2017 MARKET OUTLOOK

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Recap of 2016 Predictions:

  1. “Overall expect respectable gains of 3-4% in appreciation as interest rates will remain at historically low levels.”
  2. “I believe we will see pushback on rents in next 12 months as more units come online, but will see rents increase between 3-4% (especially in markets with healthy job growth).”-
  3. “The middle market continues to be left behind, however from a construction standpoint, I remain cautious as slight changes in fundamentals make/break the middle class.”
  4. “The ultra high-end market show see a slow down as inventory levels continue to increase.”
  5. “Don’t expect to see robust growth unless the U.S. sees escape velocity.”
  6. “A price slowdown would be a welcome relief for the longterm sustainability of this housing bull market.”
  7. “I believe the 10 Year will trade between 2.2-2.75%.”
  8. Expect volatility in the U.S. Dollar, but the dollar should strengthen by end of 2016.”

Expect volatility in the U.S. Dollar, but the dollar should strengthen by end of 2016.”

2016 Housing Outlook

2017

Bond Market

I believe the US bond market will be important to monitor this year as the slow & steady rise in yields went out the door upon the announcement of Donald Trump as the next president of the United States. 
The chart below shows the tremendous run-up in yields; as one can see, there’s been a 40 basis point rise in yields ($1T+ in value has been wiped out) in a matter of two weeks. Much of the run-up is based on the assumption that Trump will cut taxes, return growth to US via changes in trade regulations, and spend up to $1T on infrastructure. The merits of these assumptions are questionable, but the possibility for drastic changes stoked the market. 

Remember, a steady rise in rates is crucial to the long term health of the US & global economy as excessively low interest rates for prolonged periods leads to investors, corporations, and banks skewing their view of the risk/reward scale as they hunt for yield (something we’re witnessing in today’s markets whether it’s equities, venture capital, debt, or real estate). The key word is steady. If the FED continues to keep rates artificially low, asset prices will bubble to unjustifiably high levels & if the FED/market raises rates too quickly, the delicate recovery may become hindered as companies face a significantly higher borrowing cost in an economy with is not growing at more than 2.5-3%, thus, they will cut back & simultaneously seek to disperse the additional costs; the consumer will be a bearer of some of these costs. 

2017 Bond Market

I mentioned the bond market & Trump for two reasons:

  1. Sharply increased borrowing costs equates to a challenging environment if there are further significant rate increases (i.e a run up to & hold of 3% on the 10Y).
  2. As it relates to housing, much of the construction over the past 24 months has been fueled by developers locking in low borrowing costs to offset rising land & labor costs. Additionally, the consumer, as a whole, is sensitive to shifts in living expenses (i.e. mortgage payments). This sharp rise & potential subsequent rises may cause a slowdown in home purchases which will have a deflationary effect on home prices & thus a slow down in additional construction thereby stagnating economic growth.

If the Fed does hike in December, which looks like it has been baked into the market, and hikes more than once in the next 6 months, it will lead to a further decrease in the Affordability Index on home purchases; the chart below shows how home affordability has been declining albeit in a nonlinear pattern, for the past 3+ years).  

Apartments

As of October 2016, multifamily starts were on track for 454,000 units in 2016; this is similar to this time last year when starts were on pace for about 465,000 units in the multifamily sector. The major driving forces remain the same: inability to afford a down payment because of high rent, continued high levels of student debt, psychological fear, affordability in neighborhoods where would-be buyers want to reside…etc. 

From a supply & demand standpoint, 2017 will see as many units delivered as we did in 2016. The issue lies in the fact that new construction is geared towards the high end. With the exception of San Francisco (because of the tech boom), Class A apartment buildings delivering in late 2016/2017 will face significantly greater competition from similar buildings in a narrow radius. This will lead to either rent concessions (as well saw in the latter half of 2016) or a mark down in rents. The exception will be in Class A buildings which target a completely different demographic (i.e. Ten Thousand in Los Angeles).
The chart below from Doulgas Elliman provides an insight into Manhattan’s rental market (that stats are similar for other parts of NYC); as one can see the number of new lease signings is down while the inventory has bumped up creating a natural shift in S&D in favor of tenants. 

Class B & C will remain strong in 2017. In 2016, we saw many condominium deconversions; essentially taking condominium buildings which are distressed in one form or another, and converting them into Class B/B- rental products. These conversions feature many of the same condo-quality finishes in Class A but less amenities (fitness center, parking, media room…etc). These upper-middle & middle markets had been left behind on a large scale for the past few years as developers chased new construction to capitalize on low cap rates on back-end sales of stabilized trophy assets.

Looking again at the lower end of the market in NYC, according to Jonathan Miller of Miller Samuels, the entry tier saw a 4% increase Y/O/Y & virtually no concessions. This is similar in markets such as Chicago & San Francisco where negotiating rents is a nonstarter.

Look for a deceleration in Class A product & a continuation in condominium de-conversions in major cities as this segment of the apartment market will have the most upside in terms of rent growth and long term sustainability. I believe we could see a steady 2-3% increase in rents in Class B & C while Class A suffers a flatline or a slight decrease in 2017. Remember, the fundamentals for millennials have changed. Yes, they may buy a house some day, however, layer the following together and come to your own conclusion:

Middle Market

I was cautious on the Middle Market going into 2016; my sentiment remans cautious even as wage growth begins to perk up past 2%. Yes, inflation stayed low, and household debt, for the most part, stayed at healthy levels. But affordability remains the issue. I believe most of America is still extremely sensitive to changes in the cost of living. Additionally, I think we’ll see the “starter home” phenomena die off in the next decade as there will be a generational shift towards renting until marriage & then buying a home for a family. 
Overall, new construction starts look to end the year around 1.32M with 865,000 of these being single family homes. This is the highest level seen since 2007 which should bring relief to the inventory conundrum. 

The second chart shows wage growth creeping past 2% which is a boom for housing, especially considering we’ve seen a slowdown in rent growth & relatively low gas & food prices over the past 12 months.

The greatest concern for the middle & upper-middle market remains interest rates; individuals in these tiers are most affected by small swings in interest rates; this is why we’re witnessing a surge in mortgage originations post-election as the sharp rise in rates has caused buyers on the fence to jump in & lock in a low rate as, in their opinion, the bottom in rates for the US has created a floor.

Luxury

I mentioned last year that the high-end will begin to suffer & sure enough, the high-end luxury market saw a noticeable slowdown based on supply & demand. Many condo and single family developers who purchased land in 2015 using 2014/2015 sales prices are suffering with unmovable inventory. Across the country, the top 5-10% of the market has seen a drastic slowdown in terms of sales. For example, Beverly Hills sales are down 36.5% in terms of number of transactions while inventory is up 19%. This holds true for Chicago & New York where high-end condo buildings as well as single family homes offer broker bonuses and other perks to get foot traffic through their doors.
The single family new construction & high end rehabs are the ones most at risk since they tend to be smaller developers/flippers who face their notes coming due. Large condo developers are generally capital-flush so they can weather the slowdown.

The major concern lies in the fact that 2016 & 2017 continues to see new high-end product come to market while 2015 inventory continues to sit. Unique products continue to sell, however, 2014/early 2015 pricing is no longer a sustainable comparable simply because supply has increased drastically, existing homes are beginning to come onto the market as they try to provide a 10% discount to the new construction units, and local & international buyers have pulled back as many have been quite active for the past three (3) years & don’t necessarily need their 3rd or 4th $2,500-$3,000/sq.ft condominium in Manhattan or their estate in Beverly Hills. 

2017 will be tough for the top tier as fewer foreign buyers & HNW individuals take their time to select the right property for themselves and their portfolio; remember, when you’re spending $3M+ on a home, you get to ask for whatever you want. 

“The next two years will be the year of the deal. There’s not a condo project coming out of the ground where you won’t be able to walk in and say, “Here’s what I am willing to pay.”- Kevin Maloney (111 W 57th).

Closing Thoughts

Watch for the top tier in apartments, condominiums, and single family homes, to slow down based on supply/demand fundamentals, political concerns, and affordability while the middle and lower end of the market should see respectable gains based on healthy job creation, rising wages, and government housing programs to bring relief to affordability. The wild cards that could slow down the middle & lower end of the market are the following:

Opinions are my own; this is not investment advice.