Introduction

A combination of low mortgage rates and robust job growth should help to propel housing markets in 2016. Despite weak overall economic growth, the prospects for housing remain bright. Many are forecasting that home sales will reach their highest level in a decade1 see for example: http://www.freddiemac.com/finance/report/ 20160422_economic_outlook_darkens_ but_housing_remains_bright_spot.html.

These notes are summary of the key points I made in several recent economic outlook presentations, covering trends in the economy, housing, and mortgage markets.

Low mortgage rates

Mortgage rates began the year at slightly above 4 percent, but have trended down throughout the year2 Mortgage rates reported weekly in Freddie Mac’s Primary Mortgage Market Survey.. Mortgage rates have followed long-term U.S. Treasury yields down3 The historical correlation between Treasury yield and mortgage rates is very high.

Mortgage rates and 10-year Treasury yields Mortgage rates and 10-year Treasury yields

Additional context for mortgage rates. The chart below shows mortgage rates from 1971 through 2016.

Low mortgage rates help to support homebuyer affordability. For example, for a buyer looking to finance a home purchase with a $200,000 loan, a 1/4 percentage point increase in interest rate increases annual Principal and Interest mortgage payments by $341. If a household can only just qualify for a $200,000 mortgage at a 30-year rate of 3.66 percent, then with rates at 3.91 (+0.25 percentage points) the maximum loan amount this borrower could qualify for would be $194,000. From a constrained borrower’s point of view, a quarter point in rate is like a 3 percent increase in house prices.

Mortgage refinance: mostly dead, but not all dead

Outstanding Agency Mortgage Backed Securities (30-year FRM) As of December 2015, there remained a significant volume of outstanding single-family mortgage debt that could possibly benefit by refinancing into a lower mortgage rate. Just in the conventional conforming (excluding FHA/VA and Jumbo loans) space there was $655 billion oustanding with a contract rate above market interest rates. And an additional $592 billion might find a refinance attractive with mortgage rates below 4 percentage points for the 30-year fixed rate mortgage.

Low mortgage rates help to support refinance activity in 2016. Many analysts had expected mortgage rates to rise to start 2016 and spend most of the year well above 4 percent for the 30-year fixed rate mortgage. Instead, mortgage rates tumbled to start the year and breathed additional live into mortgage refinancing activity.

Freddie Mac has been forecasting that refinance mortgage activity would decline as interest rates rose. But low mortgage rates through the first four months of 2016 have allowed additional refinance activity. The charts below show the history and forecast for single-family mortgage originations from Freddie Mac’s April 2016 Outlook.

The charts show a shift from refinance to purchase mortgage activity as higher rates gradually reduce refinance activity while home sales and house price appreciation help drive purchase activity higher.

The purchase market strengthens

Mortgage origination activity is projected to remain relatively strong due to the strong projected growth in home purchase mortgage activity. This relies on two things4 Another important factor is what happens with the cash share of transactions. See for example, recent research from CoreLogic. Cash shares have trended down in recent years and that underlies most forecasts of mortgage activity. Were cash shares of home sales to rise, then purchase mortgage activity would either increase at a slower pace or even decline given the same number of home sales and the same level of house prices. : 1) continued improvement in home sales, and 2) continued positive house price growth.

Existing home sales gather strength

Despite tight inventories, existing home sales have been trending higher in recent months. The graphic below contains the history of existing home sales, as reported by the National Association of Realtors since 2006. The annotations indicate important events5 Early in the recovery there were two first-time homebuyer tax credit expirations that caused home sales to spike and drop. In 2013, the “Taper Talk” event drove mortgage rates up over a full percentage point during the spring of 2013, significantly slowing housing market activity. And in November of 2015 the implementation of TRID caused some delays in closing home sales. that drove short term trends in the existing sales market.

New home sales treading water

On the new home sales front, momentum has been slow to build. The recent history of new home sales as reported by the U.S. Census Bureau in their joint release with the Department of Housing and Urban Development (HUD) is plotted in the graph below.

It’s important the recognize that new home sales estimates are based on a relatively small sample and subject to considerable sampling uncertainty. The graph above includes the confidence interval reported by Census/HUD. Over the past year there’s been no statistically significant variation in the number of new home sales. New home sales are up significantly from the lows of a few years ago and housing construciton data suggest they’ll head higher over the next year.

Demand still strong

Mortgage applications have been trending significantly higher over the past few months. The chart below compares the year-over-year percentage change in total home sales and mortgage purchase applications. Purchase applications have been increaing at nearly a 30 percent year-over-year pace, a sign of strong housing demand. But will there been sufficient supply?

Inventory tightness

A key constraint on home sales activity has been low levels of for-sale inventory.

As the chart above shows, existing homes for sale have been flat over the past three years (with typical seasonal ups and downs) while new homes for sale have been trending higher, but from a low base. With low mortgage rates and a labor market posting solid jobs gains month after month, housing demand is likely to remain strong throughout the spring and summer.

Vacant Housing: from surplus to shortage

EARLIER THIS WEEK the Census Bureau released the latest Housing Vacancy Survey (HVS) data for the first quarter of 2016.

Much attention went to the homeownership rate estimates, which showed a decline in homeownership rates near a 48-year low.

The gif below shows the history of the homeownership rate as estimated by the HVS. homeownership gif

homeownership rate

Vacancy rates

In addition to the homeownership rate, the HVS data contained estimates of both the homeowner and rental vacancy rates. The graphs below show the history of each.

homeowner vacancy

rental vacancy

The animated gif below shows the joint evolution of the two series, along with a scatterplot showing the correlation between the two series. scatter gif

And this graphic shows the correlation of the two series with a scatterplot:

scatter still

What we can see from these data is the incredible rise and fall of vacancy rates during the housing bust and subsequent recovery. Compared to history, rental vacancy rates are bit below their historical average, while homeowner vacancy rates are bit above their historic average.

Surplus to shortage

One way to look at these data is to consider in absolute numbers how many excess vacant housing units we might have at any point in time. If we concede that a certain level of vacant housing stock is “normal”, then we can compare that to the current vacant housing stock. That is in fact, what we do the following figure:

overhang

This graph was constructed by first taking the average vacancy rate for for-sale and for-rent housing from 1994Q1-2003Q4 and then comparing the current vacancy rate to those levels. If the current vacancy rate is above (below) the historic average then we consider the vacant housing supply to be in surplus (shortage).

As of the first quarter 2016, the vacant housing supply is in shortage by this method by about 500,000 units. That is, there are about 500,000 fewer vacant housing units relative to what history tells us is normal. Note that the green bar (capturing rentals) is negative while the blue bar (capturing owned units) is positive. This means that in aggregate, the total vacant housing stock is 500,000 below “normal”, with rentals more than 500,000 short, while for-sale properties are about 50,000 above normal.

Home price growth

With available inventory low, demand picking up, and mortgage rates supporting affordability, home values have been increasing lately. The graph below shows the FHFA purchase-only house price index (SA) from 2000 through the latest release for February 2016. This compositie graph shows both the level and compound rate of growth for the index:

Over that time period house prices are at a new nominal peak, surpassing their pre-recession peak by 1.7 percent. House prices are also up more than 28 percent from the low point in 2011.

The rebound in house prices is driving up homeowner equity. Since the bottom in 2011, homeowner equity has nearly doubled. As of the fourth quarter of 2015, homeowner equity was at an estimated $12.5 trillion, just below the $13.3 trillion (not adjusted for inflation) that we had in 2006.

House prices are growing faster than rents, incomes, and other goods and services. The graph below compares the FHFA purchase-only house price index to per capita disposable income, rent of the primary residence, and the prices of all other goods excluding shelter.

The chart shows that nationally prices are roughly in line with incomes and rents since the year 2000. But the pace of recent house price gains (about 6%) is above the rate of growth of rents and incomes.

Housing market drive growth, but challenges ahead

Given positive demographics (the Millennials are yet to enter peak home-buying years), housing markets should do well. First quarter growth would have been effectively zero without the 0.49 percentage points that residential investment added to GDP growth. As long as interest rates do not rise too rapidly, the outlook for housing should remain upbeat in the near term.