In this special 100th episode of The REconomy Podcast™ from First American, Chief Economist Mark Fleming and Deputy Chief Economist Odeta Kushi gather the entire First American Economics team to address some of their most frequently asked questions about real estate, housing and affordability, recap some of their favorite predictions, and look ahead to what 2025 may bring.
Don’t miss a single REconomy episode, subscribe today.
“The expectation of a rate reduction had already influenced the market, putting downward pressure on the 10-year treasury bond yield, and by loose association, mortgage rates in recent months. That's why we've seen rates come down in recent months already. Now that the Federal Reserve has started easing, and signaled that more aggressive easing trajectory that you mentioned, mortgage rates are likely to fall even further later this year and throughout 2025.” – Mark Fleming, chief economist at First American
Odeta Kushi - Hello and welcome to the special centennial episode of The REconomy Podcast, where we discuss economic issues that impact real estate, housing and affordability. I am Odeta Kushi, deputy chief economist at First American, and here with me is the entire First American Economics team. We've got Mark Fleming, chief economist at First American, Xander Snyder, senior commercial economist, and introducing the newest member of our team, Sam Williamson, senior economist covering all things residential real estate. Welcome one. Welcome all. Hard to believe we started this podcast back in 2020 as a way to bring back some of those in-office discussions that we were missing.
Mark Fleming - Hi Odeta and everyone on the team. We've certainly come a long way from then. The 100th episode is an important milestone, and it's great that we can introduce a new team member. Welcome Sam. Care to introduce yourself to the audience?
Sam Williamson - Thank you, Mark. Hello everyone. It's great to be here. I've been a fan of the podcast for a while, especially because of all the '80s references you guys manage to sneak in. So it's an honor to be on the other side of the mic. My background is in land use economics, focusing on factors like zoning laws that influence land use and land cover dynamics in real estate markets. Before joining the team, I was an economist at the U.S. Department of Agriculture, and I'm also wrapping up my Ph.D. in Agricultural and Resource Economics at the University of Maryland in College Park. So, with introductions out of the way, I am officially ready to dive into discussing real estate markets with the team. Well, we're excited to have you, and I know Mark is excited to have another '80s music fan on the team. And, of course, we have Xander, our commercial real estate guru. Hey, Xander, welcome back.
Xander Snyder - Thanks. It's great to be here to help mark the 100th episode. Get it?
Mark Fleming - Get it. Sheesh, did you see the eye roll I just put on to start off the show, Xander? Speaking of the show, what are we actually going to cover today on this special episode?
Odeta Kushi - Great question. Well, with it being our 100th episode, I thought it would be a good opportunity to go over some of our most frequently asked questions over the last several years, how we did with our predictions and how we would answer today. So, we can begin with commercial real estate. Xander, what do you think the most common question has been over the past several years?
Xander Snyder - Well, Odeta, I'd have to say that people have had an incredible interest in the future of office and followed closely by how long this current period of price discovery that we're still in will last.
Odeta Kushi - So, four and a half years after the pandemic forced us to all work remotely, what does the office landscape look like now? And I'm asking this as we're all recording from our separate home offices.
Xander Snyder - Yeah, well, I think you just answered your own question right there. I've said this before, but I think that this time really is different with office, since remote work technology has really fundamentally changed the supply and demand dynamics for office. Tenants just don't need as much space anymore to successfully run their businesses. I've received some pushback on this point at different events from folks who heard a somewhat similar refrain in the 1980s during the savings and loan crisis, when office space was overbuilt. But here we are four and a half years later, and office physical vacancy rates are still far above what they were pre-pandemic. I think there have been now something like five concerted attempts at a return to office, with only mild success. So, at this point, I think we can say with greater confidence that remote work technology has fundamentally decreased the demand for office space. Now, I think at this point, the question is, how quickly does underutilized, but leased space turn into vacant or available space. And using First American's U-Shadow Vacancy metric, which is a measure of underutilized space, we've published research showing that major metros that have larger amounts of underutilized office space have generally had a larger increase in office availability rates, which again supports the thesis that demand for office space has permanently shifted down to some degree. After all, why spend money on a large lease if you aren't using it?
Odeta Kushi - That's fair. Do you think this downsizing in office space is nearly over, or is there more to come?
Xander Snyder - Well, since so many office leases are long term, tenants evaluate their space needs gradually, as these leases mature and expire, which may not be for several additional years for a lot of companies out there. So, while I think that this broader commercial real estate adjustment phase for other asset classes is gradually coming to an end and will probably reverse sometime next year, I don't think the same thing can be said for office. I think that office's adjustment phase will last much longer.
Odeta Kushi - Yeah, I think everyone on this call would agree with you there. Thanks, Xander. Let's move on to our next topic, which we're going to hand over to the newest member of the team, Sam. Demographics drive supply and demand dynamics in the housing market. We know that's true. Over the last several years, we've received many questions about everything from the outlook for the homeownership rate to first-time home buyer demand. So, can you walk us through where we are in the demographic, housing consumption lifecycle, and where we go from here?
Sam Williamson - I'd be happy to Odeta. So it's no secret that millennial demand for housing remains strong, even if many are on the sidelines right now. Between 1982 and 2000 there were 83.1 million millennials born, and many are just now looking to enter into the housing market.
Odeta Kushi - And we've been talking about this for many years. I mean, Mark, do you remember about a decade ago, we had to convince people that millennials were still interested in home ownership?
Mark Fleming - How can I forget? We were broken records for a number of years on this one. And, as we expected, millennials are no different than any other generation with their desire to be homeowners. It's just that they made their decisions later in life. But the question is, why were many doubtful of that millennial demand for homeownership to begin with?
Sam Williamson - So, I can answer that question. When we look at charts of homeownership rates by generation age, what we see is that around age 30, homeownership rates for millennials was approximately six percentage points lower than that of their generational predecessors, Generation X at same age.
Odeta Kushi - Well, I can definitely see why someone would look at that stat and say, this is a renter generation. I mean, what was it, the avocado toast generation? That was the label that millennials got a few years ago.
Mark Fleming - I'm not a millennial. I like avocado toast too.
Odeta Kushi - There you go. We've got one data point.
Sam Williamson - So that's largely because millennials have prioritized their education, which takes time and money, and many have consequently delayed marriage and family formation, which are strong motivators for, and correlated with homeownership. While previous generations made these lifestyle choices in their 20s, millennials are making them in their early-to-mid 30s. As evidence of this trend, the gap in homeownership rates between 40-year-old millennials and Generation X is significantly narrower at just two percentage points.
Odeta Kushi - Look at that, elder millennials walking around like they own the place.
Xander Snyder - Second eye-roll moment of the episode.
Mark Fleming - Well done.
Odeta Kushi - Thank you.
Xander Snyder - Sam. What's next on generational trends?
Sam Williamson - Well remember, millennials are still aging into their 30s. They are, in fact, the largest living generation. The population of 30-to-39 year olds will continue increasing through at least 2030, according to Census Bureau projections. Additionally, millennials' higher education attainment is translating into higher earning power, which is a strong determinant of homeownership.
Mark Fleming - And so, as usual, millennials making it all about themselves. And I would just like to point out listeners that everyone on this podcast is a millennial, but for this Generation X, old timer always left out of the conversation.
Sam Williamson - Yes, well, Mark, it's not all about millennials. I do have predictions about another generation, just not yours.
Mark Fleming - Say it ain't so, what other possible generation could it be?
Sam Williamson - Well, I'm talking about the baby boomers. Of course you are. Yes, just as younger generations have been transitioning into homeownership later and later compared to their predecessors today, seniors have been living longer and increasingly aging in place, which increases housing demand relative to prior generations. However, this transition, much like millennials transition into homeownership, is delayed, but not forgotten. The number of people 80 years of age or older, is expected to more than double between 2022 and 2040 increasing from 13 million to 28 million. So, as the baby boomer generation ages into their 80s, starting slowly in the late 2020s and picking up speed in the 2030s they will likely begin downsizing and selling their homes, putting more housing supply back on the market.
Odeta Kushi - Thanks Sam. It seems like we're in for some significant demographic shifts over the next decade, setting the stage for changes in the housing market.
Xander Snyder - Queue David Bowie's changes.
Mark Fleming - Okay, now I'm not going to go there. Nice one, Xander, and there is our 100th episode, '80s reference. Does that make it a streak for all 100? I think it does. Right?
Odeta Kushi - Someone go back and check and fact check us on that one.
Mark Fleming - We'll have to add this to the playlist, of course.
Odeta Kushi - All right, moving along and going back to Sam's earlier point about the shadow demand for homes from the millennial generation. That's because they've faced, and continue to face, a challenging housing market, to say the least. So this is a nice transition to our next most commonly asked question, which is, what's the outlook for house prices? According to our First American Data & Analytics House Price Index, house prices nationally are now 54% higher compared to pre-pandemic February 2020.
Xander Snyder - Yeah, well, no wonder it feels so tough out there right now?
Odeta Kushi - Yeah, indeed, annual house price growth reached a double-digit pace during the pandemic, a super sellers' market, and we know that ultra-low rates boosted demand while inventory was at historic lows. That's Econ 101 for house price growth.
Mark Fleming - but, Odeta, if I recall correctly, at the beginning of the pandemic, many forecasters suggested prices would decline, and precipitously by large amounts. We thought not -- a contrarian view at the time, but it was pretty clear to us that rock-bottom mortgage rates relative to already short supply coming into the pandemic was going to be much more influential on the market than any downside risk from a recession.
Odeta Kushi - Forecast correctamundo. But, as we also know, mortgage rates picked up very quickly, beginning in 2022 when the Federal Reserve began to hike interest rates to slow inflation. Higher mortgage rates have a dual impact on the housing market, creating a lock-in effect for homeowners with low rate mortgages and reducing affordability for potential first-time home buyers. So there was a pullback in demand, but supply also remained constrained, since sellers were not putting their homes on the market.
Sam Williamson - Is that still the case in today's market?
Odeta Kushi - They dynamics are similar. Elevated mortgage rates continue to keep homeowners rate locked-in, while reducing affordability for potential first-time home buyers, but the resulting pullback in demand has coincided with an uptick in supply, which is actually cooling house price growth. Note that in level space, house prices are the highest they have been in recorded history, but the pace of growth is slowing.
Mark Fleming - So Odeta, this is a trick question here. What goes up, in this case dramatically, must come down at some point, right?
Odeta Kushi - I don't expect annual house price declines, little asterisk here. This will vary by market. There actually are markets in the U.S. that have experienced house price declines from the peak, but nationally, I don't expect house price declines because housing remains fundamentally undersupplied and inventory historically low, which will keep a floor on how low house price appreciation can go.
Mark Fleming - Ever the economist, plausible deniability was in that forecast, right there.
Odeta Kushi - Maybe a little.
Mark Fleming - Very well done.
Xander Snyder - All the appropriate caveats.
Mark Fleming - Exactly.
Xander Snyder - Yeah. Well, things have come down. Mortgage rates have come down.
Odeta Kushi - That's a good point. However, lower mortgage rates might stimulate demand, AKA improved affordability, more than it increases supply, AKA unlock rate locked-in homeowners. Historically, existing-home inventory has constituted the majority of total inventory, and about 86% of current homeowners have a mortgage rate below 6%, so more demand relative to supply, potentially. We have already covered that part. It's a recipe for faster price appreciation. Again.
Mark Fleming - But, now I can't resist being the classically non-committal economist here. On the one hand, demand might be stronger than supply, and we get, as you note, accelerated price appreciation. But, on the other hand, if the supply response wins out, price appreciation may continue to slow down.
Odeta Kushi - Who called for the one-handed economist? By the way, there was a president that said they wish they had a one-handed economist.
Mark Fleming - One here, the other behind my back. There you go.
Odeta Kushi - There you go.
Sam Williamson - So, I can't help but think there's a common thread in all these questions that we haven't addressed yet. Drumroll please. Mortgage rates.
Odeta Kushi - Yes. Let's address the elephant in the room, mortgage rates. They stomp their way into every conversation. Mark, I think for this question, we have to look into the crystal ball. What are you seeing for mortgage rates?
Mark Fleming - Yes, fortunately or unfortunately, this is definitely the most frequently asked question. I guess we're saving the best for last here, and it's interesting and well timed, because the Federal Reserve Open Market Committee, the FOMC, as it's called, announced a half percentage point reduction to the benchmark federal funds rate in their recent September meeting. So, a rate cut for the first time in two years.
Xander Snyder - Right, and that it's a big deal because it is the first rate cut since monetary tightening began. And, according to the summary of economic projections that was also released in the same meeting in September, the Fed expects to reduce the base rate by an additional half a percentage point this year and another full percentage point next year. So, in other words, the Fed expects the federal funds rate to be 3.4% by the end of 2025, which is much lower than the Fed had projected at its last set of economic projections. In June, they were anticipating 4.1% at the end of 2025 just three months ago.
Mark Fleming - Yeah, that's a great point. Xander, in fact, I think that is the more important and newsworthy point than the half a percent reduction that just occurred. And, as we briefly mentioned earlier, the expectation of a rate reduction had already influenced the market, putting downward pressure on the 10-year treasury bond yield, and by loose association, mortgage rates in recent months. That's why we've seen rates come down in recent months already. Now that the Federal Reserve has started easing, and signaled that more aggressive easing trajectory that you mentioned, mortgage rates are likely to fall even further later this year and throughout 2025. Additionally, while the spread between the 10-year treasury yield and the 30-year, fixed mortgage rate has narrowed from three percentage points in 2023 -- that was a really big spread -- to approximately 2.6 percentage points today, it still remains significantly wider than usual, so there's still work to be done there.
Odeta Kushi - That's right, we've talked about this before. About a year ago, we published a blog post predicting that the spread would narrow, but not likely return to historical norms, which is between 1.7 to two percentage points.
Mark Fleming - Yes, you can check out that blog post linked in the transcript, and you'll learn all about why we made this prediction. But, looking ahead to 2025, there's room for this spread to narrow, though, again, it's unlikely to return to the historical norm. But, if that spread does narrow, mortgage rates could come down even more than the reduction implied by just the lower 10-year treasury bond. So, good news heading into 2025 for lower rates to some degree or another.
Odeta Kushi - We'll take any good news that we can. Indeed, lower mortgage rates are definitely at the heart of getting the housing market moving again. Now, let's turn back to the commercial world for our last frequently-asked question. With the Federal Reserve cutting interest rates for the first time since 2022, it's worth mentioning how slow the market has been and how eager everyone in it has been for activity to pick back up. A number of people have asked us this question in different ways, when is transaction volume going to pick back up, and what will be the catalyst for that?
Xander Snyder - Yeah, I think a low trough has been reached in transaction volume. We're either just past it, or in it right now. And, while interest rates played an important part in limiting transaction volume, the slowness in the market wasn't just an interest rate story. Higher interest rates made it costlier to borrow and therefore more expensive to purchase commercial properties. So, this limited demand to purchase properties among potential buyers, while sellers remained anchored to those really high 2021 prices that everyone got a little accustomed to and stuck on, so that created this gap in price expectations between buyers and sellers. And when there's such a disagreement about what something's worth, fewer deals close and transaction volume falls.
Odeta Kushi - I mean this anchoring bias that you mentioned, very present in commercial and residential real estate. I think we've talked about this in past episodes, but I do remember fairly early on in the CRE correction, you brought up how this market dislocation will impact the timing of the recovery compared to many in the market. You expected the recovery to be slower, taking until 2025 for the turn to really begin. This certainly seems to be the case as we approach the end of the year. But what led you to your conclusions about that timing?
Xander Snyder - Well, if you think about this slowdown as a function of that pricing disconnect, rather than just higher interest rates, then you have to consider what types of events would either force sellers to lower their prices, or buyers to raise their offers. Since treasury yields were higher than they had been for over a decade and price declines had already begun. Patient buyers had a low-risk alternative to park their capital and wait until they can get a property at that right price. So time has been on the buyer's side. Meanwhile, sellers could be forced to lower their price if mortgages came due, if they matured, and sellers therefore would lose the ability to wait for a recovery. And, when you looked at the pace of mortgage maturity through this year and also through 2025 -- we've published about this a good deal -- and you figure that on top of that, it takes several months to a year for a defaulted mortgage to turn into some sort of resolved transaction. That puts you into 2025 and that's essentially what has happened, and more maturities will continue to default next year, forcing more sellers to come to terms with these lower prices. But I do think positively that at this point, a substantial part of that price discovery process is already behind us.
Odeta Kushi - I think we have to end on that cautiously optimistic note in the commercial real estate market.
Mark Fleming - It's a wrap. 100 done.
Odeta Kushi - 100 done. Thank you all for the great discussion, and once again, welcome to the team, Sam. We're happy to have you. Thank you for joining us on this episode of The REconomy Podcast. And, as always, if you can't wait for the next episode, follow us on X. It’s @OdetaKushi for me, @MFlemingEcon for Mark, @XanderSnyderX for Xander, and @SWilliamsonEcon for Sam. Until next time.
Mark Fleming - Ch-ch-ch-changes and on, on to the next 100. What did that take us? Four years? Three years? Three more years to the next 100.
Thank you for listening, and we hope you enjoyed this episode of The REconomy Podcast from First American. We're pleased to offer you even more economic content at firstam.com/economics. This episode is copyright 2024 by First American Financial Corporation. All rights reserved.
This transcript has been edited for clarity.