By John Mulville, Regional Director – Metrostudy
Most people, especially those in the housing industry, can remember a few unbelievable anecdotes from the subprime era. One of the most memorable was the one about the Riverside County “investor” who owned 15 homes, all with “no doc” stated income loans (so called “liar loans”). Inevitably, the slightest hiccup in rent payments, taxes, dues and maintenance caused a shortfall in cash flow for this unfortunate investor that ultimately led to a bankruptcy filing.
Compare the subprime era to 2018. Our thesis for 2018 is that the current recovery is experiencing conditions that are diametrically opposite of the subprime era. In fact, the conditions that typify the current housing market expansion have established one of the firmest housing market recoveries in U.S. history.
Remember early in this recovery cycle when new home builders focused almost exclusives on upper-end housing? Here is why.
Upper-income households don’t rely on wages from working as do lower income classifications. Affluent households have investments and business income that recovered much more quickly and with greater vigor than wage income. As a result, this cycle has many more home purchases being made by financially capable households than has been the case in past recoveries. Higher income groups are financially resilient, make larger down payments and have greater reserves in case of financial distress.
A second factor is immigration. In recent years immigration has been dominated by well-educated groups that earn higher wage levels than immigrants have historically. Additionally, current immigrants have a much greater propensity to buy and will spend more on housing, with larger down payments, than existing American citizens. It is important to note that the housing stock in many foreign countries is very unattractive. Immigrants considering a purchase have reported that U.S. housing, particularly new homes, are vastly more attractive and livable than housing in developing nations.
A third factor is household debt. The so-called Great Recession rebalanced the amount of household debt with overall income levels (shown next). While it is true that the reduction in household debt came about as the result of foreclosures and short sales, it is also true that many households rid themselves of debt that could not have been paid off or amortized away. As shown below, debt service payments have retreated to levels last seen in the 1980s.
The severe shortage of new and existing homes for sale has forced those interested in purchasing to improve their standing as potential purchasers. In general, it takes a degree of determination and persistence to be a successful purchaser in today’s market. Prospective home buyers have cleaned up their credit, made multiple offers, and written “sweetheart” letters to sellers, only to find there are dozens of other buyers. Some interested buyers opt for the new home market, where they hope there is less competition. However, builders recognize the deep undersupply of homes and will tend to cater to those parties that have the best chance to qualify for a loan and the determination to complete the purchase transaction.
The competition for homes can be viewed in terms of credit scores among those that have qualified for a loan (shown next). As shown below, for 2017 the FICO score (credit ratings for consumers) for successful mortgage applicants is at an all-time high. Public homebuilders that often originate their own loans report similar stellar credit scores among their applicants. A 720 FICO score is considered to be in the “good” range and highly creditworthy. Accordingly, current scores indicate a highly qualified and capable pool of purchasers is competing for the available homes.
Much has been made about the lack of entry-level and first-time buyer activity until recently, when this activity has finally picked up. The fact that buyers are much older and marry later in life has a profound impact on the home purchase equation. Intuitively, we recognize that getting married later in life offers more maturity to the relationship; in fact, divorce rates for those married at older ages are markedly lower.
The same can be said for older homebuyers, particularly in a market climate were the determination and persistence needed to purchase will tend to exclude the less-committed buyer that may be infatuated with the concept of owning. Over time the older homeowner will prove to be a better neighbor, a better owner and a better borrower than would be typical of a much younger age profile.
Another contributor to the quality and durability of the current recovery is the lack of new home construction. The recession depressed housing construction levels in a very severe manner. Housing starts were far below the totals needed to meet population growth. New home construction rebounded very slowly, especially in Southern California, even as the economic expansion took hold and then strengthened.
The chart on page four shows building permits in six Southern California counties going back to 1990. Normal population growth suggested the need for 83,000 apartments, condos and single-family-home permits annually (as shown by the dashed red line). Permits levels have been below 83,000 in nearly all years and far below that level in most years.
The magnitude of the undersupply is large enough that there is no practical way to build our way back to supply/demand equilibrium. This indicates that strong demand will persist and that the current recovery will enjoy positive demand characteristics for years to come.
It is widely recognized that housing, or more specifically, poor credit standards and loan underwriting, led to the subprime debacle and the Great Recession. Historically and statistically, it is very unlikely that real estate will be the cause of the next economic downturn or recession. Additionally, policy makers and government officials have typically taken steps to avoid a repeat of the conditions that caused the LAST recession. The aforementioned factors indicate that housing will not be the cause of a similar disruption. Moreover, the factors suggest that the current housing market recovery may enjoy the firmest footing and the most positive alignment of conditions experienced by any housing market recovery in U.S. history.
Please refer any comments or questions to:
John Mulville, Regional Director – Metrostudy
2211 Michelson Drive, Suite 810
Irvine, CA 92612