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Housing Plateau: Bad Omen or Just a Pause?

Jason Stipp
Robert Johnson, CFA

Jason Stipp: I'm Jason Stipp for Morningstar. Housing has been a bright spot for the U.S. economy, but the data recently showed signs of plateauing. Is this just a pause or a bad omen? Here to offer his insights is Morningstar's director of economic analysis, Bob Johnson.

Bob, thanks for joining me.

Bob Johnson: Great to be here today.

Stipp: Let's talk about the data first. What has the data been showing us? What are the recent trends?

Johnson: Certainly, pricing has been one of the pieces of data that's been plateauing, albeit at a good number, and I think we're probably in a little bit of a goldilocks situation there. This week we got the Case-Shiller data for the 20 cities, and their data showed that home prices were again up about 12% year over year, which is really a good number to see. Even the more conservative FHFA data on a year-over-year basis, which always lags far behind, was showing year-over-year growth of 8% which is actually is a little bit of an acceleration for that index.

In terms of pricing, it's very interesting. A lot of the improvement is concentrated on the West Coast. Both the Pacific region, which includes everything that touches the Pacific Ocean, and the next region over, which includes Nevada and Arizona, the mountain area, so to speak, were both up in double digits; the Pacific up 21%. But the other seven regions of the country were all in single digits. It is kind of a little bit of a biased number in some of the pricing data that more of its happening along the West Coast than anywhere else.

We've also had data this week on new-home sales, which were a little bit better than the previous month, but still below their high of last April, so we're still kind of doing OK, but not accelerating there.

Then finally, we got existing-home sales which did wonderfully. We set a new recovery high; 5.48 million existing homes sold. It's the best number since 2007, kind of a broad-based improvement.

Stipp: Let's talk about some of the short-term drivers that might be affecting these numbers and also some of the short-term factors that are out there that could affect us in the next few months to come. The first one is interest rate. When the Fed first started talking about tapering in May, we did see interest rates go up pretty dramatically and pretty quickly.

Then recently the Fed has said they're not going to do it quite yet. How has this rippled through to the housing market?

Johnson: It went through and boosted the 10-year bond, and mortgages are priced off of the 10-year U.S.-government bond. The rates are very tightly intertwined, and mortgage rates are now in the kind of the 4.5% to 5.0% range after being in the 3.5% range or so. So they went up a lot. But to put that in perspective, in 1981 when I graduated from school, rates were 15% or 16%. When the major housing boom was going on in 2004, 2007, interest rates were in the 6% to 8% range. Clearly, we've moved higher in terms of mortgage rates. It dislocated a few people looking [to finance a home] right now that had very tight budgets. On the other hand, as my associate Dave Sekera points out, this is barely a blip on the radar screen--the amount that interest rates have gone up. People will adjust and, I think, come back, and that's why homebuilders remain so optimistic.

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Stipp: We have seen an effect on existing-home sales versus new-home sales because people wanted to try to lock in rates while they were lower or they were afraid that rates would get away from them?

Johnson: As I mentioned, new-home sales, which take a while to close, are really kind of in the doldrums, and they're kind of off of their peaks by quite a bit. Meanwhile, the homes that you can close on quickly, the ones that are existing homes, are at a recovery high, and frankly, a little bit of an unsustainable number. The number was really good at that 5.48 million. We had been averaging more in the 5 million range for some time. It really was quite a big monthly jump in that category. And again, I think it is because people rush to close.

Stipp: We're seeing people jump off the fence when they were worried that rates would go higher. Now that the Fed has said they're not actually going to start tapering and rates did come back down a little bit, do you think we'll see even more people come off the fence so that could actually give a little boost?

Johnson: Yes, and I almost wonder secretly if that was one of their intents because now with the rates back about 0.3% or whatever, everybody says, "Oh, I missed the last time; I'm not missing this time." And I think there's going to be a certain element of that. I think that could help sales again in a couple of months. To have a low rate lock in July is a big deal because that's when a lot of the housing activity occurs. In September, October, people are little less active in the housing market.

Stipp: Let's talk about some other things that you had worried about in the housing market, and that was specifically shortages. That is shortages of supplies, but also a shortage of inventory; quality inventory of homes that people wanted to buy, which is one of the reasons prices had been going up for a while. What are those situations looking like now?

Johnson: The inventories of actual homes are still relatively muted. New homes are a little better. I got really excited about that, in fact, because inventories are up about 18% year over year. But when you look at a monthly sales rate, it's barely moved because more homes are selling, too.

The other thing going on with new-home inventory is that, unfortunately, most of the inventory stuff at the very, very beginning of the pipeline, it is homes where the builder has the lot and has a plan, but hasn't even started working on the homes yet.

The number of homes actually available for you to walk-in and say, "I want that one, and I want it today," is actually down from a year ago, surprisingly. The inventory numbers on the surface for new homes look good. Unfortunately, it's at the stage of production that it can't close in a hurry. On existing homes, inventories are a little bit higher than they were, but they are still depressed and still holding things back.

Stipp: For new construction, what about supply shortages? Is that an issue that's causing not to be able to build as fast as they would want?

Johnson: I think we're doing a little bit better on that front right now. I think we've seen lumber prices kind of come in a little bit. There seems to be fewer shortage of goods; people have ramped up a little bit on production lines. So there aren't as many shortages; they certainly aren't overbuilding, that's for sure. But I think we've seen a little better news on that front. On the labor supply, I think we're still running a little tight.

Stipp: Are there any backlogs in permits, the permit needed before you can build a house?

Johnson: Permits are running right at the level that housing starts are running, and you need a permit in most states before you can do a start. And it's usually like a month lead time, maybe a couple of months. There's a few states, a few parts of Texas, for example, where you don't need a permit. The number is a little bit fishy. But in any case, permits right now are running at the same level as starts, so it doesn't indicate a rapid acceleration at this point in time.

Stipp: What about lending? Is it getting easier to get a mortgage?

Johnson: For many times here we sat and talked, and it was actually even into a few months ago that the bankers were actually saying it was getting tighter of all things, especially on some of the lower-grade mortgages. I think some of that's begun to break up a little bit. I think there's some news out of J.P. Morgan and some others that maybe lending might become a little bit more favorable. That's still been a big hang-up.

Stipp: Something else you mentioned is who is actually buying a lot of these homes that are being sold, and in some cases it's not individuals, but it's investors. What does that imply about the health of the housing market right now?

Johnson: From a standpoint when there are a lot of foreclosures on the market, we've really welcomed all these business-investment-type and consortium-type, people that were coming in and buying a dozen or couple of dozen homes in an area and then refurbishing and maybe flipping them out. But they really did become a substantial part of the market.

Really the normal, "I'm having a child, I need a home, I need to move up" type of buyer really isn't as robust as maybe some of the numbers would indicate. I mean, some of the numbers are up in transaction values 20%-25% year over year, but it probably isn't quite as strong as that because a lot of the demand that's out there is people just fixing up the homes.

Stipp: That demand might be a smaller group of people and that demand could be removed if…

Johnson: It could be removed in a hurry.

Stipp: We've talked about some of the short-term things that are affecting the housing market, and it looks like on both sides of the ledger there are some headwinds and some tailwinds. Let's keep our eye on the long term, which is always the most important thing. You have some reasons for long-term optimism and also some long-term risks that you'd like to lay out for us. The first one, an optimism, has to do with the population and the demographics. What do those suggest about the long-term runway for housing?

Johnson: Well, there's both some good news and some bad news there. I think people put off buying houses. People had a lot of, what we call here at Morningstar, optionality in their 20s whether they buy, whether they rent, or whether they live at home. But once you kind of have that child, or at least when that child needs to go to a school, you really want to be in maybe a home instead of a more temporary arrangement.

I think we're getting at a point now we're seeing more and more people reaching that age where they say, "If I have to rent out my old place to get the other one or whatever, my back is against the wall." I think we're reaching that demographic, and I think that's why some of the numbers have gotten better.

Stipp: As far as the current population, is there anything keeping them back from the normal kind of home-ownership rates we had seen in the past?

Johnson: Well, certainly people remember that they've lost money on a home. Certainly, there's a young-persons segment that says, "I need the mobility because for my job I've seen all the people get tied down to an area and then not be able to find a job." I think there's less interest, especially on young people, to own a home. I think when you are more established, I think that demand is there as always. I think a lot of surveys would indicate that, but I think that group in the 20 to 30s is much more tight about buying a home than they used to be.

Stipp: What about the general U.S. population growth?

Johnson: That should help. Growth isn't want it once was, but we're still growing, and so that should help housing demand. In fact, just on population we would think you could get 1.1 million housing starts, and then if you count the things that blow over or flood it out or whatever and natural wear and tear, you'd expect the need for about 1.5 million housing starts in a given year. And we're not anywhere near that number right now. We've all been optimistic long term. I've been actually little cautious last three to six months because of the shortages and tight lending conditions. But now I'm thinking we've experienced the higher interest rates, we've got through most of the bottlenecks, and now I think we're actually going to start to see some improvement in the housing market. It's kind of the wrong time of the year right now to really see it, but I think we may have seen the worst of this plateauing.

Stipp: All right, Bob. Well, thanks for the insights, both short term and long term on the housing market and for joining me today.

Johnson: Thank you.

Stipp: For Morningstar, I'm Jason Stipp. Thanks for watching.