Weak Fundamental Demand Still Confounds the Market
Daniel Edward Rosen April 5, 2012, 12:30 p.m.
Underlining a shift in assessments of the housing market, homebuilder sentiment recovered strongly during the first quarter, rising to its highest level in almost five years.
Contributing to the brighter outlook, investors have been ratcheting up their acquisitions of single-family homes. The National Association of Realtors, meanwhile, reported last week that sales of investment and vacation homes surged in 2011, with the former jumping almost two-thirds from a year earlier.
Are these gains unqualified indications of an inflexion, as they have been proffered? The devil is in the details: referenced only in passing in last week’s reporting, the association also found that owner-occupied sales fell sharply last year. Fundamental demand—where the buyer will then occupy the home—remains frustratingly weak. Investors may have clear intentions for their newly acquired assets, but only a subset of the homes sold across the nation last year truly helped to bring the supply and demand for current occupancy back into balance.
Among the lessons from the housing crisis that we must be at pains to remember, investor demand can overstate the strength of the housing market if it leads or decouples from the households that will ultimately make use of the asset. Recounting the recent history of Fort Lauderdale and other markets where volume and sentiment were run up by investors, Floridians can speak to the difference in outcomes when a condo is owned and when it is both owned and occupied. While they are at it, Florida’s housing lenders can even disabuse us of the fantastic notion that every self-declared vacation homebuyer is planning a vacation.
Disappointing trends in fundamental demand reflect a range of intractable challenges, including the lagging jobs recovery, young Americans’ fluid preferences for ownership, and potential homeowners’ difficulties in securing financing. Regarding the last of these, data that show an increase in failed contracts is consistent with an anecdotal sense of the market and with much tighter underwriting standards that underpin the increase in rejected mortgage applications. A proxy for those standards, the weighted-average FICO score of mortgages acquired by Fannie Mae in 2011 was 762. The average score for 25- to 34-year-olds—the breeding ground of new ownership—is closer to 650.
Tighter lending standards are neither surprising nor unwarranted given the Federal Housing Finance Administration’s mandate to limit taxpayer losses and return Fannie Mae and Freddie Mac to solvency. Policymakers and the conservator face conflicting objectives in this regard: good sense risk-management presents an obstacle for the first-time homebuyer whose credit score is relatively low and who is less able to counterbalance shifts in underwriting with a larger down payment. The problem is aggravated by the increasing likelihood that young families are encumbered by student debt-loads that have surpassed $1 trillion economy-wide.
Where historically low mortgage rates have been one of the few tailwinds for housing demand, the outlook must also reflect a range of forces that could push long-term treasury yields higher. The 30-year fixed commitment rate exhibits a tight correlation with the long-dated treasury and will rise if and when the latter’s bull market fades. If higher financing costs are not accompanied by improving access to credit, better assessments of house-price appreciation, and a more robust job market for younger workers, a reversal of recent gains could easily follow.
Sam Chandan, PhD, is president and chief economist of Chandan Economics and an adjunct professor at the Wharton School.