9 Reasons Why the Housing Market Risks Hitting a Perfect Storm

via marketwatch:

We believe the housing industry is at risk to face a perfect storm.

Demand

1. The rate of household formation remains consistently below its long-term trend of 1.2 million a year. Several factors account for this. The U.S. birthrate has been declining for years and presently stands at a 30-year low. The number of births in 2017 (latest available) slipped to 3.85 million, the lowest since 1987. One consequence of fewer newborns is that it reduces the demand for single-family homes.

A second factor are the new limits the White House placed on immigration into the U.S. The number of immigrants receiving green cards fell 5% in 2017 (to 1.127 million) from the year before. The administration’s goal is to slash legal immigration by half. Keep in mind that immigration has historically contributed more than 50% of this country’s population growth. If you substantially restrict foreign entry into the U.S., you remove another important source of home buying.

2. With baby boomers retiring at a rate of 10,000 a day, one would look to the millennial generation as the next wave of demand for homeownership. But many in this cohort are incapable of making such a financial commitment. They are burdened with a record $1.6 trillion in college debt. And “serious delinquencies” (those at least 90 days overdue or in default) of student debt topped a record $166 billion in the final quarter of 2018.

Read: America’s $1.5 trillion student-loan industry is a ‘failed social experiment’

Millennials are also skeptical about the future solvency of Social Security and Medicare and so feel added pressure to save more of their income for retirement, rather than for a down payment to buy a house or condo.

More difficult to measure is the psychological impact the Great Recession (2008-2009) had on millennials. They witnessed many of their friends and families lose homes or declare bankruptcy, and watched how the steep economic downturn eviscerated the long held dogma that real-estate values can forever defy gravity.

3. The 2017 Tax Act also increases the after-tax cost of homeownership, especially in regions of the country where residents face high state and local taxes. Prospective home buyers have since recalculated the cost of homeownership versus renting.

Read: This is how your life changes when you become a homeowner

4. With household debt reaching an all-time high of $13.5 trillion and interest rates rising the last three years, lenders have also turned more cautious about granting credit to households, according to the Federal Reserve’s Senior Loan Officer Survey on Banking.

5. The average low rate of 4.50% last year on a 30-year conventional mortgage was not enough of a catalyst to spur much home buying, especially for existing units. With the Fed now declaring a pause on further hikes in short-term rates, mortgage rates have dropped to 4.34% this week, which is the lowest in a year. That rate will certainly drop further in the next few days now that Treasury yieldsTMUBMUSD10Y, +1.14% have plummeted to a 14-year low Friday morning, and this could entice more prospective home buyers to get off the fence and act.

Read: Housing market is tipping in favor of buyers, real-estate agents say

But there are two offsets to consider. If the economy is markedly weakening, as the Fed’s downward revisions to growth show, Americans may instead choose to back away from such a major purchase until they feel more confident the U.S. is not heading into recession. That is especially the case now that 3-month-to-10-year Treasury yield curve inverted.

Read: Ignore the yield curve because the economy’s fundamentals are fine, top forecaster says

Secondly, we believe the current low mortgage rate is just not sustainable. Borrowing rates to purchase a home are closely tied to the 10-year Treasury yield. We’re projecting the T-note yield will climb about 100 basis points over the next year and a half. What would be driving this surge?

Simple. The U.S. will need to lure U.S. and foreign investors to fund trillion-dollar budget deficits every year for perhaps the next decade. The problem is global investors are already top-heavy owning dollar-denominated assets. In fact, foreign investors have begun shedding U.S. government debt from their portfolio in recent years. The percentage of U.S. federal debt held by foreigners has fallen from 53% in 2009 to 41% last year.

What this suggests is that investors will demand a more attractive return (i.e., higher yield) that is commensurate with the risk of carrying an excessive amount of new U.S. debt on their portfolios. Stated another way, the Treasury department will pay whatever rate the market demands in order to successfully unload an unprecedented volume of new debt issuances. Our forecast thus calls for the 10-year Treasury yield to climb over the next 18 months, and that could lift the 30-year mortgage rate to 6% or more by the second half of 2020.

Supply

Aside from the challenges home buyers face, builders have hurdles of their own to overcome.

1. The current tariffs on imports and the retaliatory actions by our trading partners have significantly raised the cost of building a home. The price of steel mill products, softwood lumber, aluminum mill shapes, and plywood have jumped 20% to 30% in the past year.

2. Home builders still face a plethora of regulations, which account for 25% of the cost of constructing a home.

3. Finding skilled labor has become especially difficult in this tight labor market. After the housing bubble and credit crisis of 2007-2009, many construction workers found more secure and even-better-paying jobs in the growing shale oil/gas industry. As a result, home builders have had little choice but to lure new hires by offering higher compensation. Others have resorted to investing more in robotic technology to offset the scarcity of workers.

4. Finally, there’s a shortage of suitable land in key cities. What lots are available have skyrocketed in price, but that ultimately reduces the affordability of purchasing a newly built home, especially for entry-level buyers.

 

 

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