Economics Group Special Commentary Mark Vitner, Senior Economist mark.vitner@wellsfargo.com (704) 410-3277 Hank Carmichael, Economic Analyst john.h.carmichael@wellsfargo.com (704) 410-3059 Even as real GDP growth strengthened to a 3 percent pace over the past two quarters, the housing market remains stuck in the same slow-motion recovery that has characterized the post-financial crisis era. While housing prices have recovered on a nominal basis, housing starts and home sales both remain well below their previous peaks. Housing is a huge driver of economic activity, not only from the labor and building materials that go into building homes but also from the multitudes of goods and services that go along and after the sale of home, ranging from financial and legal services to furniture, home appliances, home security, and pest control. The inability of housing to rise back near its previous benchmarks has been one of the reasons overall economic growth has had such a difficult time breaking away from the 2 percent range. The most recent housing data reflect the period affected most directly by Hurricane Harvey and Hurricane Irma. Those storms impacted Houston, the Texas coast and Southwest Florida, interrupting sales and new home construction. Oddly enough, the latest data show a spike in new home sales in September, which we believe was a bit of a statistical fluke. With new homes sales at such a low absolute level, the monthly seasonally-adjusted series can be extremely volatile. Sales in the South had fallen during June, July and August before rebounding a whopping 25.8 percent in September. That increase accounted for roughly 80 percent of the month s increase in new home sales. Despite the reported gains, there does not appear to have been any fundamental change in demand for new homes during the month. New and existing home sales and housing starts tend to decline during fall and winter, as less favorable weather typically takes hold and housing competes with the holidays and football for potential buyers attention. As sales and home construction tend to slow so much this time of year, we could see additional large month-to-month swings in the seasonally adjusted data if the weather is unseasonably mild. These swings should not be given much weight, as it is still far too soon to expect a bounce back from the hurricanes and would most likely be just statistical noise. Figure 1 Figure 2 240 220 Return of the Affordability Migration Population Shift Signals Movement in Housing Market S&P CoreLogic CS Home Price Index Index, January 0= 240 220 1.6 1.4 Existing & New Single-Family Home Sales Both Series In Millions of Units, Seasonally Adjusted Annual Rate New Home Sales: Sep @ 0.7 Million (Left Axis) SF Existing Home Sales: Sep @ 4.8 Million (Right Axis) 8.0 7.0 Housing starts and sales of both new and existing homes remain well below their previous peaks 1.2 6.0 180 180 1.0 5.0 0.8 4.0 160 160 0.6 3.0 140 140 0.4 2.0 120 National HPI: Aug @ 195.1 Composite-20 City: Aug @ 202.9 Composite-10 City: Aug @ 216.5 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 Source: U.S. Department of Commerce and Wells Fargo Securities 120 0.2 04 05 06 07 08 09 10 11 12 13 14 15 16 17 1.0 This report is available on wellsfargo.com/economics and on Bloomberg WFRE.
Return of the Affordability Migration We believe we are at a significant turning point in the housing recovery A Stronger Housing Recovery May Finally Be in the Offing While it is too early to expect any rebound from the hurricanes, there are ample reasons to be optimistic about housing in 2018. Both the Conference Board s and University of Michigan s measures of consumer confidence have risen to 17-year highs in recent months, reflecting the improving labor market and strengthening household balance sheets. Significantly more consumers believe jobs are plentiful today than at any other time during this expansion, and a large proportion of households report that their housing values have increased, providing more potential buyers with the wherewithal to move forward with trade-up purchases, downsizings and relocations. Moreover, improved perceptions about job security and income growth are likely to bolster first-time home buying precisely at the time the leading edge of the millennial generation is reaching their late thirties and increasingly forming families and searching for a first home. We believe we are at a significant turning point in the housing recovery, where several trends that have been holding back sales and new home construction since the financial crisis will begin to unwind. One of the more prominent trends has been the movement back toward center cities, which has coincided with the emergence of millennials and contributed to an epic apartment boom. The trend has been most prominent in tech-driven markets like San Francisco, Seattle and Austin but is apparent in most major cities. Much of this new development has been confined to high-end units in a handful of submarkets, resulting in much higher rents. Effective rents have risen nationally every quarter since the Great Recession, peaking at nearly 6 percent year-to-year in Q4 2015. The proportion of income being spent on rent has risen dramatically in many major cities and now exceeds historic benchmarks relative to income, leading an increasing proportion of renters to seek lower cost alternatives in the suburbs or secondary metro areas. Vacancy rates appear to have bottomed out on a national basis. A deluge of apartments has come to market in San Francisco, New York City, Los Angeles and Washington, D.C., resulting in rising vacancy rates and some easing in effective rents there but rents remain dramatically higher in all of these markets than at the start of the expansion and have risen much faster than median income. In addition, since apartment construction has been concentrated in just a handful of markets, overall rental vacancy rates remain relatively low nationwide, allowing rents to easily outpace income in much of the country. We expect apartment construction to pull back even further in 2018, as more apartments are completed in and around the center city of many of the nation s largest metro areas. We expect apartment development to increasingly shift to lower-cost suburban areas and secondary markets that have not seen as much new construction. This should keep apartment construction close to its recent pace in the longer run. The recently announced tax reform proposal, which proposes reducing the limit on the mortgage interest deduction to $500,000 and implement limits on the deductibility of state and local taxes, may extend the apartment boom. At a minimum, the proposed changes would remove some of the urgency of younger renters to purchase a home. Figure 3 Figure 4 600 Inventory of New Homes for Sale Non-Seasonally Adjusted, In Thousands 600 9% Apartment Supply & Demand Percent, Thousands of Units 550 500 550 500 8% 75 450 450 7% 50 400 400 6% 25 350 350 300 300 5% 0 250 250 4% -25 150 Inventory: Sep @ 284K 89 91 93 95 97 99 01 03 05 07 09 11 13 15 17 150 3% Apartment Net Completions: Q3 @ 47,271 Units (Right Axis) Apartment Net Absorption: Q3 @ 31,254 Units (Right Axis) Apartment Vacancy Rate: Q3 @ 4.5% (Left Axis) 2% 05 06 07 08 09 10 11 12 13 14 15 16 17-50 -75 Source: Census Bureau, REIS, Inc. and Wells Fargo Securities 2
Return of the Affordability Migration Sustained interest in living nearer to the city center and key employment centers in general is also impacting the demand for single-family homes. Population growth in urban centers outpaced suburban areas during the first part of this decade and urban areas continue to account for a larger proportion of metro area population growth than in previous decades. Demand for homes in neighborhoods close to many major cities has been one of the notable bright spots in this recovery, as a growing proportion of workers have sought out alternatives to long commutes. Builders have responded by focusing more on infill and teardown projects. As a result, many areas have seen a significant portion of their older housing stock torn down and replaced or renovated. The gentrification wave has dramatically changed many of the close-in communities around the country but has also driven housing prices significantly higher. New housing options near the center city are now often being developed in non-traditional areas, utilizing former factories, warehouses and retail space. This wave is not without controversy, however, and has sparked intense debate about how to create affordable housing options in many areas across the country. Displace residents from gentrified urban areas are also increasingly landing in the suburbs, creating new challenges for many of those markets. Another trend that has limited the housing recovery has been that homes are not turning over as quickly as they did in previous housing cycles. Many homeowners wound up deeply underwater following the financial crisis and have remained in place and gradually rebuilt equity. The influx of investor buyers has also slowed housing turnover, as much of the supply of fixer-uppers was bought by large institutional investors and converted to rental homes. The refinancing boom produced a further drag on turnover, with many homeowners refinancing at generation-low interest rates, often to 15-year fixed mortgages. Many of these homeowners have opted to remain in place and build equity rather than trade-up or downsize. With so many homeowners remaining in place, the supply of existing homes listed for sale has remained remarkably low. The National Association of Realtors reported that there were just 1.9 million homes available for sale at the end of September, which is down 6.4 percent over the past year. The inventory of existing homes available for sale has now fallen on a year-over-year basis for 28 consecutive months. The inventory of new homes has also remained extraordinarily low throughout much of this recovery. Part of the reason builders have kept such low inventories is that they have shrunk their business models and are focusing on smaller in-fill projects. Builders have been focusing on that market because that is where the buyers have been and it fit well with their smaller operations. As a result, large tract development has largely been absent. Land development has become more costly and difficult, as entitlement costs have increased and zoning battles have increasingly become vicious. Regulatory changes put in place following the financial crisis have also made it more difficult to borrow for land development. Buyers for new homes have also been relatively scarce, as the trend back toward urban living has captured many of the more financially capable homebuyers and many other would-be first-time buyers are being weighed down by student loans. The inventory of existing homes available for sale has now fallen on a yearover-year basis for 28 consecutive months Figure 5 Figure 6 30% 24% Home Prices vs. Wages and Salaries Year-over-Year Percentage Change Wage & Salaries (3-MMA): Sep @ 2.8% S&P/Case-Shiller Composite-20: Aug @ 5.9% National HPI: Aug @ 6.1% 30% 24% 1.5% Population Growth: Primary City vs. Suburbs Annual Average Growth Top 50 Metros, Percent Primary City Suburbs 1.5% 18% 18% 12% 12% 1.0% 1.0% 6% 6% 0% 0% -6% -6% 0.5% 0.5% -12% -12% -18% -18% -24% -24% % 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 2011 2012 2013 2014 2015 2016 Source: CoreLogic, U.S. Department of Commerce and Wells Fargo Securities % 3
Return of the Affordability Migration The momentum now appears to be shifting back toward the suburbs Return of the Affordability Migration While the return to the center cities appears to be a shift with staying power, the housing market looks to be shifting back towards some of its long-term norms. For starters, most millennials have always lived in the suburbs, so the aging-up of the group into their peak family-formation years should boost first-time home buying, even if we do not see a shift back toward the suburbs. We expect to see demand shift back toward the suburbs, however, as housing costs in and near most center cities have dramatically outpaced incomes. There is also simply less land to be developed and redeveloped in areas closer-in to center cities, particularly relative to the overall population and overall demand for housing. The return of the affordability migration is already evident in many of the areas that came of age during the era of automobiles and interstate highways. Los Angeles is one of the best examples. The early part of the economic recovery was largely concentrated in areas close to downtown Los Angeles, which has seen one of the most dramatic makeovers in recent memory, with thousands of new apartments, hotels, restaurants and entertainment venues. Residential development also increased in other close-in areas, including Santa Monica, Venice Beach and much of West Los Angeles. By contrast, demand for housing in inland areas has been slower to come back on-track. The momentum now appears to be shifting back toward the suburbs. Population and employment growth in the Inland Empire has surged over the past year and permits for single-family homes have risen 34 percent. Residential development is also perking up in Ventura County and plans appear to finally be falling in place to bring thousands of new homes to Newhall Ranch located in Santa Clarita, in the northern edge of Los Angeles County. Development is also returning to the suburbs in other historically suburban-driven markets that saw a renaissance in their urban and in-town areas earlier in the decade, including Dallas, Atlanta, Phoenix and Washington, D.C. With preliminary data now available through September, we have a pretty good idea of where home sales and housing starts will finish 2017. Sales of new homes are expected to rise 8.7 percent, while sales of existing homes rise 0.4 percent. The median price of an existing home is expected to rise 5.3 percent, while the price of new homes should rise a smaller 2.7 percent. The smaller rise in new home prices reflects the shift in construction toward more lower-priced homes, largely in suburban areas in the South and West. While it is not evident from the national data, the local data show the hurricanes dramatically reduced new home sales and construction during September. We doubt the picture will improve much in October but have little doubt that the relative attractiveness of Houston and Florida has not been diminished by the devastating storms that affected these areas. Florida is actually seeing population growth accelerate, as aging baby boomers are retiring in increasing numbers and more residents relocate from Puerto Rico to long-established communities in Orlando, Tampa and South Florida. Figure 7 San Diego Riverside San Jose Single Family Building Permits by MSA Year-over-Year Percent Change, NSA, September 2017 Figure 8 2.4 2.1 1.8 Multifamily Starts Multifamily Forecast Single-Family Starts Single-Family Forecast Housing Starts Millions of Units 2.4 2.1 1.8 San Antonio 1.5 Forecast 1.5 Cincinnati Louisville 1.2 1.2 Raleigh 0.9 0.9 Tampa 0.6 0.6 Dallas Richmond 0.3 0.3 0 10 20 30 40 50 60 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 12 14 16 18 20 Source: U.S. Department of Commerce and Wells Fargo Securities 4
Forecast 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 Real GDP, Percent Change 2.5 1.6 2.2 1.7 2.6 2.9 1.5 2.2 2.6 2.5 Residential Investment, Percent Change -2.5 0.5 13.5 11.9 3.5 10.2 5.5 0.7 2.4 5.9 Nonfarm Payroll Change (Avg. Monthly) 88 174 179 192 250 226 187 155 161 148 Unemployment Rate 9.6 8.9 8.1 7.4 6.2 5.3 4.9 4.4 4.1 3.9 Home Construction Total Housing Starts, in Thousands 586.9 608.8 780.6 924.9 1,003.3 1,111.8 1,173.7 1,20 1,28 1,37 Single-Family Starts, in Thousands 471.1 430.5 535.3 617.7 647.9 714.5 781.5 84 93 101 Multifamily Starts, in Thousands 115.8 178.3 245.3 307.2 355.4 397.3 392.2 36 35 36 Home Sales New Home Sales, Single-Family, in Thousands 322.0 305.0 369.0 429.0 437.0 501.0 561.0 61 67 74 Total Existing Home Sales, in Thousands 4,19 4,26 4,66 5,09 4,94 5,25 5,45 5,47 5,68 5,90 Existing Single-Family Home Sales, in Thousands 3,708.0 3,787.0 4,128.0 4,484.0 4,344.0 4,646.0 4,838.0 4,85 5,05 5,24 Existing Condominium & Townhouse Sales, in Thousands 474.0 477.0 528.0 603.0 591.0 608.0 614.0 62 63 66 Home Prices Median New Home, $ Thousands 221.8 227.2 245.2 268.9 288.5 294.2 307.8 316.0 328.0 34 Percent Change 2.4 2.4 7.9 9.7 7.3 2.0 4.6 2.7 3.8 3.7 Median Existing Home, $ Thousands 172.9 166.1 176.8 197.1 208.3 222.4 233.8 246.2 258.7 27 Percent Change 0.2-3.9 6.4 11.5 5.7 6.8 5.1 5.3 5.1 4.4 FHFA Purchase Only Index, Percent Change -3.0-4.1 3.0 7.2 5.2 5.5 6.1 6.3 6.0 5.8 S&P Case-Shiller C-10 Home Price Index, Percent Change 2.1-3.5 0.3 11.7 7.9 4.6 4.5 5.0 5.3 5.4 Interest Rates - Annual Averages Federal Funds Target Rate 0.25 0.25 0.25 0.25 0.25 0.27 0.52 1.25 1.75 2.25 Prime Rate 3.25 3.25 3.25 3.25 3.25 3.27 3.52 4.25 4.75 5.25 10-Year Treasury Note 3.22 2.78 1.80 2.35 2.54 2.14 1.84 2.38 2.68 2.90 Conventional 30-Year Fixed Rate, Commitment Rate 4.69 4.46 3.66 3.98 4.17 3.85 3.65 3.95 4.03 4.17 Forecast as of: National Housing Outlook Source: U.S. Dept. of Commerce, U.S. Dept. of Labor, FRB, FHFA, FHLMC, National Association of Realtors, S&P, Wells Fargo Securities Return of the Affordability Migration 5
Wells Fargo Securities Economics Group Diane Schumaker-Krieg Global Head of Research, Economics & Strategy (704) 410-1801 (212) 214-5070 diane.schumaker@wellsfargo.com John E. Silvia, Ph.D. Chief Economist (704) 410-3275 john.silvia@wellsfargo.com Mark Vitner Senior Economist (704) 410-3277 mark.vitner@wellsfargo.com Jay H. Bryson, Ph.D. Global Economist (704) 410-3274 jay.bryson@wellsfargo.com Sam Bullard Senior Economist (704) 410-3280 sam.bullard@wellsfargo.com Nick Bennenbroek Currency Strategist (212) 214-5636 nicholas.bennenbroek@wellsfargo.com Eugenio J. Alemán, Ph.D. Senior Economist (704) 410-3273 eugenio.j.aleman@wellsfargo.com Azhar Iqbal Econometrician (704) 410-3270 azhar.iqbal@wellsfargo.com Tim Quinlan Senior Economist (704) 410-3283 tim.quinlan@wellsfargo.com Eric Viloria, CFA Currency Strategist (212) 214-5637 eric.viloria@wellsfargo.com Sarah House Economist (704) 410-3282 sarah.house@wellsfargo.com Michael A. 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