Home prices remain firm with the Case/Shiller National Index up 11.3% and CoreLogic’s 12.2% when February 2014 is compared to February 2013. But by all other metrics housing activity remains weak. Existing home sales and housing starts have been slowing since late summer. Economists are almost universal in blaming high mortgage rates (4.32%), however, the National Association of Realtors (NAR) Affordability Index for all purchasers has declined but remains well-above the levels prior to 2009. Beginning after the bottom in 2010, individual and institutional investors purchased distressed homes in quantity, driving up prices of all single family homes. Mortgage rates did begin to rise in June 2013, but it was a combination of rapid price increases, low inventory, and reduced family income growth that slowed consumer home purchases, particularly for first time buyers. Investors have withdrawn from the existing home market as current homeowners and first time homebuyers have not filled the void. From 4Q2012 to 4Q2013 the NAR Affordability Index for First Time Homebuyers fell 17.2% as mortgage rates rose from 3.5% to 4.43% and house prices increased 10%, while incomes rose only 2%.
Past housing recessions have been followed by a sharp snapback in housing starts. Seasonally adjusted single family housing starts for March 2014, although rising 2.8% above the March 2013 level, totaled only 635,000, well-below the 1.823 million record reported in January 2006. But it has been the anemic increase in starts over the past five years that differs from previous housing recoveries. Depression levels of housing inventory and rapid price deterioration brought in large institutional investors and foreign purchasers not seen in previous housing cycles. Today despite a housing shortage, starts of single family homes remain 65% below the levels of the late-1990’s – 2006, Compounding the problem, new financial regulations have limited starts by making it more difficult for homebuilders to obtain construction loans. The availability of skilled construction workers also has been cited as a drag on new housing. Previous owners of distressed sales are now renters of investor-owned properties. The huge supply of rental units will gradually work its way onto the market, but in our opinion, further into the cycle.
There are a number of factors currently working to narrow the supply/demand gap in housing. The pent-up demand for single family housing will be met by easing regulations and an improving economy. Among these are:
Thawing of the credit freeze. Mortgage lenders are beginning to ease lending standards. Although remaining tight by historical measures, lenders have begun to accept lower credit scores and down payments. Last week TD Bank lowered minimum down payment requirements to 3%, targeting the elite first time homebuyers. This trend will accelerate as lenders seek to replace income from dwindling refinancing.
The upgrade cycle gains traction. According to RealtyTrac, 9.9 million properties have equity over 50% in 1Q2014, up from 9.1 million in 4Q2013. An additional 8.5 million were hovering around positive equity, up from 8.3 million in 4Q2013. In 1Q2014 there were 9.1 million homes, or 17% seriously underwater (combined loan amount minimum of 25% higher than the home market value), down from 29% in 1Q2012 when RealtyTrac began its survey. The potential for a serious upgrade cycle and a downsizing cycle for aging baby boomers exists as the overall economy improves.
A broadening of employment. While the lackluster gains in employment (2.5 million jobs annually) garner all the headlines, the breadth of the decline in unemployment levels should help the national housing market. According the Bureau of Labor Statistics, in March 2014 nonfarm payrolls increased in 34 states. In the 12 months ended March 2014, employment increased in 45 states with only 15 states having rates higher than the national average 6.7%. A gradual improvement in jobs should reduce uncertainty for real estate affordability across a broad spectrum of potential home purchasers.
Consumers have deleveraged but continue to face headwinds from Obamacare and most recently, repair bills from winter. While overall inflation remains low, higher fuel and food costs hit the middle income consumer at the margin. On a brighter note there are signs of wage increases for non-supervisory employees and with the wealth affect from stock appreciation and home prices, prudent credit expansion is a possibility. An unencumbered economy growing at 3% has many options to seek out a course of growth, sharing its spoils with investors and consumers.
Our investment policy remains long-term optimistic on corporate equities. The recent stock market sell-off of momentum stocks cannot be characterized as a definable correction, but is healthy for the long term. Contrary to most strategists, we believe that continued economic growth, accompanied by rising real interest rates, will result in a multiple expansion for equities.
Hutchens Investment Management
Hutchens Investment Management