLUE side connotes too much inventory).

Vacancy rates remain high by historic standards but continue to decline.  The homeowner vacancy rate stood at 2.6 percent in the first quarter of 2010 but at 2.0 in the first quarter of this year.   During the same period the total number of vacant units (homeowner and rental) decreased by 4.2 percent and the number of vacant units for sale by 24.2 percent.

Nothaft and Kiefer attribute the low for-sale inventory to several factors including the reluctance of owners to give up existing low interest rates.   REO sales have been trending lower as lenders and homeowners have made more frequent use of alternatives such as loan modifications and short sales.  Short sales however have been sharply curtailed since Congress allowed the Mortgage Debt Forgiveness Act to expire at the end of last year although rising homes prices and interest rates have also played a role.   CoreLogic puts the share of home sales attributable to short sales at 1 percent in March compared to 9 percent in December 2012.

Rental market conditions have continued to tighten as well. The Census Bureau puts vacancies at an average of 8.4 percent nationwide over the last four quarters, the lowest such average in 14 years. The National Multifamily Housing Council's Market Tightness Index was up considerably in April compared with three months earlier indicating that property managers in most metro areas have experienced lower vacancy rates and/or higher rent increases. Reis reported that effective rents were up 3.2 percent during the first quarter compared with a year earlier, and the Bureau of Labor Statistics' residential rent index was up 2.9 percent over the first four months of 2014 compared with a year ago; both increases outpace overall consumer price inflation.

With vacancy rates moving back in line with historical averages and for-sale inventories remaining tight it is likely that the home price indices will continue above inflation growth for the rest of 2014 although at a slower pace than last year. Rents will also rise faster than inflation but new construction coming on line will slow those gains. The important question is how much further will prices and rents have to rise to give incentives for more existing owners to list their property for sale and developers to bring more supply to the market. Construction has rebounded over the past two years but is still significantly below the levels one would expect to see given projections of household formations.