Friday, June 7, 2013

"The Housing Recovery: How Strong? How Long?" UCLA Anderson Forecast, June 2013


At long last a sustained housing recovery is now underway. Home prices are rising and housing starts have approximately doubled off of their depression lows of a few years ago. This scenario is very much in line with our forecast of one year ago. Nevertheless, the questions remain how strong will the recovery be? and how long will it last? In short, our answers are that housing starts will reach a run-rate in excess of 1.6 million units by mid-2015 and home prices will continue to rise, albeit not at the heady 9% rate of the past year. As a result the housing recovery will last until at least late 2015.

Specifically, we are forecasting that housing starts will increase from the 782,000 units recorded in 2012 to 1.03 million units and 1.35 million units in 2013 and 2014, respectively. For 2015 we are projecting housing starts to reach 1.56 million units. Along the way, multi-family housing starts will boom with an excess of 400,000 units a year being started in both 2014 and 2015.

Although this forecast may appear to be overly optimistic, against the long sweep of history it looks decidedly modest. (See Figure 1) For example, the modern era all-time low for housing starts of 554,000 units in 2009 was approximately half the recession lows reported over the period 1959-2012. Housing was truly in a depression, not a recession, from mid-2008 through the end of 2011.
Furthermore over the entire 1959-2012 time period housing starts averaged 1.47 million units a year, a level that we predict will not be exceeded until 2015. Remember that in 1959 the United States had a population of 180 million people, while today it approximates 315 million, a 75% increase. Thus it can be reasonably argued that, if anything, we are being too pessimistic.
Figure 1 Housing Starts, 1959Q1 – 2015Q4E   Sources: U.S. Department of Commerce and UCLA Anderson ForecastOur forecast is underpinned by the facts that house prices are now rising from a very low base and mortgage rates remain at historical lows. These two factors imply that ownership housing remains very affordable on a national basis and the rise in prices is gradually removing the deflationary fears that gripped the market only a few short years ago. (See Figures 2 and 3) We learned in 2010 that affordability alone is not sufficient to drive a rebound in housing starts.

To be sure the risk remains that the rise in mortgage rates we are forecasting to just under 6% in 2015 could choke off the rebound. Our sense is that with prices once again rising, a gradual rise in mortgage rates will act more as a motivator rather than as an inhibitor to potential homebuyers. Simply put, a sense of urgency will return to the market. Our view is buttressed by the fact that homebuyers are now being motivated to bid aggressively in the face of a lack of
Figure 2 Case-Shiller Home Price index, 2000 – March 2013, Monthly Data, 2000=100.
Source: Standard & Poor’s via Federal Reserve Bank of St. Louis.
Figure 3 30-Year Conventional Mortgage Rate, 2000Q1 – 2015Q4F

Figure 4 Existing Home Sales, 2000 -2015F
Sources: Freddie Mac and UCLA Anderson Forecast

Sources: National Association of Realtors and UCLA Anderson Forecast

inventory of existing homes. As prices rise, the amount of existing homes listed for sale will increase and home sales are forecasted to increase from 4.8 million in 2012 to 5.7 million units in 2015. (See Figure 4.) Of course, as the recovery matures, higher interest rates will weigh on the market.

On the macroeconomic side, housing demand will be supported by a gradually improving labor market and the continued rebound in household formations. (See Figures 5 and 6) We project that employment will reach a new all-time high in 2014, seven long years since the prior peak, which would make it the most sluggish recovery in the postwar era. Similarly, household formations which collapsed to a mere 40,000 in 2009, won’t really get back to levels achieved nearly a decade ago until this year, but 2014-15 run-rates of 1.5 million-a-year are certainly supportive of our housing start forecast for those years which are approximately at that level.

Although it is possible to make a case for a stronger housing recovery in the sense that we are coming out of a sustained period of under-building, housing activity is still being held back by a less than ebullient recovery in the broader economy, still tight, albeit easing somewhat in recent months, credit conditions in terms of down payment and credit score requirements for potential homebuyers and the rapid buildup to nearly one trillion dollars in student loan debt. (See Figure 7) Never before have so many young people been saddled with so much non-mortgage debt and that burden will keep them out of the home buying market for years to come.
The flip-side of more stringent credit requirements for home purchase and mounting student loan debt is an increase in the demand for rental apartments. After peaking at 69% as far back as 2004, the homeownership rate has steadily declined to 65.4% at the end of 2012, with a further decline likely this year. (See Figure 8) Moreover, multi-family housing demand is being buttressed by a change in consumer preferences for a more urban, as opposed to suburban, lifestyle. In order to accommodate the demand, developers, out
Figure 5 Payroll Employment, 2000Q1 – 2015Q4F
Figure 7 Student Loan Debt, 2003Q1 – 2012Q4

Sources: Bureau of Labor Statistics and UCLA Anderson Forecast

Figure 6 Household Formations, 2000 – 2015F

Sources: Federal Reserve Bank of New York and The Wall Street Journal

Sources: Bureau of the Census and UCLA Anderson Forecast

of necessity, are building more dense projects and they are being encouraged by governmental planning authorities to do just that. One of the major sea changes in the past five years has been the radical shift on the part of government from opposing higher densities to encouraging it. Where density was once considered the bane of the environment it is now considered "green." Thus where multi-family construction in many urban areas was deemed to be supply constrained, that is no longer the case.

The increased demand for apartments coupled with the recession induced collapse in construction has caused the apartment vacancy rate to plunge and rents to increase rapidly. (See Figures 9 and 10). After peaking at 8% in 2010 the 79 city REIS Apartment Vacancy Rate series declined to 4.3% in the first quarter. Concomitantly, rents, according to the consumer price index, are rising at a nearly 3% annual rate, about double the overall rate of inflation.

We believe that the official consumer price index is understating the true rate of inflation for rents because most of the publicly held apartment real estate investment trusts and private surveys have been reporting rent increases of 4% or more for the past two to three years. Why the difference? For starters, the official series over-weights rent controlled cities such as, New York, Los Angeles and Washington, D.C. Furthermore, the process of vacancy decontrol slows down the mark to market process for in-place tenants and rents in smaller apartment buildings tend to lag those of larger developments. Thus, we believe the official series will soon begin to catch up to the market reality on the ground.

With the strong fundamentals outlined above, coupled with the world-wide scramble for yield caused by global central bank policy, investors are buying apartment houses with abandon. Prices have more than surpassed their previous peak of 2007. Put bluntly, with going-in yields approximating 4-5% and with rents rising, apartment house investments look very attractive when compared to the sub-2% yields available on 10-year U.S. Treasury notes. Indeed the frenzy has spilled over to single-family home rentals where both private equity firms and newly capitalized publicly traded real estate investment trusts are buying up single family homes in bulk for the rental market.
Figure 8 Homeownership Rate, 1990 -2013F, Yearend Data, Percent
Sources: Bureau of the Census and UCLA Anderson Forecast

Figure 9 Apartment Vacancy Rate, 1980-2013Q1, Percent
Sources: REIS and Calculated Risk

Figure 10 Consumer Price Index, Rent for Primary Residence, Jan 2000 –Mar 2013
Sources: U.S Bureau of Labor Statistics via Federal Reserve Bank of Saint Louis  

All of the factors outlined above have led to a surge in multi-family construction. (See Figure 11) After bottoming at 112,000 units in 2009, multi-family housing starts more than doubled to 247,000 units in 2012 and are forecast to reach 365,000 units this year.
We fully anticipate that starts will exceed 400,000 units in both 2014 and 2015. Of course this surge in supply will begin to elevate the vacancy rate and cool the rent increases that most investors now expect. In the meantime, higher apartment rents as we noted last year, will cause tenants to once again return to the ownership market



1. See Shulman, David, "Rebuilding the Housing Economy," UCLA Anderson Forecast, June 2012.

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