As the year begins, the U.S. housing market doesn’t look very bright. Demand will likely stay depressed through 2019: Supply shortages are keeping prices high, especially in gateway cities where much of the job growth is occurring. Add to that higher interest rates, which are keeping existing homeowners from moving up the property ladder.
However, demand could get a bump from millennials looking to move from renting to owning their homes, and in markets like Atlanta where the number of new homes is rising. “It’s not going to be a great year for the housing market — [prices are] way over the market peak,” said Wharton real estate and finance professor Susan Wachter, who is also co-director of the Penn Institute for Urban Research. “What’s going to keep this market growing are millennials and the affordable Southeast.”
Wachter and real estate professor Benjamin Keys recently shared their insights on the U.S. housing market for a series titled “2019: A Look Ahead” on the Knowledge@Wharton radio show on Sirius XM. (Listen to the podcast at the top of this page.)
“We’ve seen prices go up and up in the places where the jobs are, where people want to be,” said Keys, who is also a faculty research fellow at the National Bureau of Economic Research. “And those are the places where it’s hardest to build. We’re not seeing as much supply coming online.” A few small exceptions are in the apartment sector and dense residential development, he noted.
Wachter said she saw clear evidence of a “buyers’ strike” at the high end of the market. She pointed out that median home prices have been steadily rising. As of December 2018, the median listing price for a home in the U.S. was $275,000, while in San Diego, Calif., that was nearly $680,000, according to real estate firm Zillow. “Who can afford a down payment of 10% on a $700,000 dollar home – $70,000?” she asked.
Interest rates have been rising, too, adding to the pressure on home prices, although they have eased in recent weeks. “A combination of higher interest rates and higher prices are the real concerns going forward, [even as] we’re still in a low-interest rate, low-mortgage rate environment,” Wachter said. “The real problem is high housing prices. They’re just too damn high.”
For those who find themselves priced out of home ownership, renting is also getting expensive. “Rents are higher than they were in real terms in 2007,” Wachter noted. This is not because of a follow-on effect from high home ownership prices, but rather “the underlying cost of labor, land and materials in delivering the housing to the market.”
According to Keys, the essence of the affordability problem is “about people living paycheck to paycheck.” The long economic expansion after the 2008 recession, low unemployment rates and steady GDP growth rates “mask a lot of the challenges that many households face,” he added. “There are places where even those who are employed in relatively solid, stable jobs can’t afford the housing.”
Wachter agreed the disparities are stark. “It’s the hot markets where the jobs are, but they are most challenging to buy into,” she said. “Wages have not kept up with housing prices, particularly in the markets where the jobs are.”
Wachter saw “a bifurcated market,” where housing demand is slowing at the high end because prices are too high, but is strong in other segments because of millennials. Millennials predominantly are still renting, she noted, but “this is their peak age to switch to owning — they’re 30-31. So there’s a demand for that starter home among them.” However, even starter home prices have risen substantially, and so have rents, she added. “It’s hard to save for that home while you’re spending so much on rent.”
Prices of starter homes are high because high interest rates are deterring existing homeowners from making their next home purchase, Keys pointed out. Mortgage rates have risen above 5% in recent months, while many homeowners have locked in at rates of 3.5% or 4%. “That will limit their willingness to move up a notch on the ladder. You’re going to wait until you need the four-bedroom house, until you’re really overstuffed. So, you’re going to have this this housing lock effect, and that’s going to tie up more households in those starter homes.” He said he expects to see homeowners opting for renovations instead of moving into bigger homes.
“The real problem is high housing prices. They’re just too damn high.” –Susan Wachter
In any event, Keys is relying on millennials to pick up much of the slack in housing demand this year. “The millennials will be the saving grace for the housing market in 2019 — if there is a saving grace.” He noted that homeownership rates among millennials “have really shot up” in the past two years especially.
The Southeastern markets still have adequate supply of affordable housing and are seeing decent demand growth. Wachter noted that housing starts have increased in the Southeast, while they have plummeted in the west. “Not only do we have a bifurcation across income groups, we have a new geographical bifurcation going on – the more affordable markets are in the Southeast, and Atlanta is a good example of exactly this, where we see growth still occurring.”
Similarly, some markets have seen steady increases in housing supply that could help lower prices. Keys pointed to Las Vegas, where the available inventory has steadily increased in the past six months to 82% higher year over year. Denver, too, has seen inventory increase by 45% over the past year, he added. “Usually, that much supply in the market will lead to a softening of prices.”
Supply constraints apart, high home prices are also a reflection of rising construction costs seen in more expensive materials like Canadian lumber or Chinese steel and a shortage-driven increase in labor costs. “We’ve had a decline in undocumented labor for about 10 years since the housing bust, and a tightening of the borders makes it that much more difficult,” said Keys.
According to Wachter, tighter regulation is another factor influencing home prices. “The demand is in the markets that are already heavily regulated,” she added. “The demand is where the jobs are, and the jobs are increasingly in growing urban centers. And that’s where it is extremely difficult to build [because of] increasing regulation.”
Taxes and Overseas Demand
Several other factors are also dampening housing demand. Changes in tax laws have brought caps on deductions for property taxes and mortgage interest payments. As they take effect in the 2018 tax year, they will further hurt housing demand. “As people pay their taxes in April, we will see the impact,” said Wachter.
Demand from foreign buyers for homes in high-end markets, such as in California, New Jersey and New York, is down. Overseas demand has traditionally come from China, Latin America and Europe. “The slowdown in income in China is affecting gateway cities in the U.S.,” said Wachter. “Some of these cities are affected at the high end by the tax deductibility issue, too.”
“The millennials will be the saving grace for the housing market in 2019 — if there is a saving grace.” –Benjamin Keys
When it relates to demand from overseas buyers, “New York is not competing with Boston or Washington, D.C.; it is competing with London, Zurich or Frankfurt,” said Keys. “Those buyers can be very fickle, and they can be very responsive to the political mood in the country. We think of them as being very elastic in terms of their demand.”
Wachter attributed those trends to a global slowdown in housing. “Chinese buyers are not buying in London or in Paris either,” she noted.
Trends in housing could affect the overall economy in a big way if things go out of hand, Wachter said. “If the U.S. housing sector deteriorates significantly, it could be a driver of a slowdown. Housing is no longer a positive for the economy. Net-net it might be a slight negative, but it’s not going to cause a recession in 2019 – the question is 2020. We need to look to world politics and U.S. politics to see what’s going to happen to our long-term outlook and what that does for the housing market in 2019 and 2020.”
Housing industry watchers are also speculating about policy changes expected from Mark Calabria, the Trump administration’s nominee to head the Federal Housing Finance Agency, which regulates Fannie Mae and Freddie Mac, the government-sponsored enterprises that expand the secondary market for mortgages by securitizing them. (Calabria is currently chief economist for Vice President Mike Pence.)
“[Calabria has] had some very extreme views in the past about the role of the government in playing a central role in credit policy; he wants them to take a big step back,” said Keys. “I’m curious to see, given the state of the housing market, whether the government continues its role in stabilizing credit markets or whether it takes a big step back. We will see that debate play out during his confirmation hearings in the next couple of months.”