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Housing Has Plenty of Room to Build

Jeremy Glaser
Robert Johnson, CFA

Jeremy Glaser: For Morningstar I'm Jeremy Glaser. What's holding back the real estate market? I'm here today with Bob Johnson, our director of economic analysis, for his take.

Bob, thanks for joining me.

Bob Johnson: Great to be here, today.

Glaser: We've seen over the last couple years that housing has been one of the big stories in driving the economic recovery or some hopes that housing will start to look better. But we've seen some kind of mixed data recently. What do you think is holding back the market from truly looking a lot better? What are some of the big factors there?

Johnson: I think the biggest factor overall is credit, both on the buyer side and on the builder side. I think the consumer gets a lot of attention, but the builder side is just equally as important.

And let me start though with the consumer side. Credit has been tight. Banks have new rules about the capital they have in place. The riskier the capital, the more capital they have to put up. They have to say that they moved people through to the process and checked all of these things in a checklist. If they haven't then the mortgage companies have the right to push it back to the banks and say, "This loan is yours; it's gone bad." And on top of it, the rates that they can charge aren't very high, even compared with the practically zero interest they are paying on their certificates of deposit. It's still not a wide spread. Certainly not a wide enough one to want to make them want to go crazy and do a lot of new mortgage lending.

Glaser: What does the consumer credit picture look like now versus the darkest days of financial crisis in 2009?

Johnson: Great question. One of the ways that we can take a look and see how tight the banks are is look at the FICO score on an average approved mortgage. And FICO is a measurement standard for credit, and it generally ranges from the low 100s up to a number as high as 800. And certainly something over 700 is usually considered pretty creditworthy and something under 600 you probably can't have any hope of getting any kind of loan. And so right now, those FICO scores had been relatively flat since 2009

At the very worst moment of the recession, the average FICO score on an approved mortgage was 760 and at some point in 2013, we were still at about that same 760 level. The last couple of months we've gotten a little better on that number. But we're still drastically above kind of the low 700s where we were in the middle of the housing boom. We've got still relatively tight credit conditions for consumers.

Glaser: The consumers are having trouble getting a loan. How about the homebuilders? They need loans to get these homes up.

Johnson: Exactly.

Glaser: What's happening in that front?

Johnson: The big homebuilders don’t have a problem with capital. I mean they have got many sources. They can go to the bond market and issue junk bonds, or they can go to banks in some cases and get loans on a secured basis. They have got a lot of options. The small builder that’s building one house and has to go to his bank is probably going to have a very hard time to get a loan for his building.

Certainly some of them went through some rough times in 2008 and 2009. That’s going to put a black mark against them if they didn’t do very well during that period or they had to put a couple of houses back to the bank. That will certainly turn up in the record and make it hard for them to get loans. I think that that’s going to be a continuing and ongoing problem.

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Glaser: You need workers to build those new homes, as well, after you get the loan. You have spoken in the past about skilled labor shortage. Even with unemployment where it is now is that still a problem actually finding people to work?

Johnson: You know, it still is. Surprisingly when we listen to some of the conference calls of some of the builders, they are still talking about, "With the really skilled guys, we got to fight for them with everybody else, and sometimes we have wait and shuffle and maybe we change our processes a little bit to maximize the use of these people."

But clearly as the population has aged and there have been fewer people who have these skills and many of the people who were in the housing market are now into things like health care and other things and don’t ever want to see the construction market again because of its volatility--it's made it very hard to really get an adequate labor force to really gear up.

Glaser: Looking at that new-home market again, you need land to build these on. Has that been a challenge--acquiring the land to get the permits to build these new homes? Has that been a factor?

Johnson: Some of the bigger companies in some of the far-out locations, they were able to revive a few projects there and get a little bit of land. But more people want to leave closer to the city these days and it's a long haul to get land approved, zoned, tracts, all the stuff you need to take off. And there is probably not enough available land to really long term meet all the demand that’s out there, especially as you get in a city.

Glaser: Low inventories have been an issue; there is just nothing to buy. Have inventories started to look better? How much of a factor is that?

Johnson: Inventories have started to look better, and we've gone up now. We're up year over year in inventories especially on existing homes. So we've certainly crossed the road there, and we've always said that four to six months of supply on hand is pretty healthy. And we were getting down in the 4s, and now the last month there was 5.2 in terms of months of supply. So the optimal number is probably something a little closer to 6, but we're certainly moving in the right direction. But if you shop in some markets, there just is nothing available, especially in the lower price points. You may find next to nothing or what you do will be a total dump.

That said, one of things as I talked to some of the people in real estate--and it's across several markets, high and low in different cities--it seems that what's happening is if you've got to sell because you're moving or somebody's passed away and you have to put it on the market. You put it on the market, and the buyer seemed to be there. If it's priced right and it's in a halfway clean condition, it kind of moves out and disappears in a hurry.

But it isn't likely that all of these buyers are clamoring there, or there is a ton of inventory coming on the market. It's just both sides kind of laying in the weeds and nobody's really transacting unless they absolutely have to.

Glaser: You mentioned price there; you mentioned at the top of the video that tight credit was one of the big factors. Are higher housing prices also having an impact? How does affordability work into this equation, as well?

Johnson: The standard affordability calculations show that homes are a lot less affordable than they were at the bottom. Those are all skewed a little bit, which brings up an interesting point. One of the things that's keeping the markets slow, especially the existing homes and why we're down so much year over year in terms of existing-home sales is because there's no foreclosures anymore.

Those were cheap houses that moved in a hurry, and when they did the affordability calculations, they took the median price of the house. And that included a lot of low-end homes. So it wasn't really a true measure. It looked like homes were really cheap, but all it meant was there were a lot of low-priced homes moving through the system.

Nevertheless, with home prices more carefully calculated, it would still show that affordability has gone down. Prices off the bottom are generally 20% or more up. So houses are not as affordable as they once were.

Glaser: The lack of foreclosures could be a problem, as well.

Johnson: Absolutely. There just isn't any of them available right now, and that's really kind of holding things back because that was one of the real sources were a first-time buyer might have a shot at a home. And now not so much.

Glaser: Over the long term, are all these issues we've discussed really just transitory and that you think that they will turn around? Or are there some structural issues here that will keep housing as a smaller part of GDP.

Johnson: Well, I've really spun on a short-term tale of woe here a little bit, and I want to be careful here because I do really think there's still more opportunities in the housing market. We were over 2 million starts at one point in time when population growth was really not all that much different than what it is today. We probably overbuilt, but certainly I think we can get back to 1.5 million homes at some point. I think that as a percent of GDP, we can go higher. We're running at about 3%, I think we can get to 5%-7%.

I think there's room for optimism there, and I think some of its just people have a lot more of optionality, especially people in their 20s who maybe thought about buying before and are now renting instead. And we've seen a big boom in multifamily homes. Single-family homes have not done as well. Single-family home sales from the new-home sales report last week were barely off the bottom.

Glaser: What would you be looking for then as a sign that housing market has really shaken off these woes and is ready to do better?

Johnson: Like I said, we've got these great long-term statistics that suggest the housing market has got a lot of room to run in front of it. The numbers the last few months have been terrible. Some of it has been weather; some it's been affordability and all the other issues that we've talked about today. But when you really look at it, I think some of the numbers are already starting to look better.

Existing-home sales this month were relatively flat with the previous month, and they've gone down from 5.4 million to 4.6 million units since last summer. So it's been a pretty dramatic and steady fall, and now we've finally seen a month of stabilization.

Housing starts are kind of a similar thing. They had been coming down for a long time and permits even more before that. Well, now what's happened, the actual number of permits is now running higher than the number of starts, which almost means definitionally that you have to come back up [in terms of housing starts] unless somebody has pulled a permit for a home and then said they are not building it after all, which is very rare.

I would think that we've probably seen the bottom in both markets. So I continue to watch that permits data very closely. Certainly, we always talk about employment. As long as employment stays relatively high--we add the 200,000 jobs a month that we've been seeing--I think that's support of a much stronger housing market longer term.

Glaser: Bob, thanks for your analysis today.

Johnson: Great to be here.

Glaser: For Morningstar, I'm Jeremy Glaser.