Paul Puryear, Director of Real Estate Research, analyzes the current state of the U.S. housing market.
To read the full article, see the full Investment Strategy Quarterly publication linked below.
The housing market continues to track our expectation of 1.2-1.3 million starts, although recent reports indicate some softness in new and existing home sales. We are not concerned about the speed or strength of the housing recovery at this juncture and view these data points as a somewhat normal reaction following the 65 basis point spike in mortgage rates from 4.00% to 4.65% at the beginning of the year.
More importantly, U.S. household formation rates have been consistently below the long-term average (1.2 million) this entire housing upcycle following the peak levels reached in 2005. Structurally decelerating rates of population growth in individuals aged 26 to 64, the prime household formation years, portend below-average household formation for years to come and that scenario continues to play out.
Unless influenced by economic recessions, we believe a strong correlation exists between annual new home sales (single-family permits and starts), household formation, and population growth in individuals aged 26 to 64. The period from 1972-2000 represents the strongest workforce population growth in U.S. history. However, after 2017, annual population growth amongst individuals aged 26 to 64 is not projected to reach 0.7% again until 2041. The post-war Baby Boom was an unprecedented historical event shaping U.S. society. We believe ‘reversion to the mean’ in U.S. household formation, and consequently new home demand, is a flawed assumption validated by the population growth outlook. Further, we don’t expect our economy to reap benefits from new housing construction in this upcycle at the levels realized in the past two upcycles.
With regard to the most recent data points in housing sales, we note that listed inventory for sale (new and re-sale) measured as a percentage of total housing stock is tracking its lowest recorded level in over 30 years. Consequently, there is very little for the consumer/ buyer to choose from. In addition, due to outsized inflation in the cost to build new housing and the slower growth in household income over the past few years, the affordability index has dropped below the 30-year average, despite the relatively low mortgage rate environment. Labor shortages and escalating costs continue to plague builders and have driven costs to build housing up two to three times higher than the broader CPI inflation rate. The Constant Quality (Laspeyres) Price Index1 of new single-family houses sold has inflated at a 5.6% compounded annual growth rate since early 2012. Cumulatively, the cost to build a like-kind single family home has increased 31% over the past six years. Trade wars are not helping as materials costs are now spiking. In some cases, they are surpassing the increasing labor and permitting costs that have been rising since the construction recovery began in 2012.
In addition to the population-driven demographic shift and affordability issues impacting housing demand this upcycle, lifestyle preferences are shifting as millennials are replacing baby boomers as the major home-buying age cohort. Millennials have very different preferences with regard to becoming home owners versus renting, along with lifestyle changes regarding marriage (more single heads of households and delaying marriage), and family formation (birth rates plummeting and fewer families with children). College graduates are entering the workforce at unprecedented levels, but with more student debt and weak credit scores that delay home ownership. For the first time among post-war American generations, living with parents is the most common household arrangement among young adults. As a result, noticeably absent this upcycle is the construction and purchase of entry-level housing, and we don’t expect that to change as more and more ‘new families’ are opting to rent their first home.
On a more positive note, with the first of the millennials now in their early 30s and ʻpeak millennials’ hitting age 27, there is some renewed demand in single family housing, which will create a shift in demand from apartments to both owned and for-rent single family houses. This shift will continue to drive single family starts higher in the mid-to single-digit range and multifamily starts flat to down, and we have seen an increase in household formations over the past two quarters. Data points like this, which are driven by some positive shifts in buyer behavior, pent up demand, and a strong economy, continue to drive our more positive view on the housing recovery, but we don’t see starts spiking up to the historical 1.5 million in the near to intermediate term.
All expressions of opinion reflect the judgment of Raymond James & Associates, Inc., and are subject to change. There is no assurance any of the trends mentioned will continue or that any of the forecasts mentioned will occur. Economic and market conditions are subject to change.