A sharp increase in household formations in late 2011 and early 2012 — along with signs that the steep decline in homeownership may be nearing its end — prompted our team of economists to project the start of the long-awaited single-family housing recovery last year.
However, we have warned that the recovery would likely be prolonged and bumpy, reflecting key obstacles still facing the housing market, including inventories, a stop-go economy, tight mortgage credit conditions, damaged consumer credit and the lingering impact of housing illiquidity and price declines on buyer psychology. Recent housing data confirms that the recovery is indeed under way and continuing, but we continue to believe that the path of recovery will long and uneven.
The two key developments that have enabled the nascent housing recovery are the slowdown in the homeownership decline and an initial pop in household formations. The latter initiated the first “organic,” or non-tax induced, increase in demand for single-family homes since prior to the housing bust. The dicey question for the present is that notoriously volatile household formations diminished later in 2012 at the same time the economy was going through its latest downshift. While still at a relatively healthy rate, a persistent slowing of household formations would slow demand for housing relative to the stronger pace that preceded it. Any slowdown in sales would increase the recovery time horizon and could potentially short circuit the inventory contraction that has helped firm existing home prices.
While household formations are a very volatile statistic, the slowdown coincided with the broader economic slowdown, giving credence to the data. Should the tax increases enacted early this year, along with the sequester spending cuts, slow or cause further declines in the economy, the potential exists for the nascent housing recovery to be short-circuited, as household formations dip further. New home sales posted strong gains in late 2012 and early 2013, but demand in that market also relies on a supportive macroeconomic backdrop, a strong household formation rate and optimistic buyer psychology. Clearly, any decline in new home sales would also reduce new single-family housing starts and increase the time it takes for housing to become a significant driver behind gross domestic product.
The renewed demand for housing and the sharp drop in existing home inventories are supporting home price recovery, and this contributes to the virtual cycle for recovery that we have seen so far, as it diminishes concerns by potential buyers that they are buying into a falling market. Home prices are off their troughs and growing modestly. Our survey of the four major U.S. home price indexes shows that all of them are above their trough levels. On average, the four indices (FHFA, Case-Shiller, Zillow and NAR) have increased 7.2% from a year ago and 7.3% from their respective troughs, the first sustained gains in home prices since the bust.
An important ingredient in the housing recovery has been bulk purchases of existing homes by investors, including recently by foreign firms betting on the housing recovery and buying American homes at discount prices. Traditionally, the business of buying and renting homes has been dominated by smaller investors, but over the past two years, this process has become more popular with institutional investors. Many private equity firms and pension investors are using money from foreign co-investors to purchase homes in volatile and hard-hit U.S. markets. Recently, foreign firms have taken part in the action, seeking high rates of return by initially renting homes with an exit strategy of selling them in the future in what they expect will be an improved housing market. Many foreign investors have an advantage over their U.S. counterparts, as investors from countries with strong exchange rates can outbid American investors, hoping to benefit from future exchange rate fluctuations in addition to appreciation of the underlying assets.
As existing home prices continue to trend up and foreclosure rates fall, the single-family housing market has stabilized to the point where it is no longer a drag on the economy. Yet, the housing market needs a more supportive macroeconomic backdrop. If the current pace of recovery were maintained, new home sales would reach their previous peak in 2027 at the December year-to-year growth rate or a still-distant 2021 using the 2012 annual growth rate.
Looking forward, we expect the shift from ownership to rental to cool down and demand for single-family homes to improve in earnest, as high rents and low home prices and mortgage rates entice more would-be renters to buy. An increase in the pace of economic growth would support stronger household formations and accelerate growth in demand. However, if the recovery remains saw-toothed, we can expect the housing recovery to be bumpy and slow.
