Read the April Economic Currents in PDF
A surge in demand, unleashed by plummeting mortgage rates and the abrupt shift to working from home combined with years of underbuilding have triggered the strongest home buying and building spree since the bubble of the 2000s. Home prices in suburban and resort areas soared even as apartment rents and condo prices plummeted in what had been some of the hottest urban centers. Properties moved online as fears of contagion escalated. Bidding wars broke out for properties that were never seen, resulting in some buyers’ remorse.
Most of the trends we see emerging were already in place and accelerated by the pandemic. Older millennials, who had delayed first-home purchases, finally bought more expensive properties. Many baby boomers and the silent generation decided to age in place instead of downsizing to condos, exacerbating the shortage of homes for sale.
Other trends are new. Institutional investors, who once helped clear the overhang of less expensive, speculative properties in the wake of the housing bubble, returned. They scooped up the cheapest properties to rent instead of sell, reducing the supply of homes available to less affluent, first-time buyers. Bottlenecks triggered by the pandemic, fires and the widespread destruction of timberlands in the Northwest increased the cost of new construction. Immigration, which had been falling since the housing bust, came to a standstill.
This special edition of Economic Currents
focuses on the 2021 housing outlook. Special attention will be paid to the risk that conditions could be stoking another housing price bubble. The return of speculative investors ups the risk that home values could overshoot.
Optimism Tempered by Humility
Overall economic growth is expected to average 6.6% in 2021, the fastest pace since 1984. That follows a 3.5% drop in 2020, the largest contraction since 1946. Rapidly ramping up vaccinations and the one-two punch of easy fiscal and monetary policy are to thank for the optimism. Overall economic activity will easily cross the peak touched in the fourth quarter of 2019 in the second quarter of 2021; that is terrific, but we will still have lost at least a year and half to the crisis.
The words “at least” are important. Employment lags overall economic activity. It will take until 2022 to hit the peak in employment we saw in February 2020; that does not include what might have been. We were generating more than two million jobs a year prior to the crisis, which means we are still down nearly 11 million jobs since the pandemic took hold.
The U.S. is an outlier among its peers and still not out of the woods. Pandemics are by definition global; we haven’t even reached herd immunity here. The challenge is harder given the ongoing reticence on vaccines by adults, the lag in safe vaccines for children and the emergence of more dangerous variants. Humility has proven to be more useful than hubris when forecasting the end of the pandemic.
The good news is that homeowners have more equity
in their homes than they did during the last housing
bubble; this should help cushion them against any
future correction in prices. The bad news is that higher
prices are crowding out many first-time buyers. This is
undermining their ability to build wealth and contributing
to overall inequality.
The surge in home prices has added to questions about
the Federal Reserve’s resolve to allow a full recovery in
employment with a modest overshoot in inflation before
raising rates. Shelter is the largest single component
in determining inflation and plays an outsize role in
determining living standards. We are confident that the
Fed will wait because the correlation between shelter
costs and overall inflation has broken down since the
peak of the last housing bubble. Inflation does warrant
watching, however, given the infrastructure spending the
administration is talking about implementing.
The table provides a summary of our outlook for housing.
Home buying and building are expected to top 2020
levels this year but remain well below the peak hit during
the height of the housing bubble in 2005. Other trends:
- Lenders have begun to ease credit standards to offset
the blow to refinancing activity with more purchase
applications in the face of higher mortgage rates.
- Incomes are expected to remain steady as demand
for all workers picks up and emergency aid/stimulus
checks are replaced by actual paychecks.
- Consumer sentiment is expected to improve as vaccines
become ubiquitous, workers can more safely return to
work and prospects for the future brighten.
- Inventories are expected to loosen a bit from the record
lows we saw at the start of the year, as more existing
properties are listed and construction in the pipeline is
- Institutional investors are expected to remain in the
market, which will make homes even less affordable for
middle-income households in the near term.
Home sales are expected to reach 6.87 million in 2021 with
the momentum from 2020 carrying over. Both existing and
new home sales will increase as more supply comes on
line from sellers and builders. Inventories will continue to
be tight but up from the historic lows at the start of this
New home sales are expected to top 870,000 in 2021, 6%
above the pace of 2020 and the highest level since 2006.
Supply of new homes remains thin following a decade of
underbuilding in the wake of the housing market bubble in
the early 2000s.
New homes tend to be priced at the higher end of the
market, with the National Association of Home Builders
that about 60% of middle-income
households are unable to afford the median price for a
new home: $349,400. Widespread industry consolidation
combined with a shortage of materials (mostly lumber)
and a dearth of immigrant labor have pushed prices up.
that first-time buyers now acccount for
43% of new home sales. That is a huge jump from their
last estimate of 32% in 2018.
Affluent older millennials are dominating the first-time
home buyer market. Years of stock market gains and
falling mortgage rates have separated older millennials,
who were able to repair their balances in the wake of the
2008-09 financial crisis, from younger millennials and
generation Z. The latter are still lagging in their earnings
and wealth generation relative to previous generations.
In February, the backlog of homes sold pre-construction
surged 67% from a year earlier, while the inventory of
move-in ready homes plummeted. Rising mortgage rates
prompted buyers to lock in low rates and wait for their
homes to be completed.
Speculative investors are snapping up the least
expensive properties to rent instead of sell. Houston,
which is one of the most popular markets, has a
whole industry devoted to flipping homes to rent.
Those investors boost margins for builders but limit
opportunities for middle-income buyers.
Existing home sales are forecast to reach six million in
2021, 6% higher than 2020 and the highest level since
2006. The supply of homes for sale dropped to a record low
at the start of 2021. There were a little more than
one million homes listed; that’s nearly 30% below the
level before the pandemic. It was only the second time in
more than 100 years that the number of licensed realtors
outnumbered property listings.
Supply in the market will expand when more people are
vaccinated; that will help older sellers feel comfortable
with potential buyers entering their homes.
Lockdowns and the widespread adoption of work-from-home sent buyers flocking to suburban and rural
areas. The supply of homes for sale in rural areas has
44%. Many of those homes were bought by
investors to rent as vacation homes to wealthy urbanites.
The average age of homes on the market has increased.
The youngest millennials are buying the oldest homes
and shouldering the burden of repairs and upgrades.
Housing starts are expected to hit 1.56 million in 2021,
12% above the 1.4 million pace of 2020. These gains will
not be enough to make up for the shortfall in inventories.
Starts have been trailing household formation for the
better part of a decade, which has left the market grossly
Home builders faced a perfect storm. Consolidation in the
materials market constrained capacity, notably in lumber
mills. Bottlenecks triggered by the pandemic contributed
to delays. Producers idled by lockdowns and surprised by
the surge in demand for goods are still playing catch-up.
Labor shortages are chronic. Border closures during the
pandemic left builders without the cheap labor they relied
upon to build homes. Many of the workers displaced by
the pandemic lack the skills to pivot from restaurants to
building sites. One estimate
suggests that builders need
to hire nearly a half million workers, nearly double the
pace of prepandemic hiring.
Single-family starts are forecast to rise to 1.17 million in
2021, a 17% increase from 2020. Suburban markets and
second-tier cities are expected to see the strongest gains
as the push from first-time buyers supplants the demand
for vacation homes. Downtown offices will reopen but the
return to major cities is expected to slow in response to a
hybrid of work-from-home.
The strongest metro markets are expected to remain
Austin, Seattle and Raleigh, as the technology and
professional services sectors make up a large portion
of the growth in employment in these cities. We also
should see a nice snapback in tourist destinations such as
Orlando, Las Vegas and New Orleans. San Francisco and
San Jose are showing signs of coming back. Boston is
expected to rebound, while larger and less tech-intensive
cities such as New York and Chicago are expected to lag.
Multifamily construction is forecast to come in at 391,000
in 2021, close to the level of the last two years. A drop
in construction in the most densely populated urban
areas is being mostly offset by a pickup in suburban
A recent study
found that most of the loss in demand in densely populated areas was due to a shortfall in in-migration as opposed to a surge in out-migration. Foreign students who were locked out due to border closures couldn’t rent or buy near their universities in urban centers. Young graduates moved in with their parents to save on rent and work from home.
Vaccinations and partial office reopenings are bringing young adults back. Rents in the hardest hit markets have bottomed. New York, which suffered the biggest blow to in-migration during the pandemic, posted the strongest month for condo sales in 14 years last month. Many properties are selling at a discount but coming back nonetheless.
Cities with greater exposure to finance, information and professional services industries will fare better overall than cities with more manufacturing activity. The hottest construction markets are expected to be in the South. Dallas, Austin, Houston and Raleigh continue to attract tech firms and young professionals, while Charlotte, Atlanta, Orlando, Nashville and Miami are attracting finance and consulting firms.
In the West, Phoenix, Salt Lake City and Denver are leading the way. Many fled Silicon Valley early in the pandemic to take advantage of working from home in lower-cost areas. This trend will slow in 2021 but these cities will continue to see interest from younger workers looking for more space and a lower cost of living. Sacramento experienced a surge in Bay Area migrants and will continue to be a strong contender for in-migration in 2021.
In the Midwest, Minneapolis now has more apartment construction coming on line than Chicago. Cities like Columbus and Madison are expected to do better with strong anchors provided by universities and hospitals. We expect Detroit, Cleveland and Pittsburgh to remain laggards.
The latest infrastructure spending proposed by the White House will reduce land use regulations for multifamily properties. If passed, those changes could boost construction of more affordable properties in some of the most expensive markets. (Think California.) The problem is timing. That supply cannot come on line soon enough to stem the rise in rents at the lower end of the market.
Home values are forecast to rise between 5.6% and 8.3% in 2021, depending on the measure. That’s a slowdown from the double-digit pace of 2020; the least expensive homes experienced the fastest appreciation, as inventories dried up. Housing appreciation has yet to match the frenzied pace of the housing bubble, but risks are to the upside. (See Chart 1.)
New home values have not risen as fast as existing, despite the upward pressure on costs. That could change as investors take a larger share of new construction to rent instead of sell; they accounted for about 20% of new homes sold at the start of the year.
Housing affordability actually improved at the start of the year, but those figures are misleading. (See Chart 2.) The market is driven by more affluent buyers who have the income needed to qualify easily for mortgages. Middle-income households, who once dominated the first-time buyer market, are being pushed out. This is even as lenders are easing credit standards a bit. In response, rents on more affordable apartments and homes are accelerating, making it even harder for those at the bottom of the income strata to make ends meet.
Last, but by no means least, owners have much more equity in their homes than they did during the height of the subprime lending boom. FICO scores were much higher in 2020. That protects banks against losses, should prices turn south.
“Resolute Patience” at the Fed
Federal Reserve Chair Jay Powell and his colleagues
have laid out how they will be patient:
- They will hold the line on rates and look through a
temporary flare in inflation triggered by bottlenecks.
- They will wait for employment to fully recover what was
lost to the pandemic and then some.
- They would welcome a modest, persistent overshoot in
inflation to achieve a broader recovery in employment.
Most participants at the March Federal Open Market
Committee (FOMC) meeting expect to hold off on rate
hikes until at least 2024. That has provided little solace
for the bond market, which expects rate hikes to begin in
2022. This wouldn’t be the first time the bond market has
forecast rate hikes that never materialized.
The relationship between rising home values and
inflation has broken down over the last three decades.
Lower mortgage rates, easier lending standards and
refinancing activity have dampened the effect that higher
prices have on monthly expenses.
The larger issue for the Fed is how long it takes for wages
to accelerate. It took nearly a decade, a drop in the
unemployment rate to 3.5% and a slow increase in labor
force participation to get there during the last expansion.
Why do we care about wage gains? Because
accelerating inflation doesn’t stick unless those gains
are backed up by wages. The loss of worker bargaining
power has made that difficult. Even wage gains tied
to productivity growth have proven elusive in recent
years. Much of the acceleration in wages tied to new
technologies has been limited to the firms that produced
them; they never made it into overall wage gains.
We now expect the first hike in rates to occur in late 2023
instead of early 2024, a little sooner than the Fed. Our
forecast does not include any additional stimulus tied
to the administration’s new infrastructure proposal; if
passed that could move the timing of the first rate hike up
to Spring of 2023.
The housing market has come to embody the best and
worst of the COVID recovery. Those who were able
to work from home experienced a stronger recovery
in employment. They saw their stock portfolios soar
and, when mortgage rates dropped, they seized the
opportunity. They upgraded what they had, bought first
homes, vacation retreats and everything they could to fill
First-time buyers returned, inventories plummeted and
home prices accelerated. The market remains affordable
for the well-to-do, while low- and middle-income
Affluent first-time buyers and speculators will be driving
market gains in 2021. Those gains will provide younger,
less affluent buyers with homes to rent, but not own.
Housing prices will continue to rise, but the wealth tied
to the ownership of those homes will not be shared as
much as it once was. What we are seeing is not a typical
bubble, but still troubling; it is preventing many young
buyers from climbing the ladder of wealth accumulation
built by home ownership. Wealth inequalities will worsen.
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Copyright © 2021 Diane Swonk – All rights reserved. The information provided herein is believed to be obtained from sources deemed to be accurate, timely and reliable. However, no assurance is given in that respect. The reader should not rely on this information in making economic, financial, investment or any other decisions. This communication does not constitute an offer or solicitation, or solicitation of any offer to buy or sell any security, investment or other product. Likewise, this communication serves to provide certain opinions on current market conditions, economic policy or trends and is not a recommendation to engage in, or refrain from engaging, in a particular course of action.