“From Red-Hot Recovery to Normal” - Will 2017 Be the Year?

Continuing to build on post-Great Recession gains, by some measures 2016 was the best year for the U.S. housing market in a decade, driven in large part by historically low interest rates and strong demand.  The strength of the 2016 market may have come as a surprise to those who expected growth to level off in 2016, with Zillow’s chief economist Svenja Gudell remarking, “If the expectation was that the market would transition smoothly from deep red hot recovery to normal – that certainly didn’t happen.” 

According to Freddie Mac (“Freddie”), home sales in 2016 reached their highest point since 2007 and home prices (not accounting for inflation) surpassed their 2006 record highs.  Home sales prices, as measured by the Case-Shiller National Home Price Index, saw a year-over-year gain of 5.6% in October 2016, compared to the 5.2% gain in October 2015, with Forbes noting that prices climbed every month in 2016. With respect to new construction, Kiplinger reports that single family housing starts were up 9.6% through November 2016.  Multifamily housing starts, on the other hand, were down 4.1% in the same period, likely as a result of multifamily builder caution from lessons learned during the Great Recession. As Pantheon Macroeconomics’ Ian Shepherdson puts it, “Home builders’ behavior likely is a continuing echo of their experience during the crash.  No one wants to be caught with excess inventory during a sudden downshift in demand.”  Notwithstanding the slowdown in multifamily starts, home builder confidence, as measured by the National Association of Home Builders (“NAHB”)/Wells Fargo Housing Market Index for December 2016, has reached its highest level since 2005, reflecting positivity about current sales conditions and expectations for a strong 2017.            

Several factors threaten to slow momentum in the housing market this year, including a continued shortage of affordable inventory, slowly rising interest rates and labor shortages (which could be exacerbated in the event stricter immigration policies are implemented by President Trump’s administration).  Nonetheless, many economists appear optimistic that the economic fundamentals (including high consumer confidence and low unemployment) remain strong for housing and that the market will continue to improve across most metrics in 2017, albeit at a somewhat slower rate than in 2016, especially at the beginning of the year, as the market continues to adjust to higher interest rates. 

Prices are expected to continue rising in 2017, though not as much as in 2016.  Redfin expects national median home prices to increase 5.3% in 2017, as compared to its 2016 estimate of 5.5%.  The California Association of Realtors (“CAR”) predicts that the median California home price will increase 4.3% in 2017, following an estimated 6.2% growth in 2016.  The Realtor.com 2017 National Housing Forecast projects that overall prices will rise nationally by 3.9% in 2017, while Zillow’s estimate is more conservative at 3.6%. 

Homes sales are also expected to grow in 2017, but less significantly than in 2016.  Redfin predicts that existing home sales will increase 2.8% in 2017 (following a 3.4% increase in 2016), while the National Association of Realtors (“NAR”) projects an increase of 2% (which would still bring existing home sales to a post-Great Recession high).  Realtor.com estimates that new home sales will grow 10% in 2017.  Trading Economics predicts that purchase activity will cause the homeownership rate to start trending upward again in 2017 to reach 63.5%, after declining for about a decade and reaching a four-decade low of 62.9% in the middle of 2016.  Despite the anticipated increases in both new and existing home sales over the course of 2017, Kiplinger speculates that both new and existing home sales may decline in the first few months of the year as the market adjusts to increasing interest rates. 

The strength of the 2017 market is expected to vary significantly by region, with Western markets leading the pack.  Realtor.com expects Western metros to lead the nation in price growth (5.8%) and sales growth (4.7%) in 2017, both well above Realtor.com’s respective national projections of 3.9% and 1.9%.  Of the 100 largest metros in the country, Realtor.com projects that three California metros (Los Angeles, Sacramento, and the Inland Empire) will rank in the top ten based on price and sales increases. 

With respect to new construction, Kiplinger reports that “residential construction remains at a level that shows steady demand for housing” and notes that “[b]uilding permits indicate that further growth is in store for residential construction in early 2017.”  Redfin expects that new construction will increase by 6% in 2017, compared to a 9% increase in 2016, the estimated decreased growth expected to result, in part, from labor shortages due to stricter immigration policies which may be implemented by the incoming administration).  Dodge Analytics projects a 9% increase in single family construction starts in 2017, and a 2% drop in multifamily starts (which would still mark a small step in the right direction following a 4.1% decrease in multifamily starts through November 2016). 

While moderating price growth in 2017 will provide some relief to buyers, affordability is likely to remain a significant concern.  RealtyTrac reports that home price gains continue to outpace wage growth in a majority of markets, including in Los Angeles and San Diego Counties.  According to Redfin’s chief economist Nela Richardson, “[T]he percentage of homes in America’s largest cities that are affordable on the median income has declined the past two years and will continue to fall in 2017.”  Richardson noted, “The irony of the modern housing market is that the places where we are seeing wage growth are places people can’t live because they are too unaffordable.  There is a mismatch.”  According to the NAHB, “[J]ust 62% of all new and existing homes sold in the second quarter [of 2016] were ‘affordable’ to the median U.S. household”, as reported in the PWC-Urban Land Institute (“ULI”) Emerging Trends in Real Estate – 2017.  Affordability is certainly of concern in California where, according to Leslie Appleton-Young, chief economist for CAR, only 29% of California buyers will be able to afford a median-priced home in 2017, as opposed to a third of buyers in 2016 and half of buyers in 2011. 

Available inventory is expected to grow 1.7% in 2017 (as compared to a 3.4% decrease in 2016), but a large portion of the growth is projected to be in the most expensive third of the market according to Redfin’s Richardson, which will not help to ease the shortage of affordable starter homes.  As Emerging Trends explains, “With costs high, few builders are targeting middle-income buyers.”  Richardson believes that “rate lock” due to rising interest rates is also likely to contribute to a continued housing shortage in 2017 (especially with respect to starter homes), as those homeowners with interest rates below 4% may be incentivized to remain in their homes instead of selling and taking on higher interest rate mortgages on more expensive homes. 

The 2017 market is projected to be driven largely by demand from millennial first-time buyers and baby-boomers, which groups are projected to comprise over 60% of buyers in 2017, according to the Realtor.com 2017 National Housing Forecast.  While millennials have been slow to enter the housing market, it appears that they have now begun to enter the market in large numbers.  According to Lawrence Yun, chief economist for NAR, “Young adults are settling down and deciding to buy a home after what was likely a turbulent beginning to their adult life and career following the Great Recession.” The NAR Profile of Home Buyers and Sellers reports that, in 2016, 35% of buyers were first-time buyers (up from a 30-year low of 32% in 2015, and the highest percentage since 2013, but still below the historical average of 40%).  And, of first time buyers, 61% were under 35. 

While millennial purchase activity is expected to remain strong in 2017, millennials looking to enter the market are likely to be faced with several challenges.  A lack of available starter homes (especially in the nation’s largest cities), slowly rising interest rates, and higher construction costs due to labor shortages (which, in turn, increase the cost of new homes) are likely to price some potential first-time buyers out of the market.  However, improved access to financing may help alleviate affordability challenges for first-time buyers in 2017.  Increased loan limits for Fannie Mae (“Fannie”) and Freddie-backed mortgages are set to take effect in 2017 (the first such increases since 2006), which is likely help bring starter homes within reach for some first-time buyers.  Additionally, recently introduced mortgages (from some of the nation’s largest lenders) requiring down payments as small as 1% reduce the cash savings required for some first-time buyers to enter the market.  Lowering of Federal Housing Administration fees, which some speculate may occur in 2017, could also reduce the cash needs of first-time buyers. 

Young buyers priced out of more expensive coastal markets are expected to look for starter homes in more affordable suburbs, inland markets and so-called “second-tier” cities.  Midwestern cities, which tend to offer greater affordability than their coastal counterparts, had 42% millennial market share in 2017 (above the national average of 38%), and are expected to see continued strong purchase activity from millennials in 2017, according to Realtor.com’s 2017 National Housing Forecast.  Redfin predicts that home builders may target “second-tier” cities to capitalize on demand from millennials looking for high-end finishes on a more affordable budget.   

Rent increases are expected to moderate in 2017 after several years of sustained significant growth, which will likely allow potential first-time buyers to pocket more money towards a future purchase.  According to Zillow’s Gudell, “Renters should have an easier time in 2017.  Income growth and slowing rent appreciation will combine to make renting more affordable than it has been for the past two years.”  ULI’s October 2016 Real Estate Consensus Forecast estimates that rental rates will grow 3% in 2017, following a 3.5% increase in 2016.  However, the 3% figure is still higher than the 20-year average annual growth rate of 2.8%, and rent increases continue to outpace wage growth in a majority of markets according to RealtyTrac.

While most appear to agree that interest rates are set to rise in the coming year, there are differing opinions as to how significant the increase will be.  Redfin predicts that the 30-year fixed rate will climb to 4.3%, but not any higher, and that rates will be volatile throughout the year.  NAR’s Yun expects rates to reach around 4.5% by the end of 2017, while Kiplinger projects that rates will rise to around 4.6%, and the Mortgage Bankers Association predicts an increase to 4.4%.  Even with the likely increase, rates are expected to remain historically low in 2017, and NAR does not expect that projected rate hikes will significantly affect the ability of the average family to afford a home purchase. 

Will 2017 finally be the year that the housing market transitions, in the words of Zillow’s Gudell, “from deep red-hot recovery to normal”?  While price, sales and construction growth are expected to slow somewhat from their 2016 paces, there seems to be a consensus that all will continue to move in the right direction.  Inventory is expected to increase this year following a significant decrease last year, and home builder confidence is at a decade high.  Redfin expects that homes will fly off the market at an all-time record pace in the highly competitive 2017 market.  While affordability will continue to be a significant concern, especially in larger cities, a scheduled increase in Fannie and Freddie’s loan limits and new mortgage products requiring low down payments (some as low as 1%) are likely to help first-time buyers access the market.  A decrease in the pace of rent growth will likely allow potential first-time buyers to save more for an eventual home purchase.  The purchasing activity of millennials will likely continue to pick up steam in 2017, which is a positive sign for market vitality in the coming years.  While 2017 may not be 2016 in terms of price or sales growth, there are plenty of indications that 2017 will be another solid year.  And after all that the market has been through in the last decade, “normal” would not be all that bad.