In this episode of the REconomy podcast from First American, Chief Economist Mark Fleming and Deputy Chief Economist Odeta Kushi explain what has fueled the impressive housing market rebound from the pandemic-driven slowdown in the spring and why the housing market remains on solid footing heading into 2021.
In this episode of the REconomy podcast from First American, Chief Economist Mark Fleming and Deputy Chief Economist Odeta Kushi explain what has fueled the impressive housing market rebound from the pandemic-driven slowdown in the spring and why the housing market remains on solid footing heading into 2021.
Odeta Kushi: Welcome to REconomy, a podcast from First American where we discuss economic issues that impact real estate, housing and affordability. I'm Odeta Kushi, deputy chief economist at First American and here with me is Mark Fleming, chief economist at First American, and today we are setting our sights on 2021. Will the housing market continue to drive the recovery? We'll talk about the good, the bad, and the likely. So let's jump right in. So Mark, you and I have talked a lot about how housing has historically led us out of a recession. And that's exactly what happened in this pandemic-driven decline. But what has surprised you about the housing rebound?
Mark Fleming: Well, I don't know if the housing market even rebounded, it hardly even skipped to beat. So did it pull us out? Or did it just ignore the whole thing altogether? Outside of a roughly two-month pause in home sales, with the initial lockdowns in March and April, when of course, everybody sort of had to figure out how to do home showings and things like that to continue to sell homes. It really didn't skip a beat. I think that's largely because there were a ton of good fundamentals supporting the housing market going into the pandemic. And as we've talked about, and many have written about in the last few months, like this recession, obviously was very different than past recessions, there was nothing fundamentally wrong with the economy. This was truly, as economists say, an exogenous shock. And that's one of the main reasons why the housing market was able to rebound very quickly. There's nothing fundamentally wrong with it. And in all likelihood, not to spoil the end of the podcast, but maybe do better than many of the recent years past.
Odeta Kushi: Absolutely. I mean, nominal house prices today are at their highest, 19% above the housing boom peak in 2006. And I know saying that might scare a lot of folks, they might start to enter, you know, the conversation of bubble territory. But, that's not the case. We've been saying it time and time again, this time, it's different. But maybe we should be saying last time was different, right? I mean, this time around, as you were saying the fundamentals have been exceptionally strong. And what fueled house price appreciation this time around were the strong fundamentals. And we'll get into that a little bit in the way of the tailwinds. What are the tailwinds for the housing market? And what has driven house price increases?
Mark Fleming: Yeah, I mean, you make a good point, maybe last time was different. But, I'm also kind of doing, how do you do an eye roll on a podcast here? Oh, my gosh, house prices are 19% higher than the peak, there must be something wrong. Mmmm...there's just not enough there. As we've talked about before, a lot of that has to do with rates. And it's not about the nominal value, it's about the purchasing power-adjusted value, and that's much lower. So this time is different, or last time was different, because actually, house prices were overvalued last time, and they're certainly not, but for a few exceptional markets in California, overvalued this time around. And that's one of the reasons why there's so much continued strength in the housing market. The fundamentals, as you mentioned, are very, very good. And, you know, that's really helping this time around with the sort of strength in the market in the face of the adversity of the pandemic.
Odeta Kushi: And let's talk about those these tailwinds. Why, this time, it's different, but also why we anticipate the housing market will remain strong. And again, spoiler alert for our 2021 outlook. But let's get into some of those. And the first you've already touched on and that's mortgage rates. And we have something called the Potential Home Sales Model, which looks at the fundamentals that are driving home sales in the market. And one of the most influential factors in 2020 was low mortgage rates. And I mean, LOW mortgage rates...
Mark Fleming: Historically low never before seen low rates, never to be seen, again, low rate, oh, gosh, we've been saying that for three years, and it keeps getting lower. You know, the fallacy of economic forecasting is don't ever try and forecast interest rates and or, more specifically, if you're a real estate economist mortgage rates, because you will always invariably be wrong. The caveat to that might, ironically, be, well, they are so low right now, the odds of them going higher, must be really high because they really cannot go much lower. We're running out of space for who gets paid out of the mortgage rate, let alone, you know, the opportunity cost or the risk free rate in the Treasury yield, you know, effectively close to zero. You know, and let's keep in mind, slight digression. I know we may not have planned on this, but negative rates, negative rates? Well, even if say Treasury yields go negative, which I'm not suggesting that they will, but let's pretend in this stranger things, upside-down world that that actually happens. The mortgage market wouldn't follow suit, it would likely stop lending would be the solution to that problem.
Odeta Kushi: Okay, well, you did this, you opened up the economic, wonky Pandora's box. And so I'm just gonna go in after you and just say, you know, it's very hard to forecast interest rates, we do know that and a large part of that is because the 30-year, fixed-rate mortgage is loosely benchmarked to the 10-year Treasury yield. And as we well know, the 10-year Treasury yield is influenced by geopolitical factors, and just a lot of things that that we can't forecast. We can't forecast politics a lot of the time, but it's also influenced by something else. And that is the Federal Reserve buying mortgage-backed securities. And so one of the reasons that we're feeling a little bit more confident in the 30-year, fixed mortgage rate forecast is because the Federal Reserve has indicated that it will continue to purchase mortgage-backed securities, which will put downward pressure on long-term yields and thereby mortgage rates. And so one of the fundamentals that we have in our 2021 forecast that we anticipate to continue to boost the housing market is low mortgage rates. Right now, the consensus is about 3%, with the lower boundary at about 2.8% and the higher boundary at 3.3%. And so that should really continue to boost the housing market.
Mark Fleming: Box checked. Fed says won't allow it to happen. Okay, moving on.
Odeta Kushi: You're right. Exactly. So we're getting a little bit more confident in that just because of some of the the Fed announcements and so low mortgage rates, let's assume they’re going to remain steady in 2021. There's something else something much, much bigger, in fact, the biggest that will be influencing the housing market in 2021. And that is, the millennials, and I say the biggest because they're officially the largest generational group, about 72 million strong between the ages of 24 and 39. And this is a group that is entering their peak home-buying years. The bulk of this generation turned 30 this year, entering that prime home-buying age and starting to form families.
Mark Fleming: Wait! I thought they didn't want to buy homes, I'm confused. They were never gonna buy homes, now were they? What just happened?
Odeta Kushi: The forever renter, the millennial misnomer, the avocado toast generation, right? All of these things that that have dominated headlines in years past. And that is just not the case, we're seeing more than half of all purchase mortgages originated by Fannie and Freddie going to first- time homebuyers. That's not to say that all of those first-time homebuyers are millennials, but a lot of them are, we're also seeing that the homeownership rate has largely been driven by younger millennial households. And this is a trend that we absolutely do not anticipate going away.
Odeta Kushi: And the suburban trend that everyone's talking about. This was something that we saw, even prior to the pandemic, right. I mean buying a home is a financial decision. But, it's also a lifestyle decision. And once you start to form families, you start to migrate to the suburbs, you get the fence, you get the yard, you start having kids. And so this was a pre-pandemic trend that m is maybe slightly accelerated by the pandemic and the need for a home office, if you will. And so we don't anticipate the demographic tailwind to go away anytime soon. In fact, a forecast that we've recently built shows that millennials will be the source of at least 15 million home sales in the next 10 years. And we always like to caveat that this is an extremely conservative estimate, because it does not take into consideration the higher educational attainment and household income of this generation. And we've done multiple studies, which show this is the most educated group and that is yielding some purchasing power benefits in the form of higher income.
Mark Fleming: I think that's a key point. Because, you know, this is a trend that we've seen for the last couple of years. There's the household formation growth, that is transferring from renting to owning, that started about two and a half, three years ago. I think one of the surprises or, maybe in hindsight, not so much a surprise. But initially, one of the surprises was the robustness of that millennial demand in the face of the pandemic. And, you know, while there was the pause, it's wow, all of these millennials are still out there, still looking to buy a home. Over the course of the summer, all of that pent-up demand really came into the housing market, despite the economy, the economic impact of the pandemic. And that's driven by two really important factors, which is that one, there's still that low-rate environment. So you know, better time to buy than ever because of your purchasing power, your house-buying power, but many of those millennial households are educated, with higher incomes. They are not the ones that were unfortunately being laid off in the service-based, COVID recession. And so there's this bifurcation of who gets impacted that, for luck of the housing market, really leaned much more on, or is leaning much more on the renter than the potential millennial homeowner.
Odeta Kushi: Right. And a lot of this forced savings, if you will, during the pandemic, we couldn't go out to restaurants, you know, you're not going out shopping as much and that resulted in historically high savings rates. And, as we know, millennials typically will label a down payment as the biggest barrier to homeownership. And so you have this generational group that maybe didn't lose their jobs during the pandemic, and then you have forced savings that are boosting their savings accounts and allowing them to put down more on a home. And so all of this is actually good news for those millennials.
Odeta Kushi: And it comes full circle. And let's just talk about the third aspect that we're considering a tailwind. But it could also be a headwind, we've had conversations about this. Why would you see a supply and demand imbalance in the housing market as a tailwind?
Mark Fleming: As a tailwind? Well, let's go back to the basics of supply and demand. This is sort of one of these classic Econ 101 issues. If you don't have enough supply of something relative to all that demand, millennials with high house-buying power, all of that demand that's out there? Well, that bids up prices and bidding up prices generates wealth. And so there's this effect of I'm gaining more wealth, I can afford to move that wealth into the next house. So, there's that tailwind benefit of possibly, also, just simply, I'm gaining more equity and wealth and, in a sense, actually creating a protective barrier against bad things happening. So back in the global financial crisis, there were two triggers for foreclosure. The first trigger is an inability to pay, I'm delinquent on my mortgage. The second trigger was a lack of equity. And the unfortunate thing about the global financial crisis was both of those triggers dually impacted things. And so you had lots of people with no ability to pay and a lack of equity. And that's what caused foreclosures. With such a tight supply and demand dynamic and all the house price appreciation that has accumulated wealth to the existing homeowners today, even if they have an inability to pay situation, because you know, let's be real about this, we're only halfway recovered from an extremely severe economic downturn, there's still a lot of economic hardship out there. But for most homeowners, even if they have that economic hardship, they're going to have lots of equity in their home. And while this is not ideal, this is why we call involuntary sale an option instead of foreclosure. And so we expect the benefit of all of this equity, all this high house price appreciation caused by the supply and demand dynamic being imbalanced, actually creates a protective barrier against foreclosure. And ironically, that involuntary sale in a tightly supplied market becomes the potential home for that desperate millennial wanting to buy something. So the protective issue mitigates the risk of foreclosure this time around.
Odeta Kushi: Right. And it also helps to explain why the house price increases that we're seeing are rooted in something fundamental, and that is the supply and demand imbalance. And we've looked at the data which shows that prior to 2008, the housing market was significantly overbuilt. And that helped to lead to the crisis as we know it. But this time around, we are severely under built relative to household formation and the demand for homes.
Mark Fleming: Let's call that the headwind right because this supply and demand imbalance has been growing for a number of years. It's not new this year. It's more exacerbated than ever before. We estimate our housing turnover, that is the share of the stock of homes for sale at any point in time, is at quarter century or more lows at 1.3%. That's a very, very tight lack of supply, partly driven by the fact that there are a lot more households out there today that had been formed in the last decade and we've not kept pace with building housing stock for. So that imbalance of, not just a lack of supply of something for sale, but literally a lack of housing writ large, has grown to the highest point yet. And, you know, the good news for home builders, at least, is if you build it, they will come. You just can't build it fast enough to really solve that problem. This will be a headwind for a number of years to come.
Odeta Kushi: Right and not for lack of trying from the homebuilders perspective, because we've seen housing starts increase, even in the face of construction headwinds. And we've talked about that a lot. The construction industry doesn't have enough employees. There are regulatory burdens, there are cost increases, and because they know that if they build it, someone will buy it. And with the household formation fueling demand, a lot of the millennials, they're in their mid-20s, they're not even quite 30 years old yet, and they're still forming households. We have baby boomers living longer than ever. And so household formation will continue to rise and that demand will continue to rise as well. And it's just that supply just isn't quite keeping pace. And so certainly, that is a headwind and this house price acceleration is good for that existing owner, not so much for that first-time home buyer because a lot of this inventory crunch is actually happening in that lower price tiers, first-time home buyer price tier. And so there's some struggle with that for the first-time home buyer certainly. But there is another headwind, not just supply, and that is the labor market, and the uncertainty of the labor market. We've obviously seen a pretty strong rebound in the labor market, some good numbers since we hit that trough in the spring, but those gains have been slowing. And we've also looked at foot traffic data, which is indicating a slowdown in economic activity in more recent weeks. And so what do you think about that? How do you foresee the labor market impacting the housing market going into 2021?
Mark Fleming: While not as extreme as the forced stay-at-home orders and the lockdowns that were widespread in March and April, I think we've learned a lot more in the following six months, that's not necessarily how it's going to happen exactly the same way. That said, you know, it doesn't, it doesn't take much for people to respond, of their own volition and will to take discretionary consumption spending, going to restaurants and bars, and doing all that discretionary spending, and then choosing not to do it because of a fear of getting sick. And so, what we are seeing in those declining foot traffic numbers is the fact that people are choosing to curtail that consumption spending. You mentioned savings. Savings is sort of not continuing to go down at the speed that it did before, because people are willingly, voluntarily sort of reducing that consumption. And that has the unintended consequences on the service sector employee base. So we see, consequently, the labor market slowing down because consumption, demand is slowing down. You know the truth is, consumption follows with the pandemic. The good news is vaccines are coming. And you know, we will get beyond this. But, until that point, discretionary spending activities will be very easily impacted by our voluntary decisions of consuming, or not consuming, based upon the risk. And that slows things down in the labor market and creates either slower income growth, which reduces your house-buying power, or increases the risk of not being able to make your mortgage payments.
Odeta Kushi: Right, lest we forget that most of the US economy is driven, over 70% is driven, by consumers. And so, a slowing labor market certainly has greater implications for the broader macro-economy as well. And then of course, for the housing market. But we do know that in the winter months, housing is usually a little bit quieter. And so you know, the light at the end of the tunnel here is the vaccine. And we do think that, by the time spring rolls around, the housing market constants, as we're calling them, or the fundamentals, low rates, millennial demand, limited supply, are expected to keep our home-buying demand robust, and we do note that the continued supply and demand imbalance points to continuing house price appreciation in 2021. And so this our forecast, we do anticipate home sales to remain robust, and house price appreciation to continue into 2021.
Mark Fleming: You're right, the housing market tends to go into hibernation in December in January and February. And so that's a good thing. Because when the issues that we're facing for the next few months, until the vaccine comes along, will be the hardest. Yet, this is the housing market’s slowest time. So, you really look to the spring and say, Okay, well, what's going to be different in the spring next year versus this year? Not a lot. Low rates, high demand, lack of inventory. So we sort of pick up where we're leaving off right now, come next spring with the additional benefit, obviously, of likely more vaccine rollout and addressing the pandemic and the consequential economic decisions. So, as you said, you know, 2021 is going to look a lot like 2020 did, sans pandemic.
Odeta Kushi: Absolutely. I mean, there are forecasts indicating record purchase loan originations in 2021. And a lot of that is because of these housing market constants that we just discussed. And so it's looking like housing will remain a bright spot in 2021. Would you agree, Mark?
Mark Fleming: I would agree, and it's a great way to end what has otherwise been a pretty tough year.
Odeta Kushi: A very, very tough year, indeed. Well, thank you, Mark, very much for your insights. Great as always, and thank you, everyone for joining us on this episode of the REconomy podcast. Be sure to subscribe on the REconomy podcast on Apple, Google, Spotify, or your favorite podcast platform. You can also subscribe to our blog at Firstam.com/Economics. And if you can't wait for the next episode, you can follow us on Twitter. It's @OdetaKushi for me and at @MarkFlemingEcon for Mark. Until next time.