The Housing recovery is here! Should you buy a house?

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1 The Housing recovery is here! Should you buy a house? William Wheaton Department of Economics Center for Real Estate MIT January, 2014 IAP

2 1). Why there will be a recovery. - Household Formation unusually low - But construction is also - Both have to increase 2). What kind of recovery (tenure). - Permanent shift to renting? - Multi versus Single family construction. 3). Where. - Boom states (CANFLAZ)? - The keys to appreciation: - supply elasticities, - LT demand growth - current prices relative to trend

3 The Outlook for Population, jobs and Households: Aging = more HH/pop, fewer Jobs/pop Cyclic recovery In HH formation? households employment population

4 1a). The recovery in Household Formation Household formation: 1,285,000 yearly - Then 950,000 in 2008, 750,000 in 2009, 600,000 in In 2011 it recovered to 730 and up to 960,000 in But dropped back to 850,000 in 2013 (est.) - It has to return to 1,200,000 range plus make up for lost formation of 2m during the downturn! 1b). Could there be a permanent shift in HH formation (headship rate). What determines formation? - Rising Rents (-) - Mediocre Job prospects (-) - Divorce (+), marriage(-) - Aging (+, headship)

5 1c). Some additional sources of housing unit demand - Annual demolitions average between 75,000 and 100,000, but there are episodes : urban redevelopment in the 1960 s, Failed developments today? - 2 nd home demand. The Census identifies homes that are vacant and for sale or rent, vacant and uninhabitable, and then homes that are seasonal, usual residence elsewhere, - This latter category has grown from 8% of the stock in 1970 to 16% of the stock in Annual average growth is about 200,000.

6 Forecast: still excess demand for new units during the next 5 years even if construction recovers to 1.4m! Housing Starts Less New Households Historic Equilibrium: 280,000 excess units (=demolitions + 2 nd homes ) Mil Sources: Bureau of the Census, Moody s Economy.com, Torto Wheaton Research.

7 In the aggregate Residential Construction must recover: When it does - watch GDP growth

8 2a). Will there be a recovery in the ownership rate? - Homeownership driven to unsustainable levels by easy credit 69-70%. Underwriting or rates? - Foreclosures have dropped ownership to 65.3%. - Base case: economic recovery prevents further foreclosures due to job losses. Price recovery encourages under water owners to hang in there. - Ownership still desired, result: ownership stabilizes at 65% 2b). Downside: strategic defaults walking. - Recent evidence of widespread underwater loans - Great resistance by Banks to principal reductions - Massive walking defaults? Ownership drops to 62-63% (later)

9 Scenarios for unwinding Home Ownership (+): Economic Recovery, mortgage modification (-) : Strategic Defaults 70 U.S. Homeownership Rate, %

10 MIT Center for Real Estate Mortgage Delinquency dropping: transition to foreclosure is also (All Loans) Delinquency Rate Transition to foreclosure Source: Mortgage Bankers Association

11 Rent-Own carrying costs A once-in-a-lifetime opportunity! Why isn t everyone buying? Credit rationing must be back P/R and i*p/r Ratios, 2013q2=1 30-year fixed mortgage rate, % i*p/r ratio P/R ratio Mortgage rate Sources: BLS, FHFA, CBRE EA.

12 3500 HH formation - Job growth DHH GEM P Base Case: Ownership: 65% HH formation 1.2m Owners: 800k yearly Renters: 400k Renter - Owner HH HO DRHH DOHH

13 Multi Single-Family Linkages: Supply Virtually all new Single Family housing is built for ownership. Between 70% and 90% of multifamily construction is for built rental occupancy. Historically single family construction exceeds owner household growth. Historically multi-family construction is less than renter household growth. All of this is possible because of steady flow unit conversions. The main type of unit converted is older single family. Filtering single family units constitute an enormous source of net rental supply. A buffer for changes in ownership.

14 1400 Renters MF construction DRHH MCMP Base Case: SF construction 1.1m MF construction.3m Gaps: conversions And demolitions Owners - SF construction }? }? DOHH SCM

15 Conversions responsible for most of rental Stock (Investors: vs ) 1.5 Year-over-year change in rental stock, mil units new completions demolitions conversions total

16 Supply keeps prices moving with rents (their fundamental ) except for Back moving together in the last 3-4 years (rents 1975=100 Constant leading $2011 prices up, but not for long )e ? Home Price Rent

17 Sales Duration (inventory/sales) recovers: Prices set to rise significantly 18 Sale Duration, Months Jan-06 Mar-06 May-06 Jul-06 Sep-06 Nov-06 Jan-07 Mar-07 May-07 Jul-07 Sep-07 Nov-07 Jan-08 Mar-08 May-08 Jul-08 Sep-08 Nov-08 Jan-09 Mar-09 May-09 Jul-09 Sep-09 Nov-09 Jan-10 Mar-10 May-10 Jul-10 Sep-10 Nov-10 Jan-11 Mar-11 May-11 Jul-11 Sep-11 Nov-11 Jan-12 Mar-12 May-12 Jul-12 Sep-12 Nov-12 Existing Single-Family Existing Condominiums

18 425 Real Prices - Real Rents 280 Base Price Recovery: homeownership stabilizes at 65% RHPI RRNT

19 Geographic Imbalance CANFLAZ homeownership rose/fell 2x US! Homeownership rate, % US CANVFLAZ (simple average)

20 CANFLAZ purchase of 2 nd or Investment (speculative) homes 2x US average (Condos excluded) Investment and 2nd Home Loans as Share of New Loans, % Nation San Diego Sacramento Riverside Miami Tampa Phoenix Orlando Las Vegas Fort Myers Atlantic City Source: Loan Performance, Torto Wheaton Research

21 The result: Housing price bubble in CANFLAZ: 2x rest of the US 225 CSW Sales-weighted home price index, Jan-2001= CS20 metros CANVFLAZ 7 metros Others 13 metros

22 MSA level Forecasts For 68 MSA, take FHA price data, quarterly from 1980:1 2012:2, deflate into constant $. For 68 MSA, sum total units constructed, quarterly, into housing stock. Estimate Error Correction Model predicting price given housing stock for each MSA. Estimate Vector Error Correction Model jointly predicting both prices and stock for each MSA Forecast from 2012:3 to 2022:2

23 (continued) With ECM forecast assume that MSA stock growth will be 20% lower than historic, due to demographic aging and slow recovery in headship rates from great recession. Price and Stock forecasts in left graph With VECM (right graph) both variables are forecast. Generally stock and price growth are slightly higher than with ECM.

24 Two fundamental forecast questions For each MSA, if you purchased in 2012:3 how much appreciation are you likely to experience over the next decade? What will be the user cost of owning a house: (1-t y ) i - p/p For each MSA if you purchased a house near the peak (i.e. 2007) when or will you recover your equity. When will nominal prices return to their 2007 value? Forecasts done in real prices CPI inflation 9%, assume is 20%

25 Chicago Chicago ECM stock-price forecast Chicago VECM stock-price forecast STKV RHPIV S TK RHPI

26 New York NewYork ECM stock-price forecast NewYork VECM stock-price forecast STKV RHPIV S TK RHPI

27 San Francisco SanFrancisco ECM stock-price forecast SanFrancisco VECM stock-price forecast STKV RHPIV S TK RHPI

28 Dallas Dallas Dallas ECM stock-price forecast VECM stock-price forecast STKV RHPIV S TK RHPI

29 Las Vegas LasVegas ECM stock-price forecast LasVegas VECM stock-price forecast STKV RHPIV S TK RHPI

30 Miami Miami Miami ECM stock-price forecast VECM stock-price forecast STKV RHPIV S TK RHPI

31 Phoenix Phoenix ECM stock-price forecast Phoenix VECM stock-price forecast STKV RHPIV S TK RHPI

32 Full Paper: Error Correction Models of MSA Housing Supply Elasticities: Implications for Price Recovery Available at:

33 Price Appreciation versus Recovery 1). Price appreciation will be greatest where prices have fallen the most (Atlanta, Detroit, Vegas, Miami Phoenix) and/or where there are strong upward trends (NY, Boston, Seattle, Chicago). 2). User Cost in such areas:.7x = -.025! 3). In current dollars prices recover in all areas by 2022 but: West Palm, Phoenix, Orlando, Fort Lauderdale, Charlotte, Vegas, Riverside.

34 Conclusions Housing construction is already beginning to recover but has a lot of ground to make up. Going from 800,000 to 1.4m units yearly adds.7% to GDP growth over the next 2-3 years. There has not been any permanent return to renting and in fact buying a home today looks like a lifetime opportunity. Similar to 1980s. Many areas will experience cumulative real appreciation of 30% over the next decade, 50% in current dollars. Serious Underwater homes (those purchased or refinanced near the peak) will refloat in most areas by The exceptions are the severely cyclic sand states.

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