Mortgage rates dropped below 4% this past year in the U.S., and this opened the door for many people to refinance current loans. The solid economy and strong employment numbers also fueled sales of new homes. In 2020, expectations are that the boom in refinancing will fade out and home sales will increase, but high construction costs will keep housing affordability at bay for many, according to experts.
“Home price growth has begun to flatten, and the real estate market is entering 2020 with a fair amount of momentum,” said Sam Khater, chief economist at the Federal Home Loan Mortgage Corporation, or Freddie Mac — the government-owned corporation that buys mortgages and packages them into mortgage-backed securities. He shared his views in an interview on the Wharton Business Daily show on Sirius XM.
Khater noted that the past year saw a pronounced slowdown in home sales and prices, particularly in the first half of the year. He attributed that to the run-up in mortgage rates that occurred in late 2018 and early 2019. “However, as rates fell in the second half of 2019, we saw a nice rebound in home sales,” he added. Overall home sales in 2019 were at 6 million, and Khater expected that to rise to 6.2 million in 2020, or about a 3% rise.
The Fed’s lowering of interest rates last year drove an increase in existing home sales, according to Susan Wachter, Wharton professor of real estate and finance. Expectations are for continued growth in existing home sales, which are 90% of all sales, she noted in a separate interview with Knowledge at Wharton. Specifically, she expected existing home sales to grow from 5.25 million in 2019 to about 5.5 million in 2020.
“Prevailing lows in mortgage rates are key to this [growth in home sales],” Wachter said. “The moderation in price rises in 2019 together with continued employment gains and wage growth are also factors in the positive outlook for existing home sales.” However, supply is still a problem, both in homes for sale and, especially, for new construction, except in prime real estate markets where supply exceeds demand, she noted.
No Relief for Affordability
At the same time, home prices, in general, are not likely to drop much further. “The rise in construction cost is likely to continue, with no relief from this source for affordability,” said Wachter. “Land, in markets with demand, continues to be a scarce resource. Productivity gains through mechanization have not taken hold, so labor scarcity is still a factor.”
Nonetheless, Wachter noted that at the top end, housing prices have moderated and are decreasing in major markets like New York, San Francisco and Washington, D.C., and said that was “due to a supply response to price increases in the new home luxury market.” Overall housing supply, though, continues to be limited, and particularly at first-time home buyer price points, she said.
“Millennials are now in their peak home buying years … their lagging home buying is now picking up.” –Susan Wachter
“Last year saw a pullback, moderating the record property price gains in previous years in top-end markets, particularly where demand was hit by tax code changes,” said Wachter. The 2017 Tax Cuts and Jobs Act placed a cap of $10,000 on federal deductions for state and local real estate and income taxes and eliminated some mortgage interest deductions. Those tax changes turned away prospective home buyers in many parts of the country.
The impact of the tax code changes will be most significant in places where home prices and real estate taxes have been high, such as the Northeast Corridor, particularly around New York, the Philadelphia area, Washington, D.C., the Chicago area and California, Moody’s Analytics chief economist Mark Zandi had told Knowledge at Wharton last October.
As it happens, the pipeline of new housing supply is increasing in those markets despite a fall in demand, said Wachter. That, she said, is because of a rise in construction starts in those markets in response to prior price increases. “The demand and supply side factors continue to contribute to price declines in these markets, and 2020 is likely to see further downward price adjustments in the high-end markets in these cities,” she added.
Supply Curves
According to Khater, the biggest obstacle the housing market faces is the lack of supply. Construction of single-family homes is yet to appreciably pick up, but the multifamily market is seeing “a good level of construction activity,” he said.
The shortage in housing availability means that “home sellers are in the driver’s seat,” said Khater. “The chronic shortage makes it much more difficult for buyers to find what they’re looking for.”
Khater noted that the level of unsold existing home inventory is at the lowest level ever in the last four decades, citing data from the National Association of Realtors. “We must continue to beat the drum for more inventory,” NAR chief economist Lawrence Yun said in October. “Home prices are rising too rapidly because of the housing shortage, and this lack of inventory is preventing home sales growth potential.”
The bulk of the lack of supply is in new housing, and part of it in the availability of existing homes, whose owners are “not trading up,” said Khater. “There are many Gen X buyers who are still trapped in their first home, and that’s because they can’t find the home that they want to trade up in. And so, you get this ratchet effect that occurs with the lack of construction, which is not just impacting entry level, first-time home buyers, but even trade-up buyers.”
According to Khater, “there’s strong latent demand,” but the shortage forces many home buyers to compromise. “They can’t find the exact location, the right school district, and so that compromise might be in terms of the price or the location,” he said.
Millennials Advance
One encouraging sign is that more and more millennials are embracing home ownership. “Millennials are now in their peak home buying years,” said Wachter. “With the youngest in their mid-20s and the oldest just under 40, their lagging home buying is now picking up.” She pointed to Census data which reveals that the home ownership rate among those aged under 35 years increased from 36.8% in the third quarter of 2018 to 37.5% in the corresponding quarter in 2019.
However, those numbers are significantly lower than the home ownership rates for people under 35 in earlier years, she noted. In the early 2000s, prior to the boom and bust of the mid-2000s, home ownership rates for those under 35 typically were in the 40% range, she pointed out. “We are also seeing a lower rate of home ownership in the age cohort of 35-44 years, which today at 60% is far lower than the historic rates (since the 1980s) in the high 60% range,” she said. The overall trend in household formation, or headship rates, for younger households is also down, she noted. “Both are the result of affordability barriers, with housing prices exceeding wage gains, in major markets across the country.”
“Between the flat rate environment and very good economy, and less competition for broker time, I expect 2020 will be a good year for home buyers.” –Sam Khater
According to Khater, the 72-million-strong millennial generation “will remain in the driver’s seat for the next few years.” The peak age cohort in that generation turns 30 this year, he noted. “Prior research has indicated that peak purchase activity occurs in the early-to-mid 30s, and so there will be a strong demographic tailwind from millennials for the next few years.” He noted that many millennials have begun transitioning from the rental market to the home purchase market. They also dominate the market among first-time home buyers, and that trend will continue, he added.
Historically, millennials delayed their entry into home ownership on account of several demographic, cultural and economic factors, said Khater. Delayed marriages and having children are factors that began with the tail-end of the baby boomer generation and continued, and the Great Recession of 2008 hurt millennials as they were forming their households, he added. “But now, they’re coming into the market in large numbers.”
Generation Z, which followed the millennials, has “strong feelings and attachments to home ownership,” said Khater, noting that a recent Freddie Mac survey indicates that an overwhelming majority of 86% of them want to own a home.
In 2020, the housing markets will benefit from a benign interest rate environment, by all indications. “The consensus among most economists is that the rate environment will remain lower for longer, not just here in the U.S., but also abroad,” said Khater. Much of that outlook has to do with the slower growth of the economy, slower population growth, and slower productivity growth, all of which have a downward pull on inflation, he explained. Inflation is what drives the trends in interest rates and then mortgage rates, he added.
Good Days for New Home Buyers
The lower mortgage rates in 2019 also saw a boom in refinance origination, which reached $850 billion in 2019, up from $540 billion in 2018. But Khater does not expect that trend to continue in 2020. “We expect refis to fade a bit in 2020 but still reach about $650 billion,” he said. “The main reason for the fade is that we expect rates to be flat relative to last year, and so you’ll get some burnout. There will be some that will still refinance in 2020, but the majority of them have already refinanced [their home loans].”
The slower pace of mortgage refinancing will free up bandwidth in the market for new home mortgages, which could see more people buying new homes. “Sometimes, when there’s a boom in refinances, it can crowd out some purchase origination because many of the brokers will tend to focus on refinances, which are easier to turn around and quickly refinance, versus a buyer,” said Khater. “So, between the flat rate environment and very good economy, and less competition for broker time, I expect 2020 will be a good year for home buyers.”
The broader trends are helpful for the housing market, as Khater rounded them up: “The economy is in a good place. I think the chances of a recession have receded. We’ve got good, steady job growth, good wage growth, and that will support the housing market in 2020.” Within that broader market, the housing market is “in an equilibrium, slow-growth state,” he said. “At this point, it’s not such a bad place to be.”
