Category: households

A Home Is More Than a Home

Leave a comment

March 31, 2024

by Stephen Stofka

This week’s letter is about housing, the single largest investment many people make. The deed to a home conveys a certain type of ownership of physical property, but the price reflects a share of the surrounding community, its economy, infrastructure, educational and cultural institutions. We purchase a chunk of a neighborhood when we buy a home.

These are network effects that influence demand for housing in an area. They are improvements paid for by tax dollars or business investment that are capitalized into the price of a home. Take two identical homes, put them in different neighborhoods and they will sell for different amounts. When elements of this network change, it affects the price of a home. Examples of negative changes include the closing of businesses or an industry, a decline in the quality of schools, the presence of graffiti or increased truck traffic. Positive changes might include improved parks and green zones, better schools and alternative transportation like bike lanes and convenient public transportation.

Zoning is a critical tool of a city’s strategic vision. Zoning controls the population density of an area, the available parking and the disturbance from commercial activities. Many cities have some kind of long-term plan for that vision. Los Angeles calls it a General Plan. In Denver it is called Blueprint Denver (pdf). Homes built in the post-war period in the middle of the twentieth century were often smaller. They feature a variety of building styles whose distinctive character and lower prices invite gentrification. As properties are improved, their higher appraisal values bring in more property tax revenue from that city district and the process of building an improved neighborhood network begins.

A representative for that district can argue for more spending on public amenities to enhance the neighborhood. This further lifts property values and increases tax revenues. Developers get parcels rezoned so that they can convert a single-family property into a two-family unit. This may involve “scraping” the old structure down to its foundation, then expanding the footprint of the structure to accommodate two families. As this gentrification continues, there is increased demand for rezoning an area to allow the building of accessory dwelling units, or ADUs, on a property with a single-family home. Here is a brief account of a rezoning effort in Denver in 2022.

In the past decade, the 20-city Case-Shiller Home Price Index (FRED Series SPCS20RSA) has almost doubled. The New York Fed has assembled a map with video showing the annual change in the index for the past twenty years. Readers can click on their county and see the most recent annual price change. Millennials in their late twenties and thirties feel as though some cruel prankster has removed the chair just as they started to sit down. Analysts attribute the meteoric rise in prices to lack of housing built during and after the financial crisis fifteen years ago.

Each generation faces a set of crises that stifle their ambitions. In the 1970s, just as the first Boomers were entering their late twenties, mass migration from the eastern U.S. to the western states and high inflation doubled home prices in some areas within just a few years. The decade is a comparison tool as in “How bad is it? Well, it’s not as bad as the ’70s.” The 1980s began with high interest rates, the worst recession since the Great Depression and high unemployment. Boomers had to buy houses with mortgage rates over 10%. Following that recovery was another housing scandal and the savings and loan crisis that restricted any home price growth. A homeowner who bought a home in 1980 might have seen no price appreciation by 1990. Gen-Xers who bought a home during the 2000s had a similar experience, leaving some families underwater or with little equity for a decade. Equity growth from homeownership helps support new business start-ups.

Despite the insufficient supply of affordable housing, there are more homes than households. In the graph below are the number of homes (orange line) and households (blue line) as a percent of the population. The difference is only a few percent and contains some estimate error, but represents many more homes than the number of households.

Graph showing homes and households as a percent of the population.

Household formation, the blue line in the graph above, is a key feature of the housing market. In 1960, 3.4 people lived in each household, according to the Census Bureau (see notes). By 1990, that number had steadily declined to 2.6 persons and is slightly under that today. The supply of homes naturally takes longer to adjust to changes in household formation. That mismatch in demand and supply is reflected in home prices.

During the financial crisis household formation declined as unemployment rose. Home prices fell in response to that change in demand for housing and a come down from the “sugar high” of easy credit and sloppy underwriting. The percent change in the Home Price Index, the red line in the graph below, fell below zero, indicating a decline in home prices, an event many homeowners had never experienced. The fall in home values crippled the finances of local governments who depended on a steady growth in the property taxes based on rising home values.

Graph containing two lines: 1) the percent difference between homes and households as a percent of the population, 2) the home price index. There is a large gap where the two series diverge during the financial crisis.

The thirty-year average of  the annual growth in home prices (FRED Series USSTHPI) is 4.5% and includes all refinancing. We can see in the chart above that the growth in home prices (red line) is near that long-term mark. However, rising wages and low unemployment have encouraged more household formation, the rising blue line in the first chart. Those trends could continue to keep the growth in home prices above their long-term average. Millennials with mortgages at 6-7% are anxiously waiting for lower interest rates, a chance to refinance their mortgages and reduce their monthly payments. Strong economic growth and rising incomes will continue to put upward pressure on consumer prices, slowing any decisions by the Fed to lower interest rates. These trends are self-reinforcing so that they take a decade or more to correct naturally. Too often, the correction comes via a shock of some sort that affects asset prices and incomes. Millennials have endured 9-11, the financial crisis and the pandemic. “Go ahead, slap me one more time,” this generation can say with some sarcasm. The challenge for those in each generation is to try harder and endure.

Next week I will look at the cash flows that a property owner receives from their home investment.

////////////////////

Photo by Scott Webb on Unsplash

Keyword: interest rates, mortgages, mortgage rates, housing, households

Notes on series used in the graphs. The total housing inventory is FRED Series ETOTALUSQ176N divided by Total Population Series POPTHM. Total Households is TTLHHM156N divided by the same population series. These are survey estimates so some of the difference between the two series can be attributed to a normally distributed error. The all-transactions Home Price Index is FRED Series USSTHPI. The FRED website is at https://fred.stlouisfed.org/

Housing and Bond Trends

Leave a comment

August 24, 2014

Housing

The week began with a bang as July’s Housing Market index notched its second consecutive reading of +50, growing a few points more than the 53 index of last month.  Readings above 50 indicate expansion in the market.  The index, compiled by the National Assn of Homebuilders, is a composite of sales, buyer traffic and prospective sales of both new and existing homes.  The index first sank below 50 in January and stayed in that contractionary zone for a few months before rising again in June and July.

Housing Starts rose back above the 1 million mark but the big gains were in multi-family dwellings.  Secondly, this number needs to be put in a long term perspective. We simply are not forming new households at the same pace as we did for the past half century.

After monthly declines in May and June, new home sales popped up almost 16% in July.  Existing home sales rose in July but have now shown 9 consecutive months of year-over-year decreases.

The number of existing home sales is at the same level as 1999-2000.  On a per capita basis, we are about 11-12% below the rather stable level of those years, before the housing bubble really erupted in the 2000s.

During the 1960s and 1970s, households grew annually by 2.1% (Census Bureau data).  That growth slowed to 1.4% in the 1980s and 1990s and has declined in the past decade to 1% per year.  During the 1960s and 1970s, the number of households with children headed by women exploded by over 3% per year, leading to a growing economic disparity among households.  During the 1980s, growth slowed but still hit 2.5%.  In the past two decades, this growth has stabilized at 1.2 to 1.3% per year, just a bit above the total rate of growth of all households.

The trend of slower growth in household formation shows no signs of changing in the near term.  We can expect that this will curtail any historically strong growth in the housing industry.  The price of an ETF of homebuilders, XHB, has plateaued since the spring of 2013.  The price has tripled from the dark days of 2009 but is unlikely to reach the formerly lofty heights of the mid-$40s anytime soon.

************************

Interest Rates

As the long days of summer wane and children return to school, central bankers gather in the majestic mountains of  Jackson Hole, Wyoming. Let’s crank up the wayback machine and return to those yester-years when fear and despondency continued to grip the hearts of many around the world.  In August 2010, the Chairman of the Federal Reserve, Ben Bernanke, announced that the Fed would continue to buy Treasuries and other bond instruments to maintain a balance sheet of about $2 trillion dollars, which was already far above normal levels. Bernanke hinted that the Fed would be ready to further expand the program should the economic recovery show signs of faltering. This speech would later be viewed as a pre-announcement of what would be dubbed QE2, or Quantitative Easing Part II, which the Fed announced in November 2010.  The promise of Fed support helped fuel a 30% rise in the market from August 2010 to the spring of 2011.

Like the announcement of a new pope, investors look toward the mountain and try to read the smoke signals rising up from this annual confab.  Financial gurus practiced at linear regressions and Bayesian probabilities struggle to  parse the words of Fed Chairwoman Janet Yellen. Did she use the word “likely” or “probably” in her speech? What coefficient of probability should we assign to the two words?  Did she use the present perfect progressive or the past perfect progressive verb tense?

Here’s the gist of Ms. Yellen’s speech – essentially the same gist that she has given in several testimonies before Congress:

monetary policy ultimately must be conducted in a pragmatic manner that relies not on any particular indicator or model, but instead reflects an ongoing assessment of a wide range of information in the context of our ever-evolving understanding of the economy.

Investors like simple forecasting tools – thresholds like the unemployment rate or the rate of inflation.  In 2012 and 2013, former chairman Ben Bernanke reminded investors that thresholds are benchmarks that may guide but do not rule the Fed’s decision making.  Ms. Yellen reiterated several points:

Estimates of slack necessitate difficult judgments about the magnitudes of the cyclical and structural influences affecting labor market variables, including labor force participation, the extent of part-time employment for economic reasons, and labor market flows, such as the pace of hires and quits….the aging of the workforce and other demographic trends, possible changes in the underlying degree of dynamism in the labor market, and the phenomenon of “polarization”–that is, the reduction in the relative number of middle-skill jobs.

 Each month I have encouraged readers to go beyond the employment report headlines, to look at these various  components of the labor market.  The Fed uses a complex model of 19 components:

This broadly based metric supports the conclusion that the labor market has improved significantly over the past year, but it also suggests that the decline in the unemployment rate over this period somewhat overstates the improvement in overall labor market conditions.

Long term bond prices are at all time highs, leading some to question the reward to risk ratio at these price levels.  Prices took a 10% – 12% hit in mid-2013 in anticipation of a rate hike in 2014, indicating that investors are that jumpy. Since the beginning of this year, prices have risen from those lows of late last year.  Will 2015 be the year when the Fed finally begins to raise interest rates? Investors have been asking that question for four years.

Since the spring of 2009, 5-1/2 years ago, an index of long term corporate and government bonds (VBLTX as a proxy) has risen 65%.  From the spring of 2000 to the spring of 2009, a period of nine years, this index gained the same percentage.  Perhaps too much too fast?  Only time will tell.

**************************

Takeaways

Housing growth will be constrained by the slower growth in household formation.  Further valuation increases in long term bonds seem unlikely.