Why Building More Homes Won’t Help Housing Affordability

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Certain old saws that fuel the predictions of economic pundits should periodically be tested to determine if they maintain their predictive accuracy.  Three such the old school rules that are heavily relied upon to predict and explain housing economics are the following:

1. When employment is high people buy homes
2. When interest rates are low people buy homes
3. When rent inflation is high people buy homes

Shelter is a product that millions of Americans will purchase each year, but what economic factors cause growth or decline in the purchase of this product? If high employment, low interest rates and high rent inflation, three factors that are present in today’s economy, stimulate the purchase of this product, then why has the level of growth in mortgage home sales this 8 year economic cycle disappointed many housing pundits and experts?

I give them (minor) credit that they no longer blame tight lending.  That completely unsupported thesis has finally succumbed to a slow and painful death.  The new “stalking horse”  that has replaced tight lending as the favorite unsupported thesis to explain the low sales numbers, is tight inventory.  According to the “experts” we simply don’t have enough homes to address the high demand.
In a previous article   “Low Housing Inventory Lie Still Lives On”

https://loganmohtashami.com/2016/04/08/low-housing-inventory-lie-still-lives-on/

I discuss and document with data, that existing home sales inventory ( annual months) was slightly higher in 2012-2016, the period of supposed low inventory, than in the period of 1999-2005, when housing sales were exploding.  In other words, if it is low inventory that is preventing growth in sales, why are sales lower in a time when inventory is higher than it was when sale were higher?

One of the problems with buying into the low inventory thesis is that what follows from this is the assumption that if builders build more homes, we should see purchases increase. And because supply has increased, home prices should be more affordable.

The obvious problem with this thesis is that builders are not building starter homes.  For the past four decades, in fact, builders are building bigger and bigger homes and flooding the market with higher prices homes for the wealthy. This will not do anything to make homes more affordable for the rest everyone else.

If you need proof of this, look behind you.  We already ran this experiment. Did the ramp-up in home building from 1994-2007, especially the massive over building from 2002-2006, make housing cheaper?

From Doug Short:
http://www.advisorperspectives.com/dshort/updates/Housing-Starts

Housing-Starts (1)

Adjusting to inflation, home prices were more expensive during the housing bubble years, when new homes were flooding the market.  More new homes didn’t and do not create housing affordability.

It might be the case that if builders were to build starter-homes that could compete in price with existing homes, than overall home prices inflation can cool down.  But this is a fantasy scenario that has virtually no chance of happening.  Builders have universally determined that the starter-home market is not where the profits are.

Bigger homes mean bigger profits.  In 1975 the median size of a new home was 1,500 sqft.  By 2016, the median size of a new home had increased to over 2,500 sqft.  There has been a larger inventory of new homes in 2012-2016 than anytime from 1999-2005 but fewer yearly sales
@georgepearkes
new-home-sales-and-inventory

From Doug Short:
http://www.advisorperspectives.com/dshort/updates/New-Home-Sales

Home-Sales-New

I think we can let go of the idea that if the builders build more homes, then somehow, homes overall will be more affordable.  It’s an idea that helps the builders sell stock but otherwise has no inherent value.

We have a permanent housing inflation problem that started four decades ago and will not be easily cured by dithering with the inventory of larger homes. Bigger homes for smaller families, for the sake of profit margin, has created this forever housing inflation issue.

We are almost running out of room to where using the thesis that lower rates will boost future housing demand. This housing cycle has had the lowest rate curve ever recorded post WWII for a long duration period.

30 years Mortgage rates

I don’t blame the builders for not building more.  I give them kudos for knowing that demand is too soft to push for more aggressive building.

Having said that, I believe that housing starts do have legs, because these numbers are coming up from the lowest levels ever recorded in U.S. history.

The additional factor to consider is the massive demographic bolus of younger Americans that will soon be coming of age to buy homes. They will choose between less expensive existing home available in all geographical areas or more expensive new homes clustered in a certain areas of a city.

To my friends in the housing analytics community, the affordability index that is commonly used assumes a 20% down payment and a starting debt to income ratio of 25%.  These numbers for this metric is outdated. The likelihood of a first time buyer or a move-up buyer of having 20% down, no revolving credit card debt and no auto debt is very low.

Mortgage rates could fall by as much as 2% in the next economic cycle, making the 30-year rate 1.25% – 2.25%. If this doesn’t happen then we will have broken a multiple decade streak of having 2% lower rates in each new housing cycle.  If it does happen we can expect another mini-boom of refinancing but how much it will help home purchasing is unclear.

It is unlikely that this demographic bolus of first time home buyers will be able to afford a new home.  I call this the “Tiffany Effect.” Just like most new couples cannot afford an engagement ring that comes in that distinctive blue box, only the very fortunate few will be able to afford a new home. The massive demographic push that will come in years 2020-2024, will increase housing demand but it won’t be as strong as some of my bullish friends in the housing community are betting on.

 

Logan Mohtashami is a senior loan officer at AMC Lending Group,  which has been providing mortgage services for California residents since 1987.

16 thoughts

  1. Lots of sound and fury. The answer is land; land is fixed in supply, making it a natural monopoly. The only way to make “housing” (land) affordable is Henry George’s solution: make land rent common property.

  2. Love this one! Thanks, hope you’re well!

    amy

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    Amy Tierce, Regional Vice President NMLS# 15695
    Wintrust Mortgage

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  3. “Adjusting to inflation, home prices were more expensive during the housing bubble years, when new homes were flooding the market.”

    Logan, you’re wrong about this. Mark Hanson lays out solid evidence of how the mortgage products of the bubble era effectively made for lower monthly payments (affordability) at the same price levels as today.

    Inflation adjustment is dirty in that a large amount of the CPI inflation over the past few years has been OER. Wage inflation hasn’t kept up.

    It’s the prices, stupid.

    1. What does what Mark Hanson said different from what I said. We both agree that housing inflation was rampant during the bubble years.

      However, currently, nominal home prices for existing homes are back to the bubble peak but mortgage demand is at cycle highs as well. New home prices currently are nominally way above the housing bubble peak but adjusting to inflation its roughly even and new home sales are also at cycle highs.

      But adjusting to inflation existing homes prices are still 13%-18% below the bubble peak, this explains why mortgage demand is at cycle highs in 2016

  4. would Trump Tariffs bring back jobs in long run? will lower corp. taxes help bring those jobs back ? affordability is our problem ! will minimum wage increase help anything ? would 15 dollars be to high causing loss of jobs

    1. No on Trump Tariffs, not that he would even do that anyway. Job openings for manufacturing jobs are actually at a cycle high right now. $15 min wage is only a rental demand issue. Only 3.3 million Americans work $7.25 min wage jobs most are 2nd wage earners and most all low wage service jobs are either 2nd wage earns and certainly not home buyers.

      A 2nd wage earner could be part of a home purchase if the primary earner makes money. However, in my 20 years I have never seen a min wage worker every apply for a home mortgage

  5. You contradict your own headline by conceding that building a certain type (size and cost) of homes would increase affordability, and then work around this reality by suggesting that no one has an incentive to build them. While this may be true for public homebuilders, that proves nothing.

    In fact, many operations have the cost structure to deal in affordable homes. They are typically generally busy rehabbing existing homes.

    The real problem is that mortgage lending regulations are so complex, many lenders won’t contemplate doing a sub-$50k loan for a home in a working-class neighborhood. These homes do exist in abundance outside the coastal markets.

    Below whatever price point where lenders will lend, affordable homes trade almost entirely to cash buyers. Namely, to investors who would keep them as income properties

    If lending were equally available all the way down the price ladder, a reasonable exit plan for sale of an affordable home to a first time buyer would exist. That takes concern for the building about investor activity in an area suddenly drying up off the table.

    *Some* builders could and would build homes that would ease the affordability problem, because that is how markets work. Fix the small loan lending problem, and the incentive to build inventory will take care of itself. So, yes, building more homes could increase affordability.

    1. Did the massive building in 2002-2006 make housing affordable or less affordable. Because adjusting to inflation home prices were the most expensive on record right when we push out more homes in a 3 decade cycle

      1. It wasn’t the building boom that made housing unaffordable, it was the credit boom. Even though construction is cyclical and volatile, there are physical limits (e.g, availability of building materials) Construction, cannot possibly keep up with changes in credit, much less changes in consumer purchase behavior. If anything, construction was a response to the rise in prices, and blunted that rise – even if the overhang later made the correction worse.

      2. If I am to use your logic above. Then you’re going to have to explain to me this.

        Why are new home prices well above the nominal peaks of the housing bubble and even adjusting to inflation as well.

        When —

        – New home sales have had its worst demand curve post WWII at the lowest interest rate curve post WWII

        – New home sales have missed sales expectation for 3 years in a row ( all in late cycle action) with 2 years missing by double digits

        – MI2MP model Median Income to Median Prices have deviated from the 1967 trend at the highest rate ever recorded in U.S. history

        – New home sales today on a nomial basis are only 0.2% above where they were in 1963. Adjusting to population they’re 41.8% below 1963 levels and we are still headline at the same levels in the early 1980’s recession when rates were over 14%

        – Also, for the first time ever recorded in U.S. history we are selling more bigger homes over 400K than smaller homes under 200K, with the biggest gap in prices between new vs old ever in American economics

    2. Lending standards are not tight at all

      Since 2008 ( FHA VA and GSE ) have had 0%-3.5% down loans with 620 Min fico scores and 43% debt to income ratio loans going into 2016.

      MI2MP model has now blow well always from the 1967 trend for new homes because the builders went for profit margins as they need to for wall street. However, at that cost we are now at over 2,500 median sq foot for a home in 2016.

      Hence why new home sales are still at recessionary levels in 2016, 8 years into the cycle with annual months of inventory higher than any period from 1999-2005

      1. Admittedly FHA market share is climbing, back toward 2010 peak, but the difference government programs are now almost the entirety of lending for the most affordable homes. Weakness in new home sales (for reasons I described) has more to do with the number of higher income households. That data doesn’t tell us anything one one or the other about affordability, which starts at the lower end of the market, where trading up can drive volume.

      2. Majority of all loans are through government agency. The QM laws don’t hold FHA legally liable as they do with the GSE loans. The FHA 2012 Solvency act which passed congress very easily made sure to leave that out of FHA. FHA went up to 40% of the market share from 5% after the bust. However, what got them into trouble was the DPA loans Down payment assistance which has been banned after their bad loss ratio metric.

        GSE, FHA, VA, still 0%-3.5% down with a min of 620 fico and a 43% debt to income ratios.

        Its just now poor cash flow Americans don’t buy homes, hence why we have a high level of A prime buyers now. No more exotic debt to get them in.

        However, in a few years we will have a massive supply of home buyers into the economy but this cycle was very demographically light years 2008-2019

    1. Median Income to Median Home Prices.

      This article

      Home Builders, New Homes Sales And The Affordability Myth

      Charts in her to show my point on the deviation from the 1967 trend for new homes only.

      June of 2015, I went on CNBC and warned that the builders were over valued once again because the sales estimate where simply too high, We had a correction in the builder stocks, some stocks back to 2013 pricing and then in Jan of this year I said this is the time to get in.

      April 23rd I even wrote that its time for builders to show some growth now, each report after that call has shown YoY growth.

      However, in the article below there is a Data line in which I speak of.

      Updated version I have shows more inflation but the charts show what I am talking about it.

      https://loganmohtashami.com/2016/01/25/home-builders-new-homes-sales-and-the-affordability-myth/

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