2015 has been the year of many new developments closing out and/or being announced. While quite a few projects have come online, the building boom is still in the early stages as many developers are finally feeling as confident as they did pre-crash.
As recently as October, housing starts were up by 6.5% (Y/O/Y) to an annual pace of about 1.2M units. This is still shy of the 1.6M units that is needed to accommodate household formation & population growth ( (according to the Harvard Center for Housing) & well below the 2006 peak o 2M units.
(It’s important to note multifamily starts are a driving factor behind new development)
Around this time last year I wrote that I expect to see a beat on housing starts in 2015 and rents go up between 3-6%, depending on region, for the year in my 2015 Global Outlook.
Apartment Segment
Many developers believe a continued need to construct housing geared toward renters. Generally, this course of thinking continues to succeed as rents have rose approximately 6% in the US from this time last year (less in secondary and tertiary cities & more in top tier cities i.e. SF, NYC, Miami, parts of Chicago).
A fundamental shift towards renting across virtually all age categories because of an inability to afford a down payment, strict(ish) lending, high levels of student debt, lack of staying at the same job for many years, and psychological fear based on past economic occurrences.
From a simple S & D standpoint, I believe in the next 12 months, we will see pushback on rents as more units come online. In secondary markets, such as Chicago, we’re seeing this already as the continued push towards luxury apartments is starting to get market pushback. Developers are beginning to have a harder time getting to the 95% occupancy mark and have to give credits in one way or another to reach that mark. However, in the market as a whole, I believe 2016 will see net rent increases of around 3%-4% (the rental increases will be targeted in cities & neighborhoods which have a growing job base), but 2017 will be tougher to achieve further growth without financially engineering figures.
Middle Market
I continue to remain cautious on the middle market segment of residential housing. First of all, given the lack of focus means there is opportunity to be had if developers make the effort. However, land, material, and labor costs continue to be a burden. However, in cities such Austin, Nashville, and others, we’re beginning to see these developments pop up. My concern is there is a delicate balance between upward momentum in the US economy & affordability. 2.5% growth in the US economy bodes well for housing as oil stays relatively low (barring major geopolitical news) and wages increase to allow for additional spending and savings to provide down payments, reduce student debt, and finally leap towards a purchase. However, one must realize these are slow progressions and if rents continue to outpace, the situation will take even longer to shift because lack of affordability will continue to be the trend. Some noteworthy statistics are outlined below as they are particularly important to housing.
Stats to keep in mind:
- Labor Force Participation seems to have found a bottom around the 63% area
- Homeownership looks to have bottomed (see chart below).
- Signs of wage increases on the hourly earnings are in sight, but weekly earnings are flat meaning hours worked are not increasing. However, employers are increasingly complaining about a lack of qualified labor meaning wages could pop up to increase production with current staff (in addition of minimum wage increases over the course of the next couple years)
- Construction labor wages are up 5%+ in 2015
- Household formations are supposed to begin an upward trajectory as economic upswings coincide with child rearing.
Ultra Luxury Segment
The segment of the residential housing market which is alarming is the ultra luxury market. The luxury real estate market performed extremely well as US & foreign buyers have flocked to ritzy condos in top markets to either live or stash U.S. Dollars. Overall, this segment should do well again in 2016 , but watch for signs of weakness later in the year via absorption rates. I say this for a couple reasons:
- This buyer pool has seen their net worth grow as they were able to ride up the U.S. Equities swoon & buy distressed assets via PE funds. Many of them have purchased property in the past 16 months or are looking to buy the newest developments.
- Across the pond, foreign buyers have sought safety in the currency market and have traded their home currency for the U.S. dollar (chart below depicts the strength of the dollar in the past few years & outflows from China-I realize it’s not JUST China). With the Federal Reserve being the first central bank to begin raising interest rates and the remaining central banks around the world continuing extremely easy monetary policies, there should be a continued desire for a flight to safety. The PBOC will most likely continue to initiate rate cuts, the ECB will also continue QE, and Japan is behind their desirable level of inflation and will likely continue stimulus. All these are signs for a preference for U.S. Dollars vs other currencies.
- There will be natural pushback against developers who choose to try to push the luxury market further than the market can command; those “price cuts” can be considered noise for analysis purposes.
While luxury market should do well as a basis for currency hedges & safe haven plays, a natural concern is if/when HNW individuals slow down on their purchases based on fear and frothy levels. If you’re asking, “How did they sell out in that location?” The answer is simple: ZIRP.
Closing Thoughts
Overall the housing market in the US should see respectable sales and price appreciation, however, I think gains will be more targeted in select cities/neighborhoods across the country. 3-4% appreciation and 3-4% increase in sales Y/O/Y is obtainable as interest rates will still be at historically low levels and a Fed hike should be seen as a net positive for the economy; don’t expect robust growth unless the U.S. economy sees escape velocity. Lastly, residential mortgage lending has been provided to qualifying buyers vs NINJA.
Prices have come a long way since 2009, while growth is still likely, a price slowdown would be a welcome relief for the longterm sustainability of the current bull market. ZIRP & QE have brought the housing market back, let’s ensure it doesn’t end quickly even though we seem to be in the later innings of this cycle.