It's been a couple of months since our last update on housing and housing-related consumer expenditure. As interest rates have meaningfully moderated, we’ve seen housing activity trackers picking up in November and December. Thus, it seemed timely to review the macro and Placer data. Our conclusion, housing is going to have a dynamic next couple of years.
Big picture–despite an unwelcome move higher year-to-date in the 10-year Treasury yield, mortgage rates have eased as the elevated spread between the two has begun to normalize. The move in the Treasury is in response to the Federal Reserve Board members challenging the market’s expectations for Fed Funds rate cuts this year. We view the direction of inflation as positive, but not yet “definitive” yet as we have yet to see a broadening out of lower prices for center-store grocery food items (i.e., packaged food). We expect to see “definitive” in the weeks to come, if so, Treasuries yields will ease, drawing down mortgage rates. Should the 30-year fall to 5.62%, it would improve affordability by 10% with the payment on the average existing home declining from 24.2% of median income to 21.8% (all things being equal) versus the long-term average of 20.1%. More importantly, lower rates will free up many existing homeowners from “rate lock.” A recent report from Zillow noted that 21% are considering selling their home within the next three years, up from 15% a year ago; that reflects lower rates and changes in housing needs (larger families, new job, return-to-office, change in life situations, etc.)
Existing home sales in December were about even to November, on a seasonally adjusted annual basis, to 3.78M. Prices gained 4% to a $382.6K median. If rates were lower and closer to most existing mortgage rates, home sales would be on the 6-7M range, if not higher in the near-term given pent-up demand. Total housing inventory at the end of December was 1M and unsold inventory sits at a 3.2-month supply at the current sales pace--1M units in inventory relative to 144M housing units and 85M owner occupied homes in the country is abnormal. The gap between the average length of stay in a home (13.2 years) and the actual turnover means that the last two years of subdued turnover puts pent-up demand at over 4M. On top of this, a decade of underbuilding relative to population growth created a deficit of 3.5M. Combined, that adds up to 7.5M units in pent-up demand.
Also of importance, there is still a much larger bolus of high potential first-time homeowners ahead of us as the large numbers of Millennials and Gen Z are just mounting, which will increase the 7.5M unit deficit. Should the 66–85-year-old age bracket choose to age-in-place (which is the trend), their retention of homes will make the deficit increasingly acute over the next few years. The growth in that bracket of +12M shown in the chart below, equates to roughly 5M homes that will be “withheld” from younger generations, assuming age-in-place trends continue. Not all will, but a lot will. That will create more demand for new housing and intensify the calls for zoning modification/modernization. To conclude, we aren’t calling when the jam releases, we are observing that the probability of that is mounting and inevitable. Moreover, absent a recession or "black swan events”, the recovery is likely to be a sustained, multi-year one. Given the large numbers that we are describing, where those households move will be significant to commercial real estate and retailers.
We used Placer’s Migration Trends Report to scout for regions that have experienced outsized migration over the past year. The state of California overall was little changed, but there was significant migration out of the San Francisco, Thousand Oaks/Oxnard, and Los Angeles core-based statistical area (CBSAs) and into San Diego and San Luis Obispo, with folks choosing these regions for more localization, less traffic, faster beach access, and less hassle lifestyle.
Looking at listed homes for sale per Zillow shows that San Diego at about 40% of the 2019-level 60% for Los Angeles. In other words, finding a home to buy in San Diego is a challenge.
The figures below also show that the price cuts for listed homes in Los Angeles were quite exaggerated over the past year.
What about building more? New construction is small relative to existing home sales, and existing home sales are what really moves the economy. New residential construction and single-family sales are running about at an annualized pace of 1.5M and 600K units. Single-family homes are about 1M of the 1.5M. Larger multi-unit structures (50+ units) starts were around 400K in 2023, up from pre-pandemic levels, but down -10% year-over-year due to higher interest rates. Assuming that rates continue to ease, more projects will start in 2024.
This past week, D.H. Horton reported quarterly results and CEO Paul Romanowski said, “Although inflation and mortgage interest rates remain elevated, our net sales orders increased 35% from the prior year quarter as the supply of both new and existing homes at affordable price points is still limited and demographic supporting housing demand remain favorable. Early signs for the spring selling season have been encouraging.” D.H. Horton expects to sell 5K more homes in 2024 than it did in 2023 (83K).
Given that new residential is relatively small, when the jam releases on existing, home improvement repair & remodel is going to move. We see consumer interest in the home improving in our comments above about mattress retail and in our discussion from last week. Additionally, this week Ethan Allen reported Q4 2023 results which had retail sales down -19% and orders down -9%. However, for December and January the trend has firmed up. (Ethan Allen caters to a more affluent consumer.) Ethan Allen CEO Farooq Kathwari noted, "For most of 2023, especially the last 6-7 months, consumers were focused on other areas. They had already purchased a lot of home furnishings. Their interest in other areas was evident. And what we saw actually in December is the month where we saw greater trends and traffic and interest in the home. We believe that after 6-7 months of not having that focus, consumers are getting back into the home...But overall, the perception is that consumers are now starting to get back in furnishing their homes. It's still early, but we are starting in a positive direction.”
