Home Improvement Trends in Real Estate with Brad Hunter of HomeAdvisor #498

Bruce Norris is joined this week by Brad Hunter.  Brad spearheads HomeAdvisor, which works with the analysis and tracking of housing markets and the home improvement industry using proprietary data.  In his former position, he was Chief Economist and Director of Consulting for Metro Study, where he orchestrated 100s of areas for specific housing market studies over his 18 years at the firm.  He also presented original research and insights to the federal agencies who focused on the housing industry during the depths of the housing crisis. that includes lots of real estate investor information!

Episode Highlights

  • What is HomeAdvisor and why should you visit?
  • What is the percentage of remodeling projects in today’s market?
  • How have demographics affected home improvement?
  • What output gap will we likely see filled this year?
  • How was investor participation in this last cycle, both foreign and local?
  • What should we expect to see for real estate in the coming year?

Episode Notes

Bruce asked Brad to say why people would want to visit the HomeAdvisors site and what services it provides. Brad said HomeAdvisor is an online matching service that helps put people who own homes and need somebody to help them to do a renovation or repair project together with the pros who do that kind of work. They are most well-known because of their vetting process and could reject anywhere between 10 and 15% of the pros who apply to be part of their network. They are so strict on who they let into the business.

Bruce asked if there is a feedback process somebody has used to see what worked well and what did not. Brad said there is and the individuals who use the service give ratings based on their experience. They then combine this with the screening process done up front to make sure they get somebody good. Bruce asked what the cost is for accessing this, which Brad said it does not cost anything for the consumer. He also asked if rehabbers use this; which Brad said they do and there are a lot of people buying homes, fixing them up, and putting them back on the market.

Brad finds there are two points in time where a big surge in home improvement happens relative to an individual house. This is right before it is sold and right after it is sold. People getting the house ready for sale, whether they are flippers or normal homeowners, need to get it prepared for resale. They need to get it ready to pass inspections, and if they do not pass an inspection they need to have a repair done for that as well. The overall goal is to is to make the place look beautiful, thus maximizing the curb appeal and value. After the sale occurs, the person who buys it will want to personalize it and make it their own space and put money into it as well.

Brad is an economist and knows the economy has to do with one’s willingness to spend money on discretionary projects. Bruce asked what phase or mood we are in currently. Brad said the economy definitely drives what goes on in home improvement. Confidence and equity are a couple key components. The confidence is in where your money will be in the coming year and will increase. Home equity is back, and we have seen an 80% increase in home values since the bottom. The Fed indicates the average homeowner has $167,000 worth of equity. Most of the people who were underwater in their mortgages are now well above. This is driving an increase in what is considered major home improvement projects.

Kitchen and bathroom remodels are up 50% while garage remodels are up 60%. Multiple room renovations are up nearly 70% in the last year according to the servicer requests coming through the network. There is $167,000 of equity that showed up in the life of somebody who owned a house, and the person renting it next door did not enjoy that. Bruce asked if there is a big financial outcome difference for people who do not own. Brad said absolutely and it is harder for people who do not own and are trying to get into homeownership. It is a great time if they can put together the down payment. Mortgage rates are very low, so it is a fantastic time to buy. Rents are extremely high, so it is also a fantastic time to buy relative to renting. However, a lot of people are having trouble and he often jokes they rely on a new form of GI financing, which now stands for generous in-laws.

What is interesting about the interest rates right now is Bruce does a lot of speaking in front of an audience, and there is not much appreciation on how unbelievable these rates are. They are so low that anybody considering refinancing or buying a house should take into account that this is a golden opportunity. Rates will certainly go up to some degree a year or two from now. Even if the rates are still at 4 ½ – 5%, the monthly payment could be up 15% compared to what it is today.

The other thing about this financing is almost everybody is getting something that is fixed. This means there is no balloon danger. The disadvantage of being a renter is no one will fix your room. Speaking of home improvement, Brad said when he thinks about the fact that mortgage rates will increase at some point in the future, this could cause people 2-3 years from now to put more money into home improvement or add space to an existing home. They will be faced with the decision of whether they want to walk away from his nice 3.5%, 30-year fixed and obtain a mortgage that is at 4 ½%. They may rather stick with the house they have and keep their fantastic mortgage rate. They would then put more into the house to make it more livable, which would include adding or reorganizing space.

Brad coined the concept of churn, which is what we will be missing. This is a big of a counterpart to that equation, but on balance you would still have an increase in home improvement activity. Brad has talked about churning in terms of recent numbers and existing-home sales. In his numbers, the number of servicer quests they have seen go through the system in the last year related to moving is up 90%, and the number associated with inspections is up 40%.

Bruce asked how demographics affected home improvement. Brad said the number 1 demographic is wealth, and the number 1 driver of personal wealth is equity. When you look at different age groups as another way to slice demographics, the baby boomers are doing the majority of home improvement in terms of dollars spent. Brad said they are really expecting to see the millennial generation step up in the next few years and do a lot of home improvement. They do not have a very high homeownership rate. They have to become a household first, which they have certainly delayed. What Brad is seeing in the data is that they are doing it later in life. They are getting married and having children, and we think this will increase in the future for that generation Y, which is a massive generation. It is actually bigger than the baby boom generation and will drive a lot of economic activity, home-buying, and renovation.

What is interesting about the output gap is that there are times you cannot make up the gap. However, this is one that will be made up most likely. We have a household creation gap that ultimately will be fulfilled and play catch-up. Here we will see really big numbers. It has already started to play catch-up, and there is still plenty of runway left. A few years ago when the economy was softer than it is today, we were only creating 400-500,000 households in the country per year. Now we are just over 1 million a year and will stabilize between 1.2-1.3 million a year. This justifies a lot more home construction and moving.

Bruce asked Brad how he feels about the investor participation in this last cycle. For the first time in Bruce’s memory, a single-family home was considered a cash-flow vehicle. You had hedge funds decide they would buy 10,000 homes. Bruce asked Brad how big a market-maker they were as buyers and if they would have a chance to be a market-maker if they decided to exit. Brad said they had an impact on individual markets and neighborhoods. If you look at their impact numerically in the aggregate compared to the whole country, they did not have a significant impact on what happened with prices. They were the tail, not the dog. It is likely true now that they are unwinding their holdings and selling off, which some people are not concerned about nor see as a big risk.

Bruce asked about the foreign investor participation and if they have been market-makers or isolated to small markets. Brad said it has been isolated, certainly in Miami where you had a huge influence from South American customers buying the expensive high-rise luxury condos developed in the last incredible wave. You then go to California, specifically Orange County where the Chinese buyers were driving a lot of the Irvine area housing market. They pulled back quite a bit since then, so in those kinds of micro markets they are market-makers. Their changes in behavior definitely have a major impact on what goes on, though not as much in the aggregate nationwide.

Affordability is interesting right now in that you have interest rates that start with a 3 and we are concerned. Bruce asked how he views affordability and if he is concerned about the levels they are at currently. Brad said home prices have rocketed up at such an incredible rate. In markets such as San Francisco affordability has become a major problem, especially if you want to buy a detached home in San Francisco that is well over $1 million. A lot of other markets have become extremely costly as well, even in markets like Denver. It did not even have that boom/bust cycle and it has become very pricey. It is becoming an issue such that we will probably see a slower rate of home price increase going forward.

Brad was part of a survey of 100 economists surveyed by Zillow, and they asked for his forecast of home price appreciation. Brad thinks home prices will generally go up, but will go down by a 2% rate over the next few years. Bruce asked Brad what happens to other statistics as affordability declines. For example, what happens to sales volume as affordability declines? Brad said economics says when the price gets high enough the sales slow down, you have to square that with what happens with all these households we know are being formed.

The reality is it will probably keep the rate of household formation lower than what it ordinarily would be. If the generation Y folks were behaving the same way the baby boomers did at the same age, we would be forming around 1.7 million households per year right now. Right now we are barely over 1 million. His forecast is we will end up at 1.2-1.3 million average rate, and that will be a lot lower than it ordinarily will be. This is because of affordability and the preferential shifts where people are saying the luster is gone from home improvement for a lot of potential buyers. There is a shift favoring a rental type of lifestyle for a lot of people.

Bruce said in his life he has had a few run-ups in prices, 75-80 just in California. These happened from 1986-1989 and 2000-2006. As prices go up, this is one of the main drivers of affordability direction. As those prices went up, affordability went down but the sales volume did not. Rather, it increased as affordability declined and it was construction that increased. Brad said this had to do with artificial demand to a degree. During the bubble we saw momentum buying, meaning people were buying because prices were going up so fast. They wanted to get in, get out, and make a lot of money. A lot of people did this until the music stopped and a lot of people got their heads handed to them financially.

Bruce said the same thing happened from 1985-1989, and part of the equation that happens is human nature kicks in and says they are really good at this. They will then proceed to buy something that will normally go up, so they will buy a bigger one or two. Lenders usually get rewarded by getting paid on time as prices go up. Everyone has equity, so you cannot really go into foreclosure since you have so much equity. You can exit, and that is what is interesting this time. They have a lofty affordability number. If you go across the board of California’s affordability, we are at 32-34%. This is a high number for California, yet volume of sales is pretty stagnant.

Bruce said this is an anomaly since we have really good affordability that has come off of 55 down to 35. However, their volume is not reacting like it is on sale or people are interested. Bruce asked how the lending world is contributing to the lack of volume. The period of 1985-1989 was coming out of a very deep recession, and 1981-1983 saw things catching fire in terms of overall growth. This led up to the .com bubble and people were looking for more increases in their asset values. Housing was a part of this.

On the financing side, we are starting to get a little bit more clarity about the credit box and starting to see banks loosening up a little bit. What happened was the pendulum swung too far towards ease in the boom and bubble period, then it swung too far towards tightness afterwards. We are still in the midst of this, but it seems to be easing a little. We have other affordability issues not financing related that are impinging on people’s purchasing. However, he thinks a lot of people who should be getting mortgages are not able to or are giving up on the process. The lending world is still trying to catch up with the economy, and Uber Driver has more difficulty showing his income.

One thing that fascinates Bruce is when he looks at the median income of an area and sees the resulting median price and there is sometimes a big disconnect. Using the examples of Miami and Tampa, Miami has a median income of $32 grand and a per square foot price of $364. Tampa has a median income of $5 grand and per square foot price of $106. When you have that kind of disparity in an area like Miami, Bruce asked Brad if this tells him the buyer is not living there. Brad said it does to a degree. There are two things involved here: the buyer who doesn’t live there, and within that there is the international buyer and a whole different driver of the market. In Florida, you also have a large number of people buying a house they will only live in part of the year. Those people are mostly rich and have the ability to own 3-5 homes located all over the place.

Bruce asked about when you have the standard median income in California of $60 grand, for example. Disparity of income is not huge in percentage, yet you have a very big difference in a median price that ends up in those states. Bruce asked about the reasoning for this. Brad said it always comes down to supply and demand, and the supply is very constrained in places where there are physical land constraints or very little land left. In places like coastal Los Angeles, in areas like Los Angeles, Orange, and Ventura Counties it is extremely expensive partly because there is very little land left. This is why the western portion of Riverside County has exploded, and now there are lot shortages along the north/south corridor. In areas like Houston, Texas you can grow farther and farther away from the urban core and form newer urban cores such as the woodlands and huge master community outside of Houston. There are so many dynamics, but a lot of it does relate to land supply.

Bruce did some investing in Texas, and someone had told him they were next to Dallas when they were not even close. Bruce said it would be like him being in Newport Beach and saying he was next to Costa Mesa. In Texas you are driving through 25 miles of cow pastures before you arrive somewhere else, and the availability of land is crazy.

Bruce asked Brad what he sees for real estate this year and next. Brad said we will likely see a slower pace of home price appreciation and more home production. He thinks we will also see a noticeable increase in these major home improvement and renovation projects, partly because of the home price escalation. We will likely see more of the expenditures to make the current house they are in more livable and up to date. These things are all going to be driven by supply, demand, and price.

For more good advice, you can visit his website at www.homeadvisor.com.

Brad Hunter on the Norris Group Real Estate Radio Show

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