Missing links and multipliers

Marie M. Schofield, CFA, Chief Economist and Senior Portfolio Manager | June 9, 2014

  • Several forces are colliding now and causing a downshift in the trajectory of the U.S. housing recovery.
  • Household formations remain at multi-year lows due in large part to mediocre income and job gains in combination with high student loan debt by 25 – 45 year old homebuyers.
  • Fewer homeowners mean missing multipliers for growth. As a result, housing will prove less of an accelerator for economic growth in the period ahead.

Having witnessed a negative gross domestic product (GDP) reading in the year’s first quarter, it would be appropriate to assess the strength of the fundamental supports for growth apart from the blamed inventory swings and weather induced disruptions. One of the more important underpinnings is housing. This is not just due to the direct contribution to GDP from residential construction activity, but also because of the secondary gains from numerous multipliers on consumer spending related to housing. We are now finding out just how sensitive housing is to the jump in interest rates, which started about one year ago. But several forces, in fact, are colliding now and causing a downshift in the trajectory of the housing recovery. The effects can be seen in homeownership rates that continue to fall across all age groups, but particularly among the important 25 – 45 year old homebuyer demographic. Despite predictions by economists, household formations have failed to pick up and remain at multi-year lows. The undercurrents include mediocre income and job gains in combination with high student loan debt. While some have blamed weather, the weakest areas included the west and south—areas largely unaffected by snow and cold. But the most important shifts seen now are both cyclical and secular, together with re-regulation and some noted missing links.

First, new regulations were implemented at the beginning of the year, courtesy of Dodd-Frank (Ability-to-Repay Rule), which had the effect of tightening mortgage financing conditions and eroding the pool of eligible homebuyers. This was evident in the Federal Reserve’s Senior Loan Officer Survey released in April which noted banks were beginning to tighten credit for homebuyers and see weaker demand as a result (Exhibit 1). This policy-induced re-regulation requires higher down payments and FICO scores together with stricter income-to-debt ratios. The outcome has left entry-level and first time homebuyers on the sidelines especially those with student debt. This was underscored recently by a New York Fed study* which showed that young people with student loans were much less likely to invest in houses than those without loans, which is a reversal of pre-recession trends. They believe this is one reason why the housing recovery has not been stronger. When you restrict credit in the midst of a 100 basis point rise in interest rates and a 13% jump in home prices, affordability is invariably dented, particularly for many entry-level buyers. No puzzle here. Data from the NAR (National Association of Realtors) notes the current share of first-time homebuyers at only 29% versus 35% two years ago and a typical level of 40% in past housing cycles. While many point to the low level of rates versus the last 30 years, that news is inconsequential to young potential homebuyers accustomed to low rates and shocked by a 24% spike in anticipated mortgage payments. This lack of first-time homebuyers is an important missing link now in the housing recovery.

Exhibit 1


Source: Federal Reserve Bank Senior Loan Officer Opinion Survey

Second, an important support for demand this cycle has been from investors. Attracted by distressed home prices and low financing costs, investors with deep pockets have provided an assist for sales. But their share of sales has begun to shrink as distressed inventories diminish particularly in hard hit areas in the west and south. Distressed sales number about 15% of total sales, down by half in the last two years. So this added cyclical source of demand is now shrinking and handing off to (a somewhat diminished) one based on owner-occupied demand.

The third shift being seen in the housing recovery now is the transition to rising demand for multi-family units from single-family units and for rentals versus ownership. This is linked to many secular trends, not just reduced affordability. Overall it points to shifting preferences of buyers based on demographic trends and generational tastes. Multi-family units are generally less expensive and much smaller than single family units and are usually closer to metropolitan areas. Young people may prefer to live closer to the city and/or postpone the responsibility of homeownership until later. Baby boomers closing in on retirement may choose to downsize and forego the responsibility of yard-work. Of note, both housing starts and home sales have fallen in the last year, but the multi-family segment of each has shown either stability or increases in that time. Indeed the multi-family share of total starts has not been this high since mortgage rates were in the teens 25 years ago and homes were largely unaffordable. And within multi-family, the share built for rental is now at an all-time high (Exhibit 2). Homeownership rates have dropped about 1% each of the last three years, which converts to about 1.2 million extra households looking to rentals. Apartment rents are now climbing at the fastest pace this recovery. If financing conditions and consumer preferences remain in place, these trends will continue. The distinction is important from an economic perspective, as a housing market driven by multi-family has fewer multiplier effects for economic growth. Homeowners spend about 30% more than renters (on furnishings, appliances, repairs, etc.). And fewer homeowners (or just smaller homes) mean missing multipliers for growth.

Exhibit 2


Source: National Association of Realtors

Given the secular decline in homeownership, the continued difficultly for first-time and entry-level homebuyers amid tighter financial conditions and reduced affordability, and the generational shift in preferences toward multi-family and rentals in particular, it is no wonder housing has lost some thrust. It also remains very sensitive to changes in rates. As a result, the missing multipliers mean housing will prove less of an accelerator for economic growth in the period ahead, and trends continue to point to 2% to 3% GDP gains on average but not much more.


* NY Fed (Liberty Street Economics blog): Young Student Loan Borrowers Remained on the Sidelines of the Housing Market in 2013