Waiting for a Spring Thaw in Housing

Housing starts continued to decline in March to 1.14 million units to a 22-month low, slightly below the revised February numbers. The number of single-family units remained close to February figures but multifamily units declined month-over-month. Compared to March 2018, starts on multifamily units plunged 21% while single-family starts fell 11%. The three-month average of 1.19 million units is still below our forecast of 1.21 million for the quarter.

The unrelenting winter weather in regions normally experiencing milder Spring conditions has dampened residential construction. The biggest losses occurred in the Midwest and South where a bomb cyclone, flooding, and tornados hit in March. Construction of single-family units increased in the Northeast while starts for both single- and multifamily units surged in the West.

Permits for new construction also fell in March, with 1.27 million units recorded. Both single- and multifamily permits declined. Headwinds to supply-side factors, such as extremely tight housing inventories, have made it difficult for entry-level and low-income home buyers to participate in the market. In cities with the highest entry-level housing demands, such as San Francisco, rising construction costs (due to tariffs and labor shortages) and strict zoning laws have restricted the supply of new housing.

Last week, we saw a drop in demand for refinancing push down the number of mortgage applications. New mortgage rates remain low, with the average, 30-year fixed-rate at 4.17% according to Freddie Mac. This is expected to be stable since the Federal Reserve has indicated no rate hikes in 2019. A record-low unemployment rate and year-over-year wage growth are contributing to household formation and entry-level demand. Homebuilder confidence rose in April due to increasing demand but is trailing last year’s level. Entry-level homes are the most in-demand, but new home development remains concentrated in the high-end market.

Traditionally, younger homeowners have been the biggest buyers of entry-level housing but for the current crop of millennials, the rise in total household debt is delaying first-home purchases. This is mostly due to student loan debt; aggregate mortgage debt has remained fairly flat since the crisis. Surveys show millennials want to own homes as much as older generations, but their debt burdens delay first-home purchases as long as seven years.

At this stage in the expansion cycle, we would expect builders to build more speculatively to meet household formation. This is not the case; housing starts trail household formation by a significant margin. The expansion premium, or the ratio of the median cost of new homes to existing homes, is at the highest on record: 27%. The premium at the height of the housing bubble in 2005 was less than half of that (See chart). The high premium signifies that not enough new homes are being built for the low- to middle-income buyers. This is one reason we are not seeing the traditional multiplier effects from the typical first-time buyer’s additional purchases such as furniture and appliances.

Bottom Line
There is no Spring thaw in the housing market, where significant growth has been absent since the end of 2018. While the high-end luxury market of apartments and condos continues to be overbuilt, the demand for entry-level, single-family homes continues to grow. The result is a compounding shortage of affordable housing for the majority of workers who are being pushed farther out to distant suburbs. The resulting longer commutes could sap rising wages if gas prices continue higher.

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