Terrorism. Civil unrest. A sharply divided nation in a presidential election year. Mediocre jobs and income growth. Record debt. Higher interest rates. All of this sounds like bad news for home building in 2016.
Except that it isn’t.
Based on a sampling of forecasts from, among others, the NAHB, the National Association of Realtors (NAR), Fannie Mae, and Metrostudy (owned by Hanley Wood, BUILDER’s parent company), 2016 will shape up as a modestly good year for home building, continuing a trend of improvement from the market depths of 2009 that began in 2012.
The state of the economy will have much to do with that. As 2015 entered its final month, the U.S. economy was “not doing too badly,” according to economist Paul Krugman in the Dec. 7 edition of The New York Times. In fact, according to NAR, 2015 was “the best year since the recession.”
The consensus among most economists, including Krugman, was that the Federal Reserve would raise its key overnight funds rate—the first rate hike since December 2008—possibly followed by additional increases during 2016. (Krugman argued against raising rates, citing the risk that doing so could “end the run of good economic news.”)
In the days before Krugman’s column was published, researchers at both Citigroup and J.P. Morgan warned of recession. Citigroup predicted a 65% chance of recession in 2016, while J.P. Morgan cited a 76% chance within the next three years. These two forecasts were at odds with most others, particularly among those that focus on housing. David Crowe, chief economist for the NAHB, predicted growth in gross domestic product (GDP) of 2.8% in 2016 and 2.7% in 2017. Crowe’s counterpart at the NAR, Lawrence Yun, expected 2015 GDP to come in at a tepid 2% then rise to 2.7% in 2016.
Likewise, Fannie Mae projected GDP growth at 2.4% for 2016 in its November 2015 economic forecast. And Bill McBride, founder of the well-regarded Calculated Risk housing and finance blog, wrote of the forecasts, “Looking at the economic data, the odds of a recession in 2016 are very low (extremely unlikely in my view).”
The Fed appeared to be in agreement with the housing sector and, at press time, it was expected to act. Consequently, near the end of the year, the housing sector was bracing for an increase in mortgage rates. Ordinarily, that’s not good news for home builders and sellers, but a gradual increase could benefit the housing sector, at least in the short term, as prospective buyers enter the market to lock in lower rates before they increase further.
“It certainly will matter,” says NAHB’s Crowe. But not so much for mortgages as for other types of loans since fixed mortgage rates are tied more to yields on 10-year and 30-year Treasurys, which are more affected by inflationary expectations than they are the Federal Funds rate (the rate the Fed charges banks for overnight loans and the rate they are expected to increase). Those expectations, in Crowe’s view, are very low. He sees the Consumer Price Index (CPI) logging a 1.6% gain in 2016, rising to 1.7% in 2017.
The Fannie Mae forecast sees the Federal Funds rate rising from 0.1% at year’s end to 0.3% in the first quarter of 2016, 0.5% in the second, 0.6% percent in the third, and 0.8% in the fourth. It also projects that rate rising from 1.1% to 1.5% in 2017. It expects the CPI to log in at 2.1% in both 2016 and 2017.
Where will rates go? Fannie projects that 30-year fixed-rate mortgages that meet its guidelines will average 4% percent in 2016, up from 3.8% in 2015. NAHB comes in at 4.5% in 2016 and 5.5% in 2017 for all fixed-rate mortgages, while NAR expects rates to climb to 4.5% by the end of 2016. Adjustable rate mortgages, which are a sharply lower percentage of originations than they were during the bubble years, will average roughly a percentage point less, with five-year adjustable-rate mortgages (ARMs) at 3.2% and one-year ARMs at 2.8% in 2016, according to Fannie Mae. Mortgage originations, meantime, are expected to drop from 1.71 million in 2015 to 1.40 million in 2016, almost entirely due to a decline in refinance loans. Purchase-only loans are expected to rise from 923,000 in 2015 to 953,000 in 2016, according to Fannie.
Housing Starts Outlook 2016 Chart
There should be plenty of money looking for a home, meaning mortgages should become easier to obtain for many. With much of the global economy in slowdown if not outright recession, and the dollar strong versus other currencies, money is flowing from overseas to the relative safety of the U.S. economy. “We are benefitting from foreign investment,” Crowe says. “I don’t think that is going to change regardless of what the Fed does.” Beyond that, higher rates mean more potential profit for lenders, which helps mitigate fear of risk.
NAHB sees housing starts rising from 1.109 million in 2015 to 1.258 million in 2016, with new-home sales rising from 508,000 to 641,000. That is just about half what sales were in the peak year of 2005, but edging ever closer to what the group sees as a normal annual sales volume of 800,000 to 850,000. Single-family starts, Crowe says, should come in around 713,000 for 2015 and rise to 875,000 in 2016. (The difference in starts and sales is attributable to homes built to order on land belonging to the owner.)
Fannie numbers differ a bit, with the projection for total starts to end 2015 at 1.116 million (710,000 of them single-family), rising to 1.232 million and 827,000, respectively, in 2016. NAR’s predictions are in the same ballpark at roughly 1.1 million total starts in 2015, rising to 1.3 million in 2016. However, NAR puts new-home sales at 505,000 in 2015 and 590,000 in 2016.
Metrostudy’s outlook is closer to Fannie Mae, calling for total starts of 1.235 million in 2016, with single-family up 11% to 820,000, according to chief economist Bradley Hunter. Prices, on the other hand, will encounter headwinds: “The pace of increase in new-home prices has been extremely strong, but will slow in the next couple of years,” Hunter says. “The spread between new and resale home prices has become quite large, and higher mortgage rates are in our future. Both of these factors will create a drag on home price increases going forward.”
There could be other challenges. NAHB’s Crowe says he is wary of “black swans,” or unforeseen events that could act to disrupt the global and/or domestic economies. Moreover, he adds, “What scares me the most is inconsistent expansion of employment.” In its annual housing forecast, issued in late October, the NAHB noted that total U.S. employment of 142 million in 2015 exceeded the previous peak of 138 million in 2008; however, that job growth has been heavily concentrated in the service sector, which lags goods-producing enterprise in wages.
On that note, Mark Boud, senior vice president at Metrostudy, believes improvement is ahead. “Household income growth, which has been relatively stagnant for years, will finally begin to rise fairly dramatically during the next 12 to 36 months,” he says. “Whereas household income growth has been far below 2% for the past few years, income growth will surge to at or near 3% annually during the next few years. This improvement correlates with a tightening labor pool, stronger economic growth, and higher productivity.”
As home building enters 2016, it appears that the “new normal” that established itself in the aftermath of the housing crash is going to start looking more like the old normal in some ways but continue rapid, perhaps even radical, change in others. In its annual forecast, the NAHB devoted considerable attention to survey results from Trulia housing economist Ralph McLaughlin that indicate half of all Americans prefer suburban and rural areas to urban living.
“The return to the urban area was a momentary excitement,” says Crowe of the Trulia data. “The idea of living in suburbs will return, both for affordability reasons ... and [the fact that] job locations are spread out everywhere.”
There is a problem with that, however, and it is land. Builders are running low on finished lots, owing to the time-lag between land entitlement and breaking ground. As Crowe explains, it takes four years or more to complete that process, and four years ago, lot acquisition was still mired in the downturn. He says he does see a gradual improvement in supply in 2016 and beyond.
Regarding available land, Metrostudy’s Hunter sees a big change on the horizon. “‘C’ is the new ‘B’ for builder project locations,” he says. “In the next two or three years, I expect that locations in markets all around the country that used to be considered subpar will now be in the running, and some of them will actually become the ‘B’ or even ‘A’ locations of the future.”
Still, according to Trulia research, 25% of those surveyed said they prefer urban living. Metrostudy’s Boud sees a trend toward smaller, more efficient housing options to serve that demographic. “Micro housing will be increasingly explored in urban areas of the country, both in rental and for-sale formats,” he says. “Extreme price levels in many urban areas will push many major cities to ease restrictions on unit sizes, allowing for condominiums to be built down to 225 square feet. Demand is high from foreign-born purchasers who come from areas, mainly Asian markets, that are acclimated to such living conditions. But demand will grow from younger ‘techies’ drawn to the urban core. These young workers are well paid and are increasingly drawn to real estate investments, partly due to the poor return in other investments. Though this trend will be more of a ‘fad’ in many markets, some urban markets will increasingly employ this type of housing to bring workers to jobs, ease traffic congestion, and enhance affordability.”
A bright note for builders will be a continued easing of the logjam that occurred in the materials sector as housing began its recovery in 2012. “The world economy continues to be weak,” Crowe says. “The U.S. is not going to have to compete with other countries for building materials.”
The materials sector is still in transition. Tobias Morrison, Metrostudy’s national sales manager for the building products manufacturers’ channel, says, “Labor continues to be the biggest challenge on the supply side of the equation. While most manufacturers are desperate to get back to 1.5 million housing starts, the truth is that many of them do not have enough skilled labor to meet that demand.”
Manufacturers also are shifting focus. “More and more, the supply chain is realizing that the old way of selling product through builder rebates and personal relationships is not proving to be effective in the new now,” says Morrison. “Instead, they are shifting gears from simply offering a view of products and rebates to helping the builders understand their consumer targets and how the products going into the home can help them attract their ideal consumer.”
Labor will continue to challenge builders as well. “Labor capacity dislocations, disruptions, mismatches, and asynchrony have not gone away, nor are they likely to recede,” says John McManus, editorial director of the Residential Content Group at Hanley Wood. “What we’d actually predict for 2016 is a decisive beginning of new disciplines, expertise, and practice that gets more to the heart of the labor capacity constraint issue. What that all comes down to is what price needs to be fairly paid for the accomplishment of a job.”
Regarding product, big changes loom in what is likely the fastest growing segment in home building as millennials finally enter the home-buying market. “Entry-level demand will finally increase,” says Metrostudy’s Hunter. “The only difference is that entry-level will no longer be synonymous with ‘first-time’ home buyers. Many of the buyers buying entry-level new homes will have owned existing homes previously.”
McManus sees other beneficiaries in the segment: “Our 2016 prediction is that we’re going to see smaller-volume custom home builders emerge as powerful, scaled lower-price, higher-quality builders, which syncs with our sense that younger adult buyers’ demands are not only for relative affordability, but ‘personalization’ and quality at a level that not many typical big builders find to be their comfort zone.
“Opportunity will come to companies that have processes that can scale one-offs, accommodations, variations, and flexibility,” McManus continues. “Custom builders have that in their DNA, so it will be no surprise to see the volume and pace of some of those organizations looking mighty surprising.”