Labor Market Improvement Bodes Well for Housing

The estimate from the Bureau of Economic Analysis (BEA) of sharply improved economic growth in the second quarter is good news for the housing market Freddie Mac's lead economists said today.  The advance BEA report puts GDP growth at 4.0 percent in the second quarter compared to -2.1 percent in the first while Freddie Mac forecasts continued improvement in economic growth with an average of 3.3 percent in 2015 and a continued decline in unemployment.

Chief Economist Frank E. Nothaft and Deputy Chief Leonard Kiefer see household formations picking up and projects housing starts will increase 28 percent over the 2014 rate to 1.3 million units in 2015.  Long-term interest rates will likely move up with 30-year fixed-rate mortgages at about 5 percent by the end of next year.

The economists say one concern is the underperformance of the single-family housing markets over the last several years.  The single-family markets slowed after rates began to increase in mid-2013 and while both housing starts and sales moved higher in the second quarter of 2014 this shows at best they say that the housing market is very fragile.

The path forward is for a housing market driven by fundamentals.  Nothaft and Kiefer say jobs are a fundamental driver and with the employment sector picking up steam, more and better jobs should lead to greater housing demand.  The strongest housing markets today are those with the strongest labor statistics.  As the labor market expands it will stimulate housing by driving household formations and housing demands in more markets.

Household formation however is still a concern.  Tdoubling up he Census Bureau reported net household formations over the last four quarters of 458,000 where long-term projections expect 1.2 to 1.3 million a year.  This slow formation has led to and a rise in the number of persons per household - from 2.69 persons in 2005 to 2.76 persons, an increase of 2.6 percent.  If the persons per household had held steady over that period there would be 3 million more households today. 

Those 3 million "missing" households will probably show up over the next few years, especially if the labor market continues to improve, but we don't know if the single-family housing market will be the beneficiary. The Census Bureau also reported that over the last four quarters while the number of homeowners was essentially unchanged the number of renter households increased by 458,000. Maybe the new households all want to become renters.  Historically we know that most will at least start out that way.  

Rental market vacancy rates are at the lowest levels in over 14 years. And while aggregate vacancy rates for single-family properties remain elevated there are tight for-sale inventories in many parts of the country.  Over time, the majority of those additional renter households will likely transition to homeownership. Millennials as a whole have formed households and married at older ages than prior cohorts, and will likely transition to homeownership at an older age as well.

And when they decide to become homeowners, will they be able to afford to do so?  Right now the answer is yes as homebuyer affordability remains strong in most parts of the country.  Stronger economic growth and job creation will also boost family incomes and a 5 percent increase in income increases homebuyer affordability by 12 percent. 

Even as a stronger economy, more household formations, and increased rental demands puts upward pressure on single family house prices and rents, the ratio of mortgage payment to rent ratio for the U.S. which is about the lowest it has been in more than 35 years will remain relatively low.  One big change for families who want to transition to homeownership is amassing the funds for a down payment and closing costs.  A stronger economy should allow household savings to grow.

Affordability is also sensitive to interest rates and Freddie Mac expects that they will increase only slowly over the next 16 months as the Federal Reserve indicates they will continue their accommodative policy until the labor market fully improves.