2021 Economic Forecast – Pt. 4 – Housing Market

Part 4 of our series on economic predictions in 2021 will cover the housing and real estate market, including trends in urban flight, single family housing, mortgage delinquencies, housing prices, and details on whether or not there’s a housing bubble.

And in case you missed them, see below for parts 1-3 of this economic series.


Hi, this is Bob Fraser, co-founder of Aspen Funds, and this is our 2021 Economic Forecast. We’re going to look at real estate in this section and pay a lot of attention to what is going to happen in real estate as a result of tax plans, stimulus spending, the COVID recovery, etc. And you know, our focus is again on the tides. So we focus on the big picture economic realities that are affecting the markets.

One of the things I realized decades ago, was that when the tides come in all boats float. Even boats that have holes in them, boats that are not great, all boats float. So if you invest in the wrong house, but you did it the right time, you’re going to make money. And likewise, if you invested in the right house at the wrong time, you’re going to lose money. And so when the tides go out, it doesn’t matter how good your boat is. And so we focus here on really understanding economic tides what are the major forces driving value and asset prices in our day. So let’s dive in here and we will look at the real estate market.

All right, I’m going to look at a few major trends. One of the most amazing trends that’s happening is we’re seeing urban flight. People are moving from urban centers, especially in pricier markets. So according to MYMOVE, in 2020 111,000 people have exited Manhattan. You’re seeing that exodus from higher cost urban areas. San Francisco, people are leaving these areas and, if you can work from home, why not? Why work in a crowded low-quality-of-life area, when you can have something that may be more appealing.

According to the multifamily association apartment rents, 76.4% of households made full or partial payments in September, versus 82% a year ago. So we’re definitely seeing some pressure on renters, but it’s not extreme yet. Again, helped by the direct stimulus payments, the unemployment checks and the PPP programs all contributed, so clearly seeing some challenges here.

One of the most amazing trends and something that we have been tracking and forecasting since we’ve been doing this, is a super strong single family housing market. We’re continuing an eight year trend of 5%+ year-over-year growth. So this is actually home price growth, you can see here’s the zero line here. So you can see basically since 2012, 5% per year roughly of home price growth across the United States and 7.3% year over year in October. As of October, 2020, average homes in the United States rose 7.3%. Again, it’s just smoking hot and we have been forecasting this for years and we’ll tell you what’s going on and why.

Before we look at that, according to Black Knight who tracks mortgages, mortgage delinquencies are right now at about 6.44%. During the great financial crisis, they hit almost 11%, but only 0.33% of those are in foreclosure, so it’s well below the great financial crisis peak but certainly concerning. Foreclosures are still low, the stimulus payments helped and this is unlikely to become a banking crisis like what happened in 2008 and ’09, so we’ll look at that and why.

According to Black Knight, 5.3% of mortgages are in COVID-19 forbearance plans. You can see it’s spiked up in May and has been dropping off. We are actually in the mortgage space, so we understand these numbers and they’re a little bit elevated because the forbearance is mandated by law. Fannie/Freddie Mac are required to forebear and there’s really no qualification necessary. So if you just say, ‘Hey, I have a COVID-19 difficulty,’ basically they would forebear. So a lot of these forbearance plans are simply people just putting money in their pocket who may or may not have a real challenge. So again, I think these numbers are overly inflated and not uber concerning right now.

Meanwhile, existing home sales are booming, highest in the last 15 years. This is all the way back, here’s the peak of 2006 and home sales are screaming even in the middle of the COVID crisis, home sales are absolutely booming. The 30-year fixed mortgage rate is one of the main reasons, it hit 2.67% right here. Crazy low for a 30-year fixed mortgage. Historically we can put this chart weight way back, and mortgage rates have never been this low. So it creates a massive demand and stimulative effect on home prices.

Housing prices are now above the 2006 peak except in the largest Metro areas. So this line right here, this red line is the national average. You can see the 2006 peak, well, we’re now above it. Here’s the largest 20 Metro areas and we’re just above that. And here’s the largest 10 Metros. These are big cities, San Francisco, New York, we are not quite at the previous peak. So home prices have had a pretty dramatic recovery and are now close to or above the existing peak. But after adjusting for inflation, let’s call it real housing prices, prices are still well below the peak, but close to the peak nationally. This is inflation-adjusted housing prices and you can see here nationally, we’re actually right about the peak. In the 10 largest metros, well below the peak. So after adjusting for inflation nationally, we’re 1% below and between 11-15% below in the largest metros. So prices have not recovered to where they would be with inflation.

One of the major factors driving the housing prices is it’s cheaper to buy than rent. Here’s the price to rent ratio. This is price versus rent. When it’s high, it’s cheaper to rent than to buy. So we’re still seeing prices well below the peak, 20% below the peak. It’s cheaper often to buy. And one of the factors we look at at Aspen Funds when we’re buying mortgages, is mortgages on homes where the combined principal and interest payments of the borrower is below the equivalent rent payments. And we’re seeing sometimes the principal and interest payments are half of what you would pay if you rent it. Rents have continued to go up throughout the crisis, and so it makes it cheaper to buy often than to rent. If you have good credit and you have a down payment it is generally cheaper and most metros or in many metros to buy than to rent. So that’s driving up demand.

The other piece is an acute housing supply squeeze. Today, 3.3 months of supply. So right here, it is literally an unprecedented shortage of homes on the market. Here’s the bigger story and here’s why we have been predicting housing price gains for the past and the next few years. The green line is single family starts. This is new housing builds and here’s multifamily starts. New multi-family structures are five units or more. So you can see this is all great, pre-financial crisis pretty steady, pretty strong building.

During the crisis, everything was crushed, multifamily and single family housing starts completely stopped. But what happened is during the recovery, look at this the green line, multifamily recovered significantly but single family builds never recovered. In fact, they’re below the lowest in the previous 20 years. And so single family homes have never recovered. And why is that? Well, back here, when you built a home in 2005, you could find a place where you could buy a piece of land. You build a house and you sell it and you would actually make a profit. But today if you were to buy a piece of land and build a house and sell it, you would not make a profit generally, except in the luxury market you’re seeing some of that but generally you’re not seeing much of that, certainly at the lower end of the market.

The reason is because inflation has continued on for 15 years. So the housing market took a dive, but inflation did not take a dive. And so the housing market has not kept pace with inflation. Today your cost of land, has gone up, your cost of building materials and labor have dramatically gone up. And prices when you sell it, have not kept pace. So basically homes are underpriced.

There’s two ways to fix this. Either private homes need to be cheaper to build, which is not going to happen, right? Or prices need to go up. This means there’s a shortage of supply coming onto the market, there’s no new homes competing with existing homes, why? Because they’re not being built, why? Because you can’t make money doing that. And so it’s not being built. So what’s happening is there’s been the chronic supply squeeze is partly due to the lack of new supply.

And so what’s very amazing here is we’re actually seeing for the first time homes are starting to be built. Now, we’re still just above half of where it was in 2006. So there’s not a lot of homes being built, but it’s actually starting to hit the normal range. That’s actually a good sign to me, it means that we’re going to see some new supply hitting the market. This number has to get back up here, or at least up here somewhere before we start to see any relief in housing price gains. Until then we’re going to continue to see housing prices for single family homes continue to go up.

So this is the same chart. This is the green line here but now what I did is I made it relative to population. So look at the new home starts relative to population. So not only are housing starts low, but the population of the United States has continued to increase and where do they live? Well, not in a new home because there’s no new homes being built. So we’re seeing just a chronic undersupply of new homes being built. Without new homes being built, there are simply not enough homes. And so until that happens, we’re going to see a supply squeeze continuing until prices rise to make new homes actually make sense for builders to build.

Here’s another amazing chart looking at consumer debt service. The consumer is in great shape in spite of COVID. Look at the COVID impact, this is debt service payments as a percent of disposable income. Debt service is how much you spend on an annual basis on debt service relative to your income. We’ve seen a dramatic improvement here where people are spending less money on debt. Why is that? Well, income is going up number one, and interest rates are going down. So the consumer is actually in very very good shape.

Housing affordability is increasing. Now this may be counterintuitive to a lot of people, but this is actually my version of affordability. This is personal income per capita divided by median home interest costs. So this is how much of your income are you paying for to buy a new home? This is the median home. If you bought the average home in America and you got a loan for the current interest rate, what are you going to pay in interest versus what do you earn? And you can see it’s actually rising dramatically. Why is that? Well personal income per capita is actually up. Why is that? Due to stimulus payments, etc.

In the United States personal income per capita is actually up and interest rates are actually down. So you’re seeing affordability increasing. Personal income per capita and savings from low interest rates is outpacing housing price increases right now. So again, it’s kind of surprising, but we’re seeing affordability going up, and prices continue to rise.

There’s a lot of concern about a housing bubble. Let’s look at this. This is current 2020 data from CoreLogic, who looks at mortgages. Today mortgage underwriting is far more conservative than in the 2000s. So here is the share of conforming conventional homes purchased with the DTI ratio above 45%. That’s debt to income ratio above 45%. So that’s your debt service payments relative to your income, meaning you’re spending 45% of your income on debt.

You can see 2006, which was the peak of the previous housing bubble, this was a pretty high number. Today it’s not anywhere near that. And here is the share of conforming home purchases with an LTV ratio above 95. So when you buy a new home, the loan to value meaning what’s your down payment. So this would be a 5% down. How many homes are bought with 5% down? Well, it was a significant number back at the peak of the housing bubble. Today it’s far lower.

Perhaps even more impacting is this, a chart again from the same company and showing six factors of credit quality. What’s interesting here is the percentage of low doc/no doc share, almost no low doc/no dock loans today. That was significant back in the great financial crisis, the idea that you could get a loan, you basically state your income, you don’t even have to document it. Today those simply do not happen, or they do not happen in a significant way at all.

And the second factor is the below 640 credit score originations. Again, very, very small relative to what was happening in 2000. So today we’re seeing every measure of origination loan credit quality is far, far more conservative than it was in 2000. Especially the greatest risk areas, below 640 credit score and no doc/low doc loans. So bottom line there’s no way we’re in a housing bubble right now. I appreciate other people disagreeing with me, but this is extremely clear to us.

The real estate bottom line is we’re going to see record strength continue. CoreLogic is forecasting 1.9% growth, which I don’t know how they get that after getting 7.3% in 2020. Zillow interestingly is forecasting a 10-12% growth in ’21, so that’s extraordinary. Our estimate is that growth will be at or above the 2020 level. So 8-10% growth in 2021. Why is that? Again, all the reasons we’ve said, fewer new homes being built, low supply, low interest rates, higher affordability, low price to rent ratios and a consumer that is very, very healthy. Basically every fundamental we look at is very, very strong. So we’re going to see a very good year for single family homes.

For commercial real estate, multifamily, and office, the global interest rate compression will keep cap rates low. So what I mean by that is today global interest rates, you look into Europe, interest rates are low and zero and negative, meaning if you put your money in a bank you will pay the bank to keep your money. Tt’s negative interest rates and that drives cap rates down globally. So if you have a billion dollars, are you going to put it in a bank and pay a bank to keep the money? No, what do you do with it instead? Pretty much anything else. And so you’ll go and buy an apartment complex, etc. So it creates a massive amount of liquidity where people are buying real estate and other investment properties. It keeps cap rates low and cap rates determine prices. So prices are going to continue high for the foreseeable future.

Global interest rate compression is a product of stimulus. It’s also a product of policy and it’s unlikely to change anytime soon. Interest rates are going to continue to be extremely low and that is simply going to boost multifamily and office. So I don’t know how much upside there is in those, but I don’t think there’s a significant downside.

Office demand will significantly soften as work from home becomes permanent for many or some. Even if 80% work from home becomes 20%, that’s still 20% less demand for office space, but since most office space is on long-term leases, impact was not immediate or acute. So we’re going to see softening but it’s not going to be a big problem.

Retail and lodging, huge opportunity in distressed properties. As we said, 24% of hotel lodging debt was in special servicing, which means loss mitigation. This is a huge opportunity for distressed properties possibly selling, who knows, 50 cents on the dollar. The infamous big short 3.0 trade was shorting hotel properties and hotel debt, that trade is going to be over and now I think the money is going to be made in distressed retail and lodging. So big opportunity for those who want to move into that area.

All right, next, we’re going to look at the stock market and take a peek at what’s happening in the stock market.

Related Articles

2021 Economic Forecast – Pt. 1 – The Economy

2021 Economic Forecast – Pt. 2 – COVID19 Recovery

2021 Economic Forecast – Pt. 3 – The Biden Tax Plan

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