Don’t Panic

New housing starts data from Census just came out, showing both single-family and multifamily DOWN. Single-family starts fell 5.9% (plus or minus 12.7%) in May compared with April, according to Census. They revised downward their crazy (high) estimate for multifamily (thank goodness we didn’t build that many apartments). The number is still up 9.4% over last May.

To steal a title from Douglas Adams (Hitchhiker’s Guide to the Galaxy): Don’t Panic. Don’t panic about the drop in single-family; looking past the monthly noise, the trend is still upward. The aggregate number from Census somewhat obscures the underlying trends by market. Digging deeper, we see that some markets are up strongly, while others are in the dumps. To illustrate, consider that Metrostudy’s data on housing starts, derived from our own 100% counts within the markets we cover, show that Southern California, Texas, and Florida are showing strong increases in starts, while Arizona and Nevada are down.

One encouraging change that should help shore up June and July is that the “conversion rate” of traffic has improved somewhat. Consumers are still skittish, and the effects of last year’s sticker shock have not faded completely. The traffic through builders’ showrooms is still fairly strong, so as long as the “quality” of traffic continues to improve, sales should rise soon. The NAHB survey yesterday showed weak traffic, but the trend for most of the year has been a decent flow of traffic, but the traffic that came in did not buy at the normal rate. We will continue to monitor this closely as we analyze June and try to anticipate July.

The mix of buyers is still heavily weighted toward move-up buyers. The entry-level segment is still depressed. Although DR Horton and LGI are targeting entry-level, we do not foresee a dramatic surge in demand from that segment. The extremely rapid increases in rents nationwide will tend to make the transition to ownership seem much more appealing, but the obstacles (lack of money for down payment, high student loan debt, and low employment rates among millennials) will cause delays in that transition. Many of the 20-somethings who have been living with their parents have succumbed to the temptation to consider all of their income (if they have any) disposable, but many others have saved up down payment money, and this is the key to what we see as “pent-up” households and “pent-up” new home demand.

Mortgage rates have remained surprisingly low, despite the tapering of monetary stimulus, but some upward creep is expected by next year. The affordability indices are still very favorable, but less so when it comes to new homes, which are more expensive. As rates go higher, the strain on incomes will increase.

Another headwind is going to be the “lock-in” effect. This refers to the fact that a very large proportion of home owners have sub-5% fixed mortgage rates, and many of them will be reluctant to lose that rate. This will create a feeling among some home owners, once rates get back above 5.5% or 6.0% that they are locked in to their current home. That is to say, the jump in monthly payments will have to be justified by the need to move (for a job, or for family reasons). Some who need to move will choose to rent out their former home, becoming reluctant landlords.

Housing starts for the rest of 2014 will continue to trend upward, driven by gradually-improving job growth and slowly-returning household formations, but will be capped by lot supplies in the areas where most builders want to build. Demand will strengthen, but how fast? That depends on the credit access, and the choices, of the first-time buyers.