What can we make of the seeming incongruity of indicators in the housing market as 2013 comes to a close?
Mortgage applications recently hit a 13-year low. Existing home sales fell for the third consecutive month – and for the first time on a year-over-year basis in quite some time. Pending home sales also fell for the third consecutive month. But homebuilder sentiment rose significantly, we saw an enormous spike in housing starts, and existing home prices continue to creep up, although more slowly than they rose earlier in the year.
It’s easy to write off these paradoxes as just more evidence of how volatile and unpredictable the housing market has been while recovering from the boom and bust cycle that it just went through. And there’s probably some truth to that, which makes predicting what’s going to happen in 2014 that much more difficult. But there are some things that seem pretty likely to happen in the coming year.
Interest rates are likely to continue to rise, at least in part due to the much discussed "tapering" of the Federal Reserve’s Quantitative Easing program. Most economists who cover the mortgage industry expect that the rate on conforming, 30-year fixed rate loans will end 2014 around 5.5% — still at the low end of historic rates, but significantly higher than at the beginning of 2013, and high enough to let the air out of the refinance balloon.
Rising interest rates, along with rising home prices, will reduce affordability, especially in an economy that continues to be plagued by wage stagnation – even though home prices are well off their peak in most markets and interest rates remain relatively low, income growth simply hasn’t kept pace. So many would-be homebuyers will be unable to enter the market.
Another likely impediment to homebuying will be tighter credit, due to the formal implementation of the CFPB ‘s new QM and Ability-to-Repay rules. Somewhere between 10-20% of the type of borrowers who qualified for a loan in 2013 probably won’t be able to do so under the new guidelines. Ultimately, probably late in 2014, we’ll see the return of private capital, and the secondary market, which will make it possible for non-bank lenders to offer non-QM loans to less-than-perfectly-qualified borrowers.
But these loans will come with significantly higher interest rates – to more accurately reflect risk-based pricing – and further erode affordability.
Home prices will probably continue to go up, albeit at a slower pace than we’ve seen over the past year, due to an influx of new (and more expensive) homes, fewer distressed homes entering the market, and low inventory levels, due to high levels of activity by institutional and individual investors, who will continue to buy single family homes to meet the growing need for rental units.
This need for rental properties is due at least in part to lower-than-anticipated purchase activity among first-time homebuyers, the segment that usually fuels the housing ecosystem. Household formation has slowed during recent quarters as a record number of the 25-35-year-old population has opted to live with mom and dad rather than move out on its own. When they do move out, this group increasingly decides to rent rather than buy, even though in most markets, it’s more expensive to rent than to own a home.
A big reason for this is that unemployment and underemployment remain stubbornly high for this cohort, making it difficult for them to either meet the qualifications needed in today’s lending environment, or be willing to enter into a long-term financial commitment.
Despite all of this – loans being harder to get, and more expensive, weakness in the first-time buyer segment, slow household formation, and worsening affordability – I don’t think we’ll see the housing market drop off significantly in 2014. What we’re likely to see next year is something pretty similar to what we’re seeing this year: about 4.9-5.1 million home sales, prices increasing by about 3-4% and the slow, gradual recovery of the housing market after one of the longest and most traumatic downturns in history.
While we’ve come a long way back from the bottom of the housing market, the next giant leap forward will only come with the return to health of the jobs market – one that creates higher numbers of good paying, full-time jobs, and drives higher labor force participation rates. So, in the end analysis, the key to the return of a more robust housing market is the return of a more robust U.S. economy. Will we see that happen in 2014? It doesn’t seem likely, but only time will tell.