US HOUSING MARKET ANALYST

Transcription

1 US HOUSING MARKET ANALYST Q 9 th Sep. House price inflation will slow further Executive Summary -- Loosening mortgage credit conditions, decent jobs gains and accelerating wage growth will help home sales rise over the next months. But the improvement in selling conditions is also tempting sellers back to the market and triggering an expansion in homebuilding. This supply response means that house price inflation will slow to around % per annum. (Page.) Economic Backdrop -- The strength of the incoming survey and activity data suggests that GDP growth is accelerating now that credit conditions have eased and the fiscal drag faded. (Pages -.) Valuations & Affordability -- Housing is approaching fair value. But very favourable mortgage affordability means that instances of mortgage stress will remain rare. (Pages -.) Activity -- Loosening credit conditions bode well for housing market activity, particularly for the firsttime buyer segment that has been largely absent from the recovery thus far. (Pages -9.) Supply -- The increasing level of homes for sale is being driven by the higher level of house prices and is unlikely to let up any time soon. (Pages -.) House Prices -- House price inflation is slowing and may be as low as % y/y by the end of the year. We are anticipating gains of around this level for the next few years as well. (Pages -.) Alternative House Price Scenarios -- If retreating investment buyers leave a hole in housing demand that repeat and first-time buyers can t fill, price growth will be weaker than we expect. (Pages -.) Homebuilding -- Shortages of developable lots and skilled labour are constraining homebuilding. But both these constraints are fading, which will allow housing starts to rise more strongly. (Pages -.) Rental Market -- Lower total returns over the next year or two will cause institutional investors to pull back. But the sector should be attractive to Mom and Pop investors for a while yet. (Pages -9.) State Outlook -- The short-term outlook is most promising in Ohio, Texas and South Carolina and least promising in Alabama, Kentucky and Arkansas. (Pages -.) Paul Diggle Tel: + () 9 North America Europe Asia Bloor Street West, Suite Buckingham Palace Road #-, Collyer Quay Toronto, ON London Singapore, 9 MW E SWW 9TR Tel: Canada United Kingdom Tel: + Tel: + () Managing Director Chief Property Economist Senior US Economist Property Economist Roger Bootle (roger.bootle@capitaleconomics.com) Ed Stansfield (ed.stansfield@capitaleconomics.com) Paul Dales (paul.dales@capitaleconomics.com) Paul Diggle (paul.diggle@capitaleconomics.com) US Housing Market Analyst

2 Executive Summary Loosening mortgage credit conditions, decent Despite the improving sales market, house jobs gains and an eventual acceleration in price growth is slowing rapidly as we had wage growth will help home sales to rise over forecast. On balance that s good news as the next months. But the improvement in housing is approaching, and on some selling conditions is also tempting sellers back measures has exceeded, fair value. The scope to the market and triggering an expansion in for rapid, sustainable, price gains is homebuilding. This supply response will see increasingly limited. house price inflation fall to around % per annum by the end of this year and sustain that The slowdown in house price growth reflects level for the next few years. the steady rise in supply. Homeowners have become more willing to list their homes and GDP growth has picked up substantially and homebuilders have brought an increasing the message from the incoming activity surveys number of new homes to the market. is that growth will remain strong now that credit conditions are easing and the fiscal drag This supply response will continue to weigh on is fading. Despite the slowdown in August, we house price growth, which we expect to slow expect monthly non-farm payrolls to increase from.% y/y in the latest Case-Shiller reading by, or so over the next months, to % y/y by the end of the year. House price which will keep unemployment on a growth will continue around that pace for the downward path. In turn, dwindling labour next few years. market slack means that wage growth will soon accelerate. There are risks to this forecast both on the upside and the downside. Strong jobs growth The mortgage market has joined other sectors combined with still-low interest rates could see such as autos in seeing a loosening in credit housing demand rise rapidly and prices follow. conditions. While figures from the Mortgage More likely, though, is that retreating investors Bankers Association suggest that this hasn t and cash buyers leave a hole in housing yet translated into a rise in mortgage demand that repeat and first-time buyers are applications, lenders responding to the Fed s unable to fill, leading to weaker price growth Senior Loan Officer Survey report seeing a than we are anticipating. strong increase in demand for mortgage loans. Slowing house price inflation means that the Either way, sales of existing homes have total returns from housing will decline over the climbed back to long-run norms, while sales of next year or two. The upshot is that new homes finally appear to be improving as institutional investors will continue to pull well. There is still plenty of scope for the latter back from all but the most undervalued to rise from here, particularly now that the markets such as Ohio. But the rental vacancy pool of would-be first-time buyers is finding it rate is low and rents are on an upward path. easier to access mortgage finance. Thus the sector should be attractive to Mom and Pop investors for a while yet. US Housing Market Analyst

3 Main Forecasts TABLE : NATIONAL HOUSE PRICES Forecasts Forecasts Q/Q Year Forecasts Q Qf Qf Qf Qf Qf Qf Qf f f f f Case-Shiller Prices (s.a.) (%q/q) (%y/y) TABLE : NATIONAL HOUSING MARKET INDICATORS Forecasts Forecasts Year Average Forecasts Q Qf Qf Qf Qf Qf Qf Qf f f f f Total Home Sales (Mill, Ann.) (%y/y) New Sales (Mill, Ann.) (%y/y) Existing Sales (Mill, Ann.) (%y/y) Homes For Sale (Mill.) (%y/y) New (Mill.) (%y/y) Existing (Mill.) (%y/y) Housing Starts (s, Ann.) (%y/y) Single-family (s, Ann.) 9 9 Multi-family (s, Ann) 9 Real Residential Investment (%y/y) Land Prices (%q/q) Rents (%y/y) Rental Yield (%) Total Rental Return (%) Seasonally adjusted by Capital Economics. Before tax & depreciation. TABLE : NATIONAL ECONOMIC INDICATORS (%q/q annualised Forecasts Forecasts Year Average Forecasts unless otherwise stated) Q Qf Qf Qf Qf Qf Qf Qf f f f f GDP Real Personal Disposable Income Unemployment Rate (%) CPI Inflation (%) Fed Funds Rate (%) Year Treasury Yield (%) Year Fixed Mortgage Rate (%) End period. Sources - Thomson Datastream, Lincoln Institute of Land Policy, Capital Economics US Housing Market Analyst

4 Economic Backdrop Faster GDP growth will prompt rate hike early next year The recent strength evident in much of the incoming survey and activity data suggests that we were right to believe GDP growth would accelerate once credit conditions eased and the fiscal drag faded. We expect the economy to expand at an annualised pace of % over the next months (see Chart ), prompting the Fed to begin raising its policy rate from near-zero next March. Both the ISM manufacturing and services indices are at multi-year highs and a weighted average of those two is at a level that historically has been consistent with annualised GDP growth of %. (See Chart.) We don't expect growth to reach those stratospheric heights, but we do think that the recovery has finally broken out of the lacklustre pace of around % that has been the norm since. The strengthening dollar represents only a modest downside risk to our upbeat GDP growth projections. The US is, after all, a relatively closed service-based economy and the dollar's appreciation has, up to now at least, been quite modest. Its impact is also being offset by the corresponding decline in global crude oil prices. (See Chart.) Even though some of the decline has been reversed in recent weeks, the downward trend in longterm interest rates that began around the start of this year is also a positive for the economy. The risks of an external shock that derails the US recovery can never be fully discounted, but those risks have receded over the past months. The euro-zone has emerged from recession and, while growth is still lacklustre, the ECB is being more proactive and peripheral country borrowing costs have fallen sharply. Growth has slowed in China, but there is still little evidence that this slowdown will develop into anything more nefarious. Although employment growth slowed in August, we expect monthly gains in non-farm payrolls to average close to, over the next months. (See Chart.) That would be sufficient to keep the unemployment rate on a downward trend. Admittedly, the still elevated number of people working part-time for economic reasons suggests that labour market slack is slightly bigger than the unemployment rate at.% implies. (See Chart.) Nevertheless, we still think that the slack left is limited and, although it hasn't happened yet, we expect wage growth to begin accelerating soon. (See Chart.) In an environment where we expect productivity growth to remain muted, faster wage growth will add to the upward pressure on price inflation taking it back to, and then above, the Fed's % target. (See Chart.) We anticipate that the combination of strong economic growth, further declines in the unemployment rate and rising price and wage inflation will prompt the Fed to begin raising its policy rate from near-zero in March. We expect the fed funds rate to be nearly.% by end-, which would be a slightly more aggressive tightening than implied by the consensus forecast. (See Chart.) US Housing Market Analyst

5 Economic Backdrop Charts Chart : Real GDP (%q/q Annualised) CE Forecasts Chart : Weighted ISM Activity Index & GDP Weighted ISM Index (Adv. qtr, LHS) GDP (%y/y, RHS) Chart : Trade-Weighted Dollar & Crude Oil Price WTI Crude Oil ($pb, LHS) Broad Trade Weighted Dollar Index (RHS) Jan- Apr- Jul- Oct- Jan- Apr- Jul- Oct- Chart : Change in Payroll Employment (s) Change in Payroll Employment Six Month Average Jan- May- Sep- Jan- May- Sep- Jan- May- Chart : Unemp. & Involuntary Part-Time Emp. Rates (%). Working Part-Time For Economic Reasons (LHS).. Unemployment Rate (RHS) Chart : Wages & Labour Compensation (%y/y) Compensation Per Employee Hour Employment Cost Index Average Hourly Earnings Chart : Core Consumer Price Inflation (%) Chart : Fed Funds Rate Projections (%).. Core CPI Forecast Core PCE. WSJ Consensus. Fed's % target.. Fed Projections Capital Economics End End End Sources -- Thomson Datastream, Capital Economics US Housing Market Analyst

6 Valuations & Affordability Increasingly less scope for strong price gains Housing is within touching distance of fair Mortgage rates are set to rise from here, but value, which points to limited scope for housing affordability will remain better than further, sustainable, strong price gains. average for the next few years. Our forecasts Nevertheless, it is very affordable, suggesting for -year Treasuries imply -year mortgage that cases of mortgage stress will remain rare. interest rates increasing to.% by the end of Mortgage interest rates are unchanged since our previous Analyst, with -year fixed rates increasing by just one basis point, to.%. That stability came despite a decline in - this year,.% by end- and % by end-. (See Chart.) Factoring in the house price inflation we expect, that would leave mortgage payments at % of median income. year Treasuries. The resulting higher spread Most measures of housing valuations are also between Treasuries and mortgage rates reflects better than long-runs norms. The simplest investors uncertainty about the future role of compares real house prices to their trend level, Fannie Mae and Freddie Mac. which shows that house prices are about % Initial fees and charges were little changed during the third quarter at.%. (See Chart.) While the bigger picture is that fees and charges have risen by basis points over the past year and by 9 basis points since, it s not clear whether they will rise any further. New FHFA Director Mel Watt appears to be opposed to further guarantee fee hikes on the below trend. (See Chart.) A similar message is told by measures that compare house prices to incomes. The ratio of house prices to income per employee is % below long-run norms, while prices to incomes per capita are 9% below long-run norms. The slight decline in house prices in the second quarter mean that the valuation picture improved a little. grounds that it restricts mortgage availability. From the perspective of many overseas buyers, Either way, mortgage affordability is favourable. The NAR s affordability index stood at in July, a level it has more-or-less sustained since October. (See Chart.) This means that the average household has US housing is still a good deal as well. (See Chart.) Thanks to strong income growth, Indian and Chinese buyers in particular should be attracted to US housing on the basis of valuations. % of the income necessary to qualify for Yet housing is no longer undervalued for mortgage credit to buy the average home. domestic buyers on other measures. Indeed, a Admittedly, our calculation of the typical monthly mortgage payment as a proportion of average income rose to.% in July, from.9% at the time of our previous Analyst. But that is still comfortably below the long-run average of %. (See Chart.) comparison with rents suggests that housing is % to 9% overvalued. (See Chart.) On balance, given the quality of the rental data, we put more stock by the comparison with incomes, but this measure is a reminder that scope for further strong price gains looks increasingly limited. US Housing Market Analyst

7 Valuations & Affordability Charts Chart : Initial Fees & Charges on FHFA Mortgages (Equivalent % Amortised Over Years) Chart : NAR Mortgage Affordability Index Housing more affordable Seasonally adjusted by Capital Economics Chart : Average Monthly Mortgage Payments (% of Median Income) Chart : -Year Mortgage Rates & -Year Treasury Yields (%) -Yr Fixed Mortgage Rate -Yr Treasury Yield Forecasts Long-Run Average Chart : Real House Prices (Index) Real Case-Shiller House Prices (=) Trend Chart : Case-Shiller House Prices to Incomes (% Over/Undervalued Versus 9- Average) Against Disposable Income Per Capita Against Disposable Income Per Employee Overvalued Undervalued Chart : Case-Shiller House Prices to Foreign Incomes Per Capita(% Over/Undervalued Versus Long-Run Average) Q Q *Mexico, India & China use annual GDP per capita Germany France Mexico UK Canada India China Chart : Case-Shiller House Prices to Rents (% Over/Undervalued Versus 9- Average) Owner-Occupiers Imputed Rent CPI Rents Sources -- Thomson Datastream, Bloomberg, Capital Economics US Housing Market Analyst

8 Activity First-time buyer activity will pick up Loosening credit conditions bode well for average of %. (See Chart.) But loosening housing market activity, particularly for the credit conditions will see access to credit first-time buyer segment that has been largely become easier for first-time buyers, who are a absent from the recovery thus far. vital first link in chains of housing transactions. Mortgage applications for home purchase fell The % m/m jump in new home sales in to their lowest level in five months in August to a six-year high suggests that this is September. (See Chart.) More generally, helping to boost the new homes market. (See mortgage applications are at rock-bottom Chart.) Even so, new home sales are barely levels in an historical context. But these data half long-run norms relative to the size of the do not sit comfortably with other measures of population. There is plenty of room for new mortgage market activity. home sales to grow strongly over the next few years. The Fed s Senior Loan Officer Survey showed a net balance of % of banks experienced At.m annualised at the start of the third stronger demand for mortgage loans in the quarter, existing homes per capita have third quarter. (See Chart.) That was the first exceeded long-run norms. The sector is less positive reading in four quarters and looks dependent on mortgage finance, with % of consistent with an upturn in home sales sales currently going to all-cash buyers. activity. The same survey also revealed a Encouragingly, the strength of existing home significant loosening in mortgage credit sales has come despite a drop off in distressed conditions, with an all-time high net balance sales, to 9% from % at the start of the year. of % of lenders reporting looser lending criteria. Foreign buyers will make a small but important contribution to activity. The largest source of It s still the case that the most credit-worthy are foreign buyers is Canada, but favourable having an easier time accessing mortgage currency movements and the strength of credit. The average FICO score of approved domestic growth mean that China will take this mortgages has levelled off at, points mantle over the next few years. (See Chart.) above the score of the average US household. (See Chart.) And the growing size of We expect existing home sales to flatten off mortgage advances relative to house prices from here. After.9m sales in, we are indicates that those with higher earnings forecasting.m in,.m in and buying more expensive homes are the most.m in. If we are right that loosening active in terms of borrowing. credit conditions will allow more first-time buyers into the housing market, then new That explains why the share of first-time buyers home sales could rise from, in to is very low. At 9% at the start of the third, next year,, in and quarter, the share is well below the long-run 9, in. (See Chart.) US Housing Market Analyst

9 Activity Charts Chart : Mortgage Applications for Home Purchase (Index) Mortgage Applications (for Home Purchase) Week Average Chart : Mortgage Lenders Tightening Credit & Reporting Stronger Demand (% Balance) - Looser credit / - stronger demand Tightening Credit Conditions (Inverted, LHS) - Reporting Stronger Demand - (RHS) - - Chart : Average FICO Credit Score of Successful Mortgage Applications Aug- Mar- Oct- May- Dec- Jul- Chart : Value of Average Mortgage Application & House Prices (Index, = ) Average Value of Mortgage Application House Price Chart : Share of Existing Home Sales to First-Time Buyers (%) Chart : New Home Sales (s, Annualised) Long-term average Oct- Jul-9 Apr- Jan- Oct- Jul- Apr- Jan- Jan- Jul- Jan- Jul- Jan- Jul- Jan- Jul- Chart : Share of International Purchases by Nationality (%) Chart : Home Sales (Millions, Annualised) New Home Sales (LHS) Existing Home Sales (RHS) Forecasts Sources -- Thomson Datastream, Ellie Mae, NAR, Capital Economics US Housing Market Analyst 9

10 Supply Willing sellers and new builds pushing up inventory Listings are outpacing home sales, meaning that the inventory of homes for sale is rising. This increase in supply is being driven by the higher level of house prices and is unlikely to let up any time soon. The inventory of homes for sale has increased % since January, to.9m from.m. The % rise in the number of existing homes for sale has accounted for most of that increase, although the much smaller new homes sector has also seen a % rise in inventory. (See Chart.) Relative to the % peak-to-trough fall in inventory since, however, these are modest gains. The increase in inventory has come despite the recent improvement in the pace of home sales. Indeed, survey measures of buyer and seller traffic coming through realtors doors still show that would-be buyers outnumber sellers. But not everyone who wants to buy can, the upshot being more homes are being listed than are being sold. (See Chart.) Indeed, listings per capita, a measure of how willing homeowners and homebuilders are to offer up homes to the market, are back to longrun norms. (See Chart.) The share of consumers who think that this is a good time to sell a home rose to % at the start of the third quarter. Two years ago, that share was just %. (See Chart.) Selling is a more attractive prospect thanks to the % increase in house prices since, which means that more homeowners can afford to sell. (See Chart.) For homeowners who bought from 9 onwards, recent price rises even offer the prospect of capital gains. In addition, the steady if unspectacular rise in housing completions is adding to the inventory of new homes for sale. (See Chart.) As we outline in the homebuilding section below, while the sector continues to face a number of challenges, we are anticipating a steady pick up in output over the next few years. That will in turn support new housing supply. The increasing number of willing sellers will be partly offset by a continued decline in forced sales. The foreclosure start rate has now returned to levels that were normal prior to the housing crash. (See Chart.) There is still an elevated overhang of homes in the foreclosure inventory, although that too has come down from a peak of.m to.m in the second quarter. Our forecasts envisage a steady increase in the inventory of homes for sale at more-or-less the pace of recent quarters. (See Chart.) Existing homes for sale may average.m this year before increasing to.m in,.m in and.m in. New housing inventory will have less of an effect on the overall picture as the sector is so small, but gains will be proportionally much larger. We are expecting inventory of, this year,, in,, in and, in. On these forecasts, both existing and new housing inventory would be above long-run averages by. US Housing Market Analyst

11 Supply Charts Chart : Existing & New Homes for Sales (Millions) Existing Homes For Sale (LHS) New Homes For Sale (RHS) 99- averages Chart : Total Home Sales & Homes Listed For Sale (Millions, Annualised) Home Sales Homes Put Up for Sale (m Average) 9 Chart : Homes Listed Per People (Annualised) Chart : Consumers Attitudes to the Housing Market (%) 9- Average Good Time to Buy Good Time to Sell Jun- Mar- Dec- Sep- Jun- Mar- Chart : Homeowners Views on Selling Conditions (%) Good time to sell because prices higher (LHS) - Bad time to sell because can't afford it (RHS, Inverted) More homwoners selling Chart : Housing Completions (s, Annualised) 9 Chart : Foreclosure Start Rate & Foreclosure Inventory Rate (%). Foreclosure Start Rate (LHS)... Foreclosure Inventory Rate (RHS) Chart : New & Existing Homes for Sale (Millions) Existing Homes For Sale (LHS) New Homes For Sale (RHS) 9- averages Forecasts Sources -- Thomson Datastream, Fannie Mae, Conference Board, CE US Housing Market Analyst

12 House Prices Growing at around % House price inflation has slowed from %- % to %-% in the space of months. We expect house price inflation to slow to % by the end of this year. Our forecasts for home sales and housing inventory suggest that house price inflation will remain around that level for the next few years. The new monthly Case-Shiller national house price index reported small month-on-month declines in each of April, May and June. (See Chart.) That made for a.% decline during the second quarter as a whole, the first fall in two and a half years. On an annual basis, house prices are up %, although that s down from a peak of.% at the end of last year. Admittedly, the Case-Shiller index appears to have been skewed downwards by the lingering effect of the high share of distressed sales during the crash, which has affected the seasonal adjustment process. Distressed house prices fell most sharply during the downturn. But recent strong demand for distressed homes means that they have led the subsequent upturn. (See Chart.) Indeed, adjusting the Case-Shiller measure with seasonal factors from before the crisis paints a more sanguine picture of the previous few months. On this basis, house prices do not appear to be in outright decline. (See Chart.) Either way, however, the evidence from a range of measures is that house price inflation is coming off the boil. (See Chart.) That s consistent with the loosening in housing market supply conditions over the past few quarters. The slowdown in house price inflation is evident in all price tiers. (See Chart.) The most expensive third of homes by value are seeing the slowest rate of house price appreciation, of.% y/y at the end of the second quarter. But it s the cheapest third of homes by value that have seen the largest slowdown. House price inflation among this tier has slowed from.% y/y a year ago to.% y/y at the end of the second quarter. This sharp slowdown reflects the dwindling numbers of investment buyers targeting cheap, distressed homes. Realtors and consumers have continued to moderate their house price expectations. From annual gains of.% and.9% a year ago, expectations are now for house prices to increase by.% and.% respectively. (See Chart.) While neither group has been a great forecaster of prices in the past, the fact that they expect house price inflation to moderate should itself help prices to slow. We re not quite as downbeat as these two groups, but we still expect price inflation to moderate further. Our forecasts for home sales and inventory imply the months supply of unsold stock loosening from. at the start of the third quarter to. by the end of our forecasting window in. That s consistent with a further modest slowdown in house price appreciation. (See Chart.) Indeed, price growth may slow to % y/y by the end of the year and then hover around that level over the next few years. (See Chart.) US Housing Market Analyst

13 House Price Charts.. Chart : Case-Shiller National House Prices (%m/m, Seasonally Adjusted).. Chart : CoreLogic House Prices (%y/y) Distressed Properties Non-Distressed Properties Jan- Jul- Jan- Jul- Jan- Chart : Case-Shiller National House Prices -- Effect of Different Seasonal Adjustment (%m/m). Pre- Seasonal Adjustment. National Monthly Series.. Chart : Alternative Measures of House Prices (%m/m Annualised) Zillow FHFA CoreLogic Jan- May- Sep- Jan- May- Chart : Case-Shiller House Price Tiers (%y/y) High Tier - Middle Tier - Low Tier Chart : Realtors & Consumers Expected Change in House Prices Over the Next Year (%)... Realtors' Expectations.... Consumers' Expectations Jun- Jan- Aug- Mar- Oct- May- Dec- Jul- Chart : House Prices & Months Supply of Unsold Stock Inventory down, Forecast prices up Months' Supply of Total Homes (Inverted, Adv. m, LHS) - - CoreLogic House Prices (%y/y, RHS) Chart : National Case-Shiller House Prices (SA) F'cast - - %q/q (LHS) %y/y (RHS) Sources -- Thomson Datastream, Zillow, NAR, Fannie Mae, CE US Housing Market Analyst

14 Alternative House Price Scenarios Retreating investors pose the biggest risk to the outlook Our house price forecasts are based on our see the recent deterioration in housing market best assessment of the prospects for the valuation metrics accelerate, potentially economy, housing demand and supply. But storing up trouble for the future. (See Chart.) there are both upside and downside risks around these forecasts. Strong jobs growth However, a downside scenario seems more combined with still-low interest rates could see likely. Moderating total returns and a lack of housing demand rise rapidly and prices follow. distressed supply mean that investors and cash More likely, though, is that retreating investors buyers are starting to take a back seat. (See and cash buyers leave a hole in housing Chart.) That s a worry when first-time buyers demand that repeat and first-time buyers are account for a historically low share of housing unable to fill. demand. (See Chart.) We expect the Fed to begin raising its policy If mortgage credit conditions do not continue rate from near-zero next March, slightly sooner loosening, or not as quickly as we expect, first- than the Fed s own projections imply. But if time and other mortgage-dependents buyers there s been lasting structural damage to the will struggle to take up the slack left by economy s growth potential inflicted by the retreating investors and cash buyers. recession, both we and the Fed may be Alternatively, if there is more slack in the overestimating the extent to which interest labour market than we estimate, wage growth rates will have to rise to keep inflation in will not accelerate from here and organic check. If that s right, then mortgage interest housing demand would be subdued. (See rates will remain lower for longer. (See Chart Chart.) As our ready-reckoner shows, every.) As our ready-reckoner shows, after a year s % rise in disposable income tends to increase lag, every.% rise in mortgage interest rates house price inflation by up to.% in tends to reduce house price inflation by subsequent years. between % and % per year. (See Table.) In this downside scenario, house price growth Alternatively, now that house price growth is could feasibly turn negative next year and slowing, homeowners may hold off from listing remain subdued for the foreseeable future. their homes. If supply conditions tighten, house price growth would accelerate again. Changes to the housing stock and population And if this pattern were to repeat itself, house can also affect house prices, as our ready- price growth could rise and fall in a sawtooth reckoner shows. But these are typically very like fashion, but generally be higher than our slow moving changes and in the short-term we central forecasts suggest. expect the level of housing demand at any one time to be the most significant determinant of In these upside circumstances, house prices house prices. could rise at close to double-digits rates over the next few years. (See Chart.) That would US Housing Market Analyst

15 Alternative House Price Scenario Charts 9 Chart : -Year Fixed Mortgage Rates (%) Capital Economics Forecast Upside Scenario Projections Chart : Case-Shiller House Prices (%y/y) - - Downside Scenario CE Forecast Upside Scenario Chart : Case-Shiller House Price to Incomes (% Over/Undervalued Versus 9- Average) Upside Scenario Projections Capital Economics Forecast Overvalued Undervalued Chart : Existing Home Sales to Cash Buyers & Investors (%) Jan- Oct- Jul- Apr- Jan- Oct- Jul- Chart : Existing Home Sales to First-Time Buyers (%) Long-term average Oct- Jul-9 Apr- Jan- Oct- Jul- Apr- Jan- Chart : Nominal Disposable Income (%y/y) Projections - CE Forecast - Downside Scenario Table : Capital Economics House Price Inflation Ready-Reckoner (% Effect on Annual House Price Inflation In Each Year) Year Year Year Year Year.% rise in mortgage rates % rise in the unemployment rate % rise in disposable incomes......% rise in the population % rise in the housing stock Effects are the results of simulation tests applied to an econometric model of house prices. Sources -- Thomson Datastream, NAR, Capital Economics US Housing Market Analyst

16 Homebuilding Land and labour constraints fading Homebuilders have been struggling against a shortage of developable lots and a dearth of skilled labour. But both these constraints are set to fade, allowing housing starts to rise. At 9, annualised at the start of the third quarter, housing starts are little changed since our previous Analyst. Indeed, despite significant month-to-month variability, starts have not shown a sustained increase since early-. (See Chart.) The relatively subdued level of housing starts reflects the low level of new home sales, as well as a shortage of skilled residential construction labour. At least % of homebuilders are facing a shortage of carpenters and framers, whose skills were not easily transferable into home maintenance during the housing crash and so left the sector entirely. (See Chart.) The consequences of labour shortages have been higher house prices, overrunning project timelines and fewer housing starts. (See Chart.) In addition, homebuilders stopped adding to their land banks during the crash, meaning that many are now lacking space on which to build. In the scramble to acquire lots, land price inflation peaked at.% y/y in, and was still elevated at.% in the first quarter of. (See Chart.) Yet these look like temporary constraints. Labour shortages will ease now that the housing market recovery means construction workers can be assured of steady work. And rising land prices are a sign that homebuilders have already started adding to their land banks. In the meantime, smaller lot sizes indicate that they ve been making better use of their existing holdings. (See Chart.) Also positive for the homebuilding outlook is the increase in the share of new homes selling earlier in the construction process. Some % of new home sales in August occurred before ground was broken or during construction, compared with an average of % since. Meanwhile, homes that sold after completion did so in just. months, compared with an average of months since. Earlier sales give homebuilders the cash flow and confidence to start more homes. Finally, the size of the shortfall between household formation as measured by the Current Population Survey and housing starts points to a significant pick up in the latter. Cumulative under-building over the past three years may be as high as. million homes. (See Chart.) That was initially justified by the overbuilding during the boom years, but low vacancy rates suggest that excess supply has now been exhausted. The upshot is that we envisage housing starts rising to.m this year,.m in,.9m in and.m in. Most of that growth will initially come from multi-family starts, but we also expect single-family starts to rise strongly. (See Chart.) Our forecasts for housing starts imply decent growth in residential fixed investment. (See Chart.) That means that housing will contribute roughly.% q/q annualised to GDP growth over the next few years. US Housing Market Analyst

17 Homebuilding Charts,,,,9,,,, 9 Chart : Housing Starts (s, Annualised) 9,,,,9,,,, 9 Chart : Share of Homebuilders Reporting a Shortage of Workers by Trade, (%) Carpenters Rough Framing Crews Carpenters Finished Bricklayers & Masons Painters Roofers Plumbers Electricians Excavators HVAC W'therproofing Workers Building Managers Higher prices Chart : Consequences of Labour Shortages (% of Respondents) Delays Wider search for labour Projects unprofitable Refused projects Slowed order acceptances Lost/cancelled sales Chart : Land Price Inflation (%y/y) %q/q (RHS) %y/y (LHS) Chart : Average Lot Size of New Single-Family Homes (Square Feet, s) Chart : Housing Completions Less Household Formation (Millions) Chart : Housing Starts (s, Annualised) Single-Family Starts Forecasts Multi-Family Starts Chart : Housing Starts & Residential Investment (%y/y) Housing Starts (Adv. Qtr.) Residential Investment Forecast Sources -- Thomson Datastream, NAHB, Lincoln Institute, Census Bureau US Housing Market Analyst

18 Rental Market Low vacancy rates will support rental growth A sharp dip in the total returns from housing over the next year or two may cause some institutional investors to pull back. But wider economic and credit market conditions should keep the rental vacancy rate low and rents on an upward path. Thus the sector should be attractive to Mom and Pop investors for a while yet. The available data on residential rents suggest that they have risen by around % over the past year and that the pace of gains has picked up a little from rates of around.% at the beginning of the year. (See Chart.) That seems consistent with our view that, having risen by a touch under % last year, rental growth might average % this year and next. Certainly, the current balance of supply and demand conditions in the market suggests that rental growth is more likely to strengthen than to soften in the months ahead. For example, although it has recently stabilised, at around %, the rental vacancy rate is low by past standards. (See Chart.) That suggests that landlords, rather than their tenants, currently have the upper hand in any negotiations. The alternative NHMC measure of the tightness of the apartment market points to a similar conclusion. (See Chart.) The outlook for demand for rented housing also seems pretty solid. The growth in the numbers of households entering the sector has cooled a little over the past year. (See Chart.) However, the share of households in the rented sector already stands at a 9-year high. With credit conditions only thawing gradually, that share is more likely to edge higher than to fall back over the next year or two. There is also little to suggest that rents are starting from a level that is too high. Indeed, relative to household incomes, rents are almost exactly in line with their average level over the past years or so. (See Chart.) Thus as income growth picks up over the next year or so, we see no reason why rental growth won t match, or more likely exceed those rates if supply conditions remain relatively tight. However, over the medium term, conditions are unlikely to remain quite so favourable for landlords. Surveys suggest that there is little sign of homeownership aspirations fading, with over 9% of respondents viewing it as an important part of the American Dream. (See Chart.) As credit conditions ease, demand for rented accommodation is likely to ease. Homebuilders are also targeting the sector, with roughly half of all starts intended for the rental market -- a figure that is close to record highs. (See Chart.) The scale of this supply response suggests that rental vacancy rates are likely to rise over the medium term, preventing a sustained surge in rental growth. Our forecasts envisage that total returns from residential property will slow from around % this year, to around % over the remainder of the forecast horizon. (See Chart.) This is largely thanks to a slowdown in the rate of house price gains. While those returns may be unexceptional by past standards, they will nevertheless compare fairly favourably to the returns on other assets. US Housing Market Analyst

19 Rental Market Charts Chart : Rental Value Growth (%y/y) Chart : CPI Rents & Rental Vacancy Rate - CPI Rent of Primary Residence Zillow $/Square Foot REIS Apartment Effective Rents (Multi-Family) - 9 Rental Vacancy Rate (%, Inverted, Adv. yr, LHS) CPI Rents (%y/y, RHS) Chart : CPI Rents & NMHC Apartment Market Tightness NMHC Apartment Market Tightness (Index, Adv. Qrts, LHS) Rents (%y/y, RHS) Chart : Household Entering Rental Sector (Mns, y/y) Chart : CPI Rents to Average Hourly Earnings (Long-Run Average=) Chart : Countrywide Financial Security Index (%) 9 9- Average Buying a home is an important part of achieving the American Dream Buying a home is an attainable goal for a middle income family Chart : Housing Starts Intended for Rental Market Chart : Rental Yields & Total Returns (%) F'casts s, Annualised (LHS) % of all Starts (RHS) - - Rental Yield (LHS) Total Return (RHS) Sources -- Thomson Datastream, Zillow, Lincoln Institute, Countrywide US Housing Market Analyst 9

20 State Outlook Prospects strongest in Ohio, weakest in Arkansas The continued slowdown in house price appreciation that we are expecting at the national level still leaves plenty of room for State-level differences. Based on an analysis of the economic backdrop, as well as housing supply and demand, we have ranked each State according to its short-term housing prospects. (See State Monitor Table on pages -.) The short-term outlook is most promising in Ohio, Texas and South Carolina and least promising in Alabama, Kentucky and Arkansas. The driver of outperformance in Ohio is more likely to be investors and cash buyers than mortgage-dependent buyers. Ohio is the State where housing is most undervalued, by some %. (See Chart.) Despite housing still being an attractive proposition however, many existing homeowners are unable to take advantage. After all, at % the share of negative equity is among the highest in the country. (See Chart.) Despite the legacy of negative equity, supply conditions in Ohio are not particularly loose. Indeed, if anything, looking across different States, higher levels of negative equity are associated with tighter supply conditions. (See Chart.) That s because investors and cash buyers have rapidly bought up distressed supply in these States. The other States at the top of our rankings, Texas and South Carolina, have relatively low homeowner vacancy rates, signalling that supply conditions there are tight. Texas and South Carolina are among the top- States in terms of personal income growth, which is supporting organic housing demand. (See Chart.) Meanwhile, income growth has turned negative in North Dakota, previously one of the strongest performing housing markets. That probably reflects the decline in energy prices, which has hit shale oil and gas production in North Dakota. Texas is benefitting from decent levels of foreign demand. (See Chart.) But over the next few years we anticipate that California -- where house prices are still growing strongly -- will be the biggest beneficiary of foreign housing demand. (See Chart.) The State is particularly popular with buyers from China, for whom favourable currency movements and growing incomes makes US housing look significantly undervalued. While foreign demand represents an upside risk for California, we think the risks for New York and New Jersey are skewed to the downside because of the large overhang of foreclosures. This will support inventory levels and keep a lid on house price growth. (See Chart.) We also see more downside than upside risks for D.C, as housing there is significantly overvalued. But our ranking suggests that housing market prospects are least promising in Alabama, Kentucky and Arkansas. Higher than average unemployment levels and weak rates of personal income growth mean that housing demand in these States is weak and supply is elevated. Kentucky and Arkansas have among the highest homeowner vacancy rates in the country. (See Chart.) US Housing Market Analyst

21 State Outlook Charts Chart : FHFA House Prices to Disposable Incomes Per Capita (% Over/Undervalued Versus 9- Average) most undervalued least undervalued/ most overvalued Chart : Mortgages in Negative Equity (%) States With Lowest Share States With Highest Share Chart : Negative Equity & Homeowner Vacancy Rates. Devaition of Vacancy Rate from 99- Avg (%-Pts) Texas S. Carolina Ohio Arizona Florida Nevada Share of Mortgages in Negative Equity (%) - - Chart : Personal Income Growth, Q (%y/y) States with fastest growth States with slowest growth - - Chart : Share of International Homebuyers by State (%) 9 Chart : FHFA House Prices, Q (%y/y) States With Strongest Change States With Weakest Change Chart : Foreclosure Inventory (% Point Deviation From Trend) States with highest share States with lowest share - Chart : Homeowner Vacancy Rate (%). Rate below long-run average Rate above long-run average Sources -- Thomson Datastream, CoreLogic, Capital Economics US Housing Market Analyst

22 State Monitor House Prices (FHFA, s.a.) Economic Backdrop Change Valuation Unemployment Rate Personal Income Ranking %q/q %y/y % Q Q Q Q Deviation from 99- Av. %y/y Q Deviation from 99- Av. () () () () () () () () National Ohio Texas South Carolina Florida West Virginia Vermont Massachusetts Alaska Kansas District of Colombia Wyoming Colorado New York California Oregon North Dakota Maine Montana Michigan Idaho Utah North Carolina New Hampshire Washington Rhode Island Nevada Hawaii Delaware South Dakota Maryland Mississippi Louisiana Pennsylvania Connecticut Indiana New Jersey Oklahoma New Mexico Illinois Missouri Nebraska Arizona Georgia Wisconsin Minnesota Tennessee Virginia Iowa Alabama Kentucky Arkansas % under/overvalued against income per capita relative to the 99- average. has the most favourable economic conditions, has the least favourable. Takes into account the deviation of unemployment rate and income growth from 99- averages. US Housing Market Analyst

23 State Monitor (continued) Demand Supply Market Existing Home Sales per people Average Homeowner Vacancy Rate Tightness Sales Q Overall Market & Economic Conditions Deviation from 99- Av. Ranking % Q Deviation from 99- Av. Ranking Ranking Ranking (Chge) (9) () () () () () () () National Ohio (+) Texas (+) South Carolina (+) Florida (-) West Virginia (-) Vermont (+) Massachusetts (+) Alaska.... (+) Kansas (+) District of Colombia (-) Wyoming (-) Colorado (+) New York (-) California (-) Oregon (-) North Dakota (-) Maine.... (-) Montana (+) Michigan (+9) Idaho....9 (-) Utah (+) North Carolina (+) New Hampshire (-) Washington (-) Rhode Island (-) Nevada (+) Hawaii (+) Delaware (+) South Dakota (-) Maryland (+) Mississippi (+) Louisiana (-) Pennsylvania.... (-) Connecticut (+) Indiana (+) New Jersey.... (+) Oklahoma.... (-) New Mexico (+) Illinois (+) Missouri (-) Nebraska (-) Arizona.... (-) Georgia.... (-9) Wisconsin.... (-) Minnesota (-) Tennessee...9. (-9) Virginia (-) Iowa (-) Alabama (-) Kentucky () Arkansas () Interpolated from historical NAR data and CoreLogic data. A tight market has high demand and low supply. has the tightest, has the weakest. has the strongest demand relative to the long-run average, has the weakest. has the lowest supply relative to the long-run average, has the highest Average of demand and supply rankings. has the tightest market, has the loosest. Average of economic and housing market tightness rankings. US Housing Market Analyst f