On Friday, September 27, the Norris Group proudly presents its 12th annual award-winning black tie event I Survived Real Estate. An incredible lineup of industry experts will join Bruce and Aaron Norris to discuss perplexing industry trends, head-scratching legislation, massive tech disruption, and opportunities emerging for real estate professionals. All proceeds from the event benefit Make A Wish and St. Jude Children’s Research Hospital. This event is not possible without the generous help of the following platinum partners: the San Diego Creative Real Estate Investors Association, InvestClub, ThinkRealty, Coach Fullerton, PropertyRadar, the Apartment Owners Association, MVT Productions, and Realty411. Visit isurvivedrealestate.com for event information.
Bruce Norris is joined this week by Robert Dietz. Robert has a Ph.D. and is Chief Economist for the National Association of Home Builders. His responsibilities include housing market analysis, forecasting and industry surveys, and housing policy research. Prior to joining NAHB in 2005, Robert worked as an economist for the Congressional Joint Committee on Taxation. He has testified before Congress on housing, economic, and tax issues. He is a leading expert on home construction, analysis, and trends.
- What is the HMI Index, and where did it stand prior to the crash?
- What has characterized the cycle we have had since the Great Recession?
- How difficult has it become to build affordable housing?
- Why does there seem to be a decline in the urgency and intent to purchase a home?
- Where are builders moving to in order to construct new homes?
- How much are cities charging on average for impact fees?
- Where do interest rates stand, and how can there be negative rates?
The first thing Bruce thought of was how 2005 was a good time to join the National Builders Association. Builders were having the time of their life, and then things changed quite a bit. Bruce asked him about the transition that he saw. For example, the HMI Index was probably around 70 in 2005. Robert joined the industry at an interesting time, although he has been doing housing and real estate analysis for quite a while. The HMI is the NAHB/Wells Fargo Housing Market Index. It’s the monthly single-family builder confidence measure. It’s measured at a zero to 100 scale. They go out to survey builders, mainly small builders, and regional builders. Any score above a level of 50 indicates the more the builders in the survey view market conditions, which is a combination of demand-side issues and supply-side issues. They view those market conditions as positive. If you’re thinking about the early part of the last decade running into the Great Recession, market confidence was fairly positive. As that cycle began to age and it was clear that there was building out beyond household formations, builder confidence really dropped. At a low point, it was at a level of 8, which is really low. This was the depths of the Great Recession.
During his tenure at NAHB, he spent about three and a half years as the Chief Economist. Before that, he spent about 10 years doing industry analysis and tax policy analysis. The cycle we’ve had after the Great Recession has really been characterized particularly on the single-family side by a significant amount of under building. A lot of that is due to not necessarily demand issues and the problems with affordability and the ability to save for the down payment. What’s made this cycle different is that builders have faced persistent labor shortages, and it’s gotten a lot more difficult to access and develop the land. That has, of course, been over a period of many years contributed to a housing affordability crisis. The “Something’s Got To Give” moment essentially occurred last fall when mortgage interest rates hit 5 percent. Rates had been going up, of course, because of tax reform and the good amount of economic momentum. However, that housing affordability crunch that occurred in late 2018 really did take the wind out of the sails of the housing market. That’s essentially what we’re dealing with right now. We’ve got a little bit of a soft patch going, and some of the data that we have for April and May indicates that lower mortgage interest rates well below 4 percent. Maybe we have now turned the corner, at least in the local time period consideration.
What’s interesting about that is that we have a history of bouncing between 40 percent and 17 percent. In 2018 when the interest rates got as high as they were going to get, we were at 28. Historically, when we go from 28 to 17, we have an off to the races moment. That’s three or four years of extraordinary volume and price escalation as we go from 28 to 17 affordability. Bruce said what’s confusing to his is the affordability number 28 that we were at during our lowest. We didn’t have our normal reaction, yet it wasn’t unaffordable. Bruce wondered if, on a national number, whether we were reaching historic lows at a 5 percent mortgage rate in 2018 or if there were other contributors that made people just not want to buy. Robert said the NAHB works with the Housing Opportunity Index, which is their affordability indices. For California markets, the NAHB index has levels in Los Angeles and San Francisco where only 6,7, 8 percent of the combination of new and existing home sales are affordable for a family right in the middle of the income distribution. Those are incredibly low rates.
Historically, nationwide last fall we probably hit about a one-decade low on housing affordability considerations. What made this different was that if you talked to anyone familiar with mortgage interest rates in the 80s or the 70s, a 5 percent mortgage interest rate really doesn’t sound that high. It’s of course not, but what’s different is a combination of both the physical economics and the fact that there’s a dearth of particularly resale inventory at all levels of the housing market. Then, you have a combination of no resale and low construction activity at the entry-level. It’s that sort of missing low-end that’s really the challenge. If you’re already a homeowner, it’s pushed up home prices. That’s been good for the remodeling market for the last few years, although we’re seeing some softening in the remodeling market in 2019. That lack of inventory is very frustrating, particularly for millennial homebuyers who are finally starting to see some acceleration of wage gains over the last year or two. They have been out of school long enough that they’re starting to save some money, but builders have just not been able to supply housing at that entry-level price point. Nationwide, we’re talking about new home prices below $250,000. Part of the reason for that is the regulatory costs associated with developing, acquiring land, and then building the home. Those costs have gone up a lot in this cycle.
They did a study in 2011 and then repeated a study in 2016. Over that five-year period, regulatory burdens associated with lot development and home construction for single-family homes went up 29 percent over that five-year period. Nationwide, for the typical new single-family home, they had about $80,000 of various kinds of development costs. When you have regulatory burdens such as impact fees and design and green space requirements, it becomes a death by a thousand bucks exercise. How do you build $200,000 newly built single-family home when you have $80,000 of various kinds of government rules you have to pay for? It just becomes very difficult. There are some markets where it can be done. Some of that is geographic, while some are structural, such as townhouses.
When Bruce was a young married guy, he was lucky enough that the builders in California were building predominately entry-level homes. However, that was just a cycle. They’re not able to do that now. They will buy a lot, receive a permit, and they are already at $150 grand in an area that’s rural. Bruce asked where they are migrating to or if they are just deciding to never own. Robert said you see this clearly in both the migration data in terms of where people moving from as well as where some of the high growth rates and home construction are taking place. They’re not moving enough to reduce the population, but you’re losing potential population from markets like California, parts of Oregon and Washington, and then moving east. You see hot markets in places like Idaho, Utah, and Montana, which has done fairly well though after cooling off a little bit in 2019. They’re moving into these mountain states for different reasons. The cost of doing business is a little bit lower, which is good for employers. It’s easier to acquire land; and you can develop lots and communities faster, which is good for housing supply.
When you have the combination of jobs and relatively more affordable housing, you’re going to get growth. When Robert was in Spokane, Washington, he visited a different market effectively each week. He was there back in March, and there is a market that’s expanding. It has good price growth because they’re benefiting from the relative affordability conditions with respect to housing compared to, for example, Seattle and Portland. If you look at growth, right now it’s in places like the southern states where there’s a lot of momentum. This would be places like the Carolinas, parts of Georgia and Texas, and traditional places where you have a population from the Northeast and the Midwest that’s moving there combined with relatively wealthy baby boomers who able to pay cash and buy homes. Then there are the mountain states where affordability really does trump some of the areas in the West Coast. Therefore, housing affordability is on the verge of becoming a presidential election campaign issue. Housing often struggles sometimes to make its way among other big political issues that tend to be hot button issues that make cable news and are discussed on the radio. You’re seeing a lot of presidential candidates right now talk about housing policy and land policy. Combine that with a rise in the YIMBY movement, the Yes In My Backyard Movement, we’re going to see housing and housing affordability discussion going into 2020.
Aaron Norris met Robert in Austin at a conference for the real estate editors, and he was asking him specifically about California since they have the chart of the regulatory costs. He asked him if that included the cost of SEQA lawsuits as well as possibly the PR and communications piece. When a builder goes into an area and is trying to get through a large project, those numbers aren’t even calculated in that. One project the CBIA worked on involving a ranch took over a decade, and they donated 95 percent of the project to the land conservancy. When you can’t get through a project in over a decade, that’s a lot. Bruce had a friend who had a very unusually large parcel of land that finally butted up against population growth. It went into escrow with a pretty good-sized builder who spent $10 million in 10 years, and he finally gave the land back to the guy. He could never get it through.
You see it happening nationwide where it’s just taking longer and longer to develop the land. There is a Harvard economist who studies housing markets, and he wrote a paper in 2014 and 2015. That research showed that no single regulatory policy has as large an impact on the well-being of ordinary American households as our land-use rules. It’s hard to measure because every place has its own hang-ups and different kinds of concerns. Without a doubt, it has an impact in terms of rent markets, and the ability to afford an apartment has an impact on the ability to buy a home.
One of the numbers they have been watching this cycle that’s been kind of disturbing is the fact that even though the unemployment rate is well below 4 percent, you have some rebound in household formations. The share of young adults who now live with their parents has gone from one in 10 young adults 25 to 34-year olds two decades ago to one in five now. It has doubled, and it has doubled out of sync with the labor market cycle. Usually, that moves along with joblessness and people live at home during tough economic times. Instead, it continues to rise. Some will blame social factors or helicopter parenting, but he thinks a lot of it really has to do with housing affordability.
Bruce doesn’t recognize the urgency to own something either. He got married young at 17, and it was at the top of his list to own a house. He had a little can in the kitchen, and he would save $20 whenever he could. It was a big deal. They built a track of homes as a company in 2004 and 2005, and people were camping out overnight in a remote location. People were getting to buy them with nothing down. They were willing to drive two and a half hours each way to work to get their name on a grant deed. There was an urgency that Bruce does not see in the market now. That’s just missing.
From doing surveys with buyers, Robert has seen this declining intent to purchase. He thinks the lack of urgency, or in some cases actual resignation, has a lot to do with the fact that housing affordability challenges have been there so long that for millennials, some young Gen Xers, and increasingly Gen Z, have already decided the ability to save one hundred or two hundred thousand dollars to put down a sizable down payment is just so beyond their objectives. This also includes trying to build up a 401K, paying down their student loans, saving for their wedding, buying a new car. There is such a large list of cash crunch items for young household types that they have already accepted it.
That doesn’t mean that there’s some change in preferences. One of them, at the margin, is we’re seeing some additional growth of single-family built for rent. The stock of rental single-family homes has grown by about 5 million nationwide. The vast majority of that are owner-occupied homes where the homeowners have moved and they’re choosing to rent that out as their own household level business. There has been some growth in single-family built-for-rent. Historically, that market has been about 2.7% of single-family starts. Today, it’s a little less than five. It’s gone up, and they have seen you know tens of thousands of units that are being built by builders for rental purposes. He thinks the growth is going to be in places where you haven’t necessarily seen that before. That would include a lot of these West Coast markets that have affordability. That’s one way that builders in the market can provide a single-family structure type. Ultimately, when you go out and you survey people to learn the former preferences, those Millennials still want to become homeowners, about two-thirds of them. It’s certainly a great way to build wealth, it’s just a challenge to be able to do it in the near term.
When you look at the net worth of somebody retiring with or without homeownership, it’s just a very big difference. The wealth of the typical homeowner is well above a few hundred thousand, and the wealth of the typical renter is below $10,000. It’s scary. People see their 401Ks in the light, but the wealth associated with a home due to the way the amortizing mortgage works has been a kind of American dream creator.
What’s interesting about mortgage rates is there was a foreign country that Aaron sent Bruce an article on whose new rate for a 10-year loan is minus a half. He’s trying to get his arms around negative interest rates. He thought we would get there may be in one of the T-bills, but it never occurred to him that you would borrow mortgage money at minus percent. He’s still having a hard time getting his brain wrapped around that one. The economics of that are a little difficult to do. Clearly, one of the big economic trends we’re seeing is a lot of these European countries have 10-year government bond rates that are negative. What’s going on there is basically a flight to quality combined with an echo of World War Two. You can’t overstate what impact that has had on global economic conditions.
You have the baby boomers, and they are the wealthiest generation. They’re seeking relatively riskless assets, so government debt is one of the ways to do that. That’s one of the reasons that the discussion about an inverted yield curve is a little more complicated than in past cycles, even within the U.S. Some of that may not just be domestic investors seeking out a riskless asset. We have a lot of international investors as well. The challenge with the U.S. housing market is the fact that we’ve gone from about a 5 percent 30-year fixed-rate mortgage to about a 3.6% rate on average today, and there has not been a big take off in home sales, nor did they expect one when you look back 6-8 months ago. The reason why is to benefit from those low rates, you still have to accumulate the down payment, and you still have to be making a decision about where you’re going to buy and hold the home over five years. That has become increasingly difficult.
We have these interest rates, and yet you look at the employment chart and it looks like we have full employment. At the same time, we have a 10-year T-Bill at around 1.5. When you have a recession, you generally have the ammo to lower these rates four to five percentage points. When we have a recession show up, we’re not going to have that kind of ammo. Bruce asked Roberts what kind of policies he thinks will be implemented to help get out of the next recession. He said this is an interesting one because a year ago it seemed like the Fed was very focused on raising the Fed funds rate, which they did four times for 100 basis points in 2018. They were trying to raise rates in order to have ammo or the room for maneuver in case a downturn came. But, by raising rates aggressively they weaken the overall situation of the macroeconomy and brought on the very downturn that they were trying to fight, at least at a soft patch level. It’s a very bizarre strategy, and they’re clearly backing away from it.
Sometimes we can be guilty of Blackboard thinking or hypothetical thinking, but Robert is less concerned about the kind of lack of ammo argument mainly because he thinks the Great Recession proved that the Fed and central banks have other tools, including quantitative easing, where they can go and buy government debt and hold it on their balance sheet. That’s one of the benefits you get from the reserve currency and having that ability to regulate the monetary supply. There’s room to engage in quantitative easing when it’s required, although Robert does not think we’re there yet. While we have GDP growth slowing over the next 12-18 months or below 2 percent growth rates, we don’t have a recession on our table. We have something that looks a little bit like a growth recession that starts with the unemployment rate going up a little bit and growth slowing down.
The other tools we can’t forget our fiscal and regulatory policy. There’s still room for this administration to continue to make regulatory improvements. One idea out there that could help housing markets is the idea of tying some of the grant funding that comes from HUD and other agencies at the federal level to the improvement made by state and local governments in terms of their land-use rules, zoning rules, or how long a permit takes. It really incentivizes improvement on the regulatory side. There’s also fiscal policy. We’ve had a big tax cut in the form of the 2017 Tax Reform Bill, so he wouldn’t necessarily be expecting some big tax cut. But there could be some bipartisan agreement around something like an infrastructure financing bill. Given that interest rates on government debt are quite low, this would seem to be, from the economics point of view, a good time to do infrastructure financing. That could include things that would improve home construction like offsetting permanency reductions and making capital improvements. He is less concerned about the ability of the government having enough arrows in the quiver to deal with a downturn and more concerned about the fundamentals that are causing the slowdown in the economy. Those would include things like tariffs and the ongoing labor shortage.
Bruce asked Robert if he thinks the tax deduction changed as housing was hurt since most people probably don’t even deduct their interest at this point. He said they expect there to be a slowdown in-home price growth. They expected demand to be somewhat offset by moving to a regime now where you have basically about 34 million households a year. That included the mortgage interest deduction. Today, it’s a little less than 15 million. There’s been a pretty significant drop in people getting a direct benefit from the MID. Now there’s a $10,000 limit on state and local taxes, including property taxes. What a lot of people don’t talk about and that my team has done some pretty good modeling on is the fact that the Tax Reform Bill meant that most people who used to pay AMT as well as a lot of people that had big SALT deductions, sales tax, property tax, and income tax probably paid AMT. When you are in the entire system of the income tax, your SALT cap was zero because all your SALT deductions were wiped away. About 95% of those who used to pay AMT no longer do so. Because of the changes, we think on the net were good for housing and were good for builders because all the tax reductions, they expected some transition effects involving home price growth.
What’s interesting is if you look at, for example, single-family permit growth for the first half of 2019, you actually have single-family construction gains in states like Connecticut and New Jersey which would’ve been stating that you would have been concerned about with changes in the itemized deduction side for housing. They have grown in some of these other states where you have a fallback. His view on tax is a little contrary, and he tends to look at the net benefits. Overall, he thinks they’re positive. You certainly do see some weakness in high-end condo markets. Those would be places where the SALT limitation would have an effect. We can’t forget that protecting the business interest deduction for builders, small and big bill builders, was a big win for the industry when interest deductibility was tapped for most other businesses. It was protected for real estate and utilities. The protection of the principal gain exclusion for owning a home, the $250,000-$500,000 tax exclusion, was also a big win. Most of the slowness in the housing market is really do affordability and the fact that it’s just so much harder to add housing supply to all the different housing markets nationwide.
The Norris Group originates and services loans in California and Florida under California DRE License 01219911, Florida Mortgage Lender License 1577, and NMLS License 1623669. For more information on hard money lending, go www.thenorrisgroup.com and click the Hard Money tab.
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