Doug Duncan Joins Bruce Norris on the Real Estate Radio Show #401

Norris Bruce

Bruce Norris is an active investor, hard money lender, and real estate educator with over 30 years experience. Bruce has been involved in over 2,000 real estate transactions as a buyer, seller, builder and money partner.

Norris Bruce
September 26, 2014
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On Friday, October 24, the Norris Group proudly presents its 7th annual award-winning black-tie event I Survived Real Estate. An incredible lineup of industry experts will join Bruce Norris to discuss perplexing industry trends, head-scratching legislation, and opportunities emerging for real estate professionals. Proceeds from the event benefit Make a Wish and St. Jude Children’s Research Hospital. This event could not have been possible without the generous help of the following platinum partners: Auction.com, HousingWire, PropertyRadar, the Apartment Owners Association, the San Diego Creative Real Estate Investors Association and President Bill Tan, InvestClub for Women and Iris Veneracion, San Jose Real Estate Investors Association and Geraldine Barry, MVT Productions, and White House Catering. For event information, visit isurvivedrealestate.com.

Bruce Norris is joined this week by Doug Duncan. Duncan is the Chief Economist and vice president of Fannie Mae. He manages Fannie Mae’s strategy division and economics in the mortgage market analysis groups. In this leadership role, Duncan provides all economic housing and mortgage market forecasts. He also serves as company thought leader and spokesperson on economic and mortgage market issues. Doug also researches external factors in the economy and how they could impact the company and the housing industry.

Bruce asked Doug if anything surprised him in 2014 when he took a look at the year from the perspective of December 2013. Since we are now ¾ of the way through the year, Bruce asked Doug if anything jumped out that surprised him. He said the one thing that is close to that category is that the new construction is weaker than they had anticipated. In 2013 they nailed it pretty close. They thought there would be about 950,000 starts, and it turned out to be about 923,000 starts. They thought in 2014 they would ram up a little bit more to around 1,050,000, but it looks like we will barely be over 1,000,000. This was a little bit of a surprise to them. They have dug in some, and it looks like the hurdles of getting land, having it permitted, finding the right labor, both the numbers and experienced people, and geographies are the main hurdles.

Bruce asked how he feels about the sales of existing homes, to which Doug said they are down a little. They had seen at the beginning of the year they might be up by a couple percent, but they were actually down by a couple percent. They were off a little bit, but not as far off as they were on the housing starts. However, they had expected a slowdown because of the rate rise. They had taken a look at the last few times mortgage rates rose rapidly in a short time period. In both those instances, it was not house prices that were hit, it was the number of homes sold. They expected significant slowdown in 2013/2014, and in their view being flat would have been slowdown since most of them were expecting a 10% increase. Therefore, they felt okay about this part of the forecasts. If there is another rate rise, it will likely be tougher in 2015. However, they do not have this in their forecast since they think rates will stay where they are at today. What they do see another 5% increase in next year is in sales.

Bruce said what is interesting is that we are talking about rate increases that start with the number 4. In other words, this still causes problems for people. A rate going from 4-4 ½ causes a decision to either not be made or makes it impossible to qualify. It is not so much the level of interest rates that makes so much difference as it is the direction and speed of change in interest rates. Rates are falling, and this is off of refinancing incentives. This improves affordability unless incomes are falling also to where we are in a recession that could affect job loss. This would also affect things overall. When rates rise, if they rise at a pace which is approximated by the growth in real incomes, particularly for the middle class, then you don’t really see much impact on housing since the rise in real rates offsets the increase in mortgage payments that comes from that mortgage and the interest changes. When rates rise rapidly, households take time to adjust, and it definitely takes a hit. If rates go up, there will have to be a period of adjustment. They have not seen the income growth they need to see that adjustments rapidly. Doug said the Fed is very attentive to the fact of not only the rates rising, but the speed at which they are rising that will have an impact. This would be a misfactor on the market.

In the 70s, we had obvious rate hikes; but we also had growth and earnings that were very aggressive as well. That did not deter sales, yet it probably had very healthy sales because the hikes and wages were matching the hikes in the interest rates. There are three things to think about what would happen when rates rise. The answer has to do with why rates are rising. Rates are rising because the economy is strengthening and the value of investments are increasing. Incomes can also be rising, which offsets the increase in mortgage costs. If rates are rising because inflationary expectations are rising, you can also look at housing as an intermediate term known as an inflation hedge. Housing demand continues, and the housing sector does okay. If rates are rising because the Fed sees inflationary expectations rising and wants to keep them down, then economic activity and income growth slows. This leads to the number of homes sold falling. A lot of people infer that house prices will fall, but that is not actually what happens. The number of units turn back, but that is all.

In 2013 in California, we had a pretty aggressive price year. We really had momentum going into 2014, and now that we are closing in at the end of September that momentum seems to be completely gone. Bruce said that is unusual since normally momentum builds on momentum. This time that did not happen, so when you look at 2015 it is not building on momentum. When you do not build on momentum, people’s willingness to make a decision and their feeling that there is no rush may make them hold off on decisions about buying real estate. This could be true especially when they are continually told interest rates will not be changing any time soon. Doug said they have been doing a lot of surveying over the last four years, and out of a survey of 1,000 households they do every month there is a monthly series of indicators. They have done all sorts of special sub-groups looking at different parts of consumers.

There is no question that, particularly among younger households today, there is a conservatism. There are a couple basis, one being that rates are not expected to go anywhere anytime soon. House prices have come up, although they are still pretty affordable in most areas, although not all. The pace of increase has also been slowing, so in the consumers’ mind there is not really a reason to rush into the marketplace. They saw the damage that a lot of households took when they were afraid not to get on the ladder. They were saying they wanted to have their finances in shape, not only to acquire the house but to maintain it as well.

The stigma related to renting is also gone. It is viewed as a very reasonable housing choice for households of many different types. In some cases, you can save up the money in order to become an owner. In other cases, you may change jobs a few years from now and the payback period for the upfront cost on acquiring a house is longer than three years. The question then is why you would take the risk of not only being able to earn back that upfront cost in appreciation if you are not going to be there for a long period of time. We see a number of shifts like this in the consumer data. In the case of California, the state is made up of a couple of markets. It has some parts that are doing really well, while in other parts prices are still on the decline. As in all things, California is special.

The way the younger generation is responding is unusual at this age. This millennial generation has a big pile of people in their late 20s that not only are not buying a house, but they are not getting married or forming households. This is an unusual generation, and part of this is the absence of job growth for a lot of them. Other factors include student debt. The staff called Doug on something he was point out regularly that the share of young adults living with their parents is the highest it has ever been. This is true, so Doug would make the joke that both parties of that transaction saw it as an adverse situation. The staff called Doug asking if he knew that for sure, and he said it is a cultural thing. They actually surveyed the parents who have adult children living at home and asked them what they think about this. As it turns out, they are fine with it. There are a whole lot of reasons in the 18-22 year old brackets, especially being they are in college and tuition is expensive. They are living at home, and the parents are helping them not to take on more college debt by cutting their housing costs. In those households, about 54% of the household of the parents have full-time jobs, which they found to be a lower number than they thought. Only about 20% of the children have full-time jobs.

When you look at the older age group, you find out only about 38% of the parents in those homes have full-time employment. A much higher percentage, around 45%, of the adult children have full-time jobs. There is clearly a financial contribution that is being made to those households. When they asked the parents if they wanted them to move out, over 70% of those with the 18-22 year olds said they were comfortable with them staying at home and about 63% for the older group said the same thing. This reflects a number of economic factors surrounding the household. When they were asked when they were expected to move out, they said 2-5 years. This gives you a sense that there is not a sense of urgency on the demand side of the equation.

Bruce asked if part of the reason for this is that even though they have the education, they are not getting the jobs that they thought would be available. Doug said this is clearly the case, and there are a lot of anecdotes to this. Doug said he intends to watch the wage statistics for all non-supervisory workers, not just the production. The production ones have some manufacturing components to them and tend to be more highly compensated. If you look at the total non-supervisory wage rates, it has been flat. This is certainly a piece of it.

Doug saw recent data from the American Community surveys that took note of the people between the ages of 30 and 32 who are married, have college experience, an income, and a baby. They compared them to previous cohorts of that group to see what their homeownership rate was, and they are significantly lower than previous cohorts. At least in the near term, there is even among these prime first-time homebuyers, a conservatism regarding taking on the delegation of owning a home.

Regarding the job market, we have made up almost all of the jobs if not all of them that were lost in the Great Recession. Bruce asked if they are the same jobs that we gave up as far as full-time or earning capacity for those positions. Doug said there are two things to think about here. One is whether or not the number of jobs is meaningful. It is true that a few months ago we reached the same number of employed people. However, if you look at it for full-time employment, what you see is that according to our efforts we will not be back to the same full-time jobs until after the middle of 2015 around August. It depends on how many jobs we have between now and then. If you then adjust for the increase in the working age population, we do not get back to the same number of whole jobs until into 2016. If you adjust for that working-age population and look for the same number of full-time jobs, that is not until the middle of 2018. Clearly there are some structural issues related to that.

The other factor is if you look at the period of the recession, what you saw was an increase of about 2-3 million jobs that became part-time. These never came back to full-time. We saw a level shift in the number of part-time jobs. Since the end of the recession, most of the jobs they have been adding have been full-time. They never converted any of those part-time jobs back to full-time jobs.

There is also the category of people who are not employed, but they are no longer accounted in the unemployment because they stopped looking. This seems to be most of the gain. If you look at that chart compared to the gains in unemployment, it looks like they just disappeared and are no longer being counted. Doug said there are two or three things going on here as well. One is the leading edge of the baby boomers retiring. Doug does not know the exact numbers, but the estimates are around 10,000 per day. You have that as a natural part of the workforce that is going away. There has also been a documented significant increase in people living off disability. On this one, these are highly unlikely to come back out of disability and into the workforce. If you think about where they are age-wise and the remaining work time they may have as well as the real wage rates they would have to get in order for it to be more valuable to them than the remaining lifetime disability payments, it is really hard to see how this would hit the wage rate to where it would encourage them to go off disability.

These are two known factors, but the more disturbing thing is you can go all the way back to the 1950s and chart the workforce participation rate of males aged 16-54. You will see that it has been falling continually. What the tailwind was economically was you can view the same chart for women in the workforce, and you will see they were rising until 2000 when their participation peaked. Now they too are declining in terms of participation. Unless there is some structural policy that would encourage the re-entry to the workforce for those not retired or on disability. In addition, if we do not reform immigration, then that really suggests that change in the workforce structure would mean slower economic growth going forward. We have some serious challenges ahead of us in that regard.

Bruce asked Doug if he sees an immigration law change happening in the next twelve months and what impact it would have on real estate. Doug said he does not see this happening until after the next presidential election. If it were to happen, it would be a plus for housing. Doug has been curious that the housing industry has not been involved in the immigration debate because the domestic population birth rates is not replacements. The U.S. total birth rates is only replaced with the immigrant population. Bruce does not know how hard it would be for them to qualify for a loan within a few years of getting that citizenship. The long-term effect would be really positive, but the short-term effect might be very expensive on the system for health insurance in a state like California.

There’s no question that it is a mixed bag. Doug tends to be an optimist on immigration and believes that our immigration population is a net addition to economic growth. They did a piece recently looking at the pace of movement into homeownership of domestic households compared to immigrant households. These kinds of households move to home ownership much more rapidly than domestic households. On a balance for the housing industry, it is a net plus. Bruce said he wanted to see this report since it makes a lot of sense to him.

Bruce asked Doug about the mood of Congress towards real estate as far as it taking goodies away sometime next year. This could include interest rate deductions, no tax forgiveness on debt. Doug said he does not think you will see a move to curtail the mortgage industry interest deduction any time soon. If anything in that time, they might lower the cap on seconds or possibly eliminate it all together. He has not seen any proposals to date that would have any traction to do that. The non-taxable status of debt forgiveness, while it expired at the beginning of the year, will likely continue to be seen putting resolution on the government this week through mid-December. During this time he would expect it to be renewed at least for another year. It is hard to say what the negotiation will be, but it would likely be renewed retroactively back to the beginning of this year.

The one thing that changed that was hard for California was FHA lowered their loan limit in Riverside from 500 to 350. Bruce asked if he sees this being stable, or is the goal to get more conservative over time. Doug said at the present time he does not foresee another change. He is not sure what the thinking is, but likely part of it is to have some stability in the market and let the market adjust to this. Bruce asked if the real estate industry in general supporting the economy a lot less than it usually does at this point, both in construction and resale of existing homes. Doug said it definitely is. They did some work four years ago where they looked at, according to the US demographic profile, what would lead a normal level of housing construction between 2016 and 2020. Their estimate was an annual average units produced for multifamily and single-family manufactured housing would be around $1.6 million. This year we are just passing $1 million.

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