A Bullish New Year for New-Home Building
According to Mark Zandi, chief economist for Moody’s Analytics, prospects are good for the U.S. economy in 2018. Economic expansion celebrated its eighth year in November, making it the third longest in American history. Zandi expects this expansion could become the longest in history, possibly surpassing the tech-driven boom of the 1990s, which lasted 10 years.
Economists from many facets of the industry, including Metrostudy, the NAHB, and the National Association of Realtors (NAR), all project positive economic growth in 2018, with one caveat. The significant wild card for the economic outlook in the next two to three years surrounds the fiscal policy decisions of the Trump administration, including the tax bill, which was expected to be signed into law at the end of December. The legislation could reduce ownership benefits, which would lead to fewer sales, lower prices, and dropping home values. However, despite the uncertainty from the nation’s capital, most indicators point to a good year for U.S. builders.
Despite labor concerns, 2018 start projections from multiple economists are still in a healthy range. The NAHB forecasts a 7.9% increase in single-family starts during 2018, and projects that single-family starts will reach 996,000 in 2019, representing 74% of their “normal” baseline (1,343,000 starts), calculated and justified by population growth and the need to replace older homes. Moody’s forecasts that starts will reach 1.8 million next year, which would be a 6.4% increase from its 2017 projection, and NAR predicts a 7% increase.
Mark Boud, senior vice president and chief economist of Metrostudy, expects new-home construction starts to make continued gains over the next three years, peaking at approximately 1.5 million housing starts in 2020. Boud projects that permits, housing supply, and housing demand will peak in 2020 as well, however, demand is expected to continue to outpace supply until 2023, even after demand has reached its peak.
The rate of job creation in 2018 isn’t expected to match that of 2017, but that’s a result of the U.S. economy reaching full employment. There are a record number of open job positions currently—over 6 million—which is positive given that it’s harder to fill open jobs when the workforce is nearly full. The bad news for builders in this case, however, is that a large share of those open positions are in the construction industry, and labor shortages will continue to be an impediment for housing in 2018. Job growth is about double the pace of labor growth, and the odds are good that unemployment may fall below 4% by November 2018 for the first time since the late 1990s.
Wage growth is slowly accelerating, and Zandi expects this to continue in 2018. “Wage growth is key to consumer expansion, and I expect housing to lead the way,” Zandi said in the NAHB’s Midyear Construction Forecast. “There’s clearly been a dearth for the [entry-level, lower price point] segment of the housing market due to constraints like [labor shortages], but I expect more single-family homes [in that segment] will be built in the next two to three years, which will provide a lot of juice for economic growth.”
Due to inventory constraints in many markets, rising prices were a challenge for prospective buyers of new and existing homes throughout 2017, and the latest S&P CoreLogic Case-Shiller U.S. National Home Price Index reported home price gains at an annual rate of 5.9%. Price growth is expected to ease slightly in 2018, but will continue to be an issue for buyers in lower price brackets, as supply of new and existing entry-level homes remains low.
The NAR expects inventory will increase in 2018, and that home prices will appreciate at a markedly slower rate of 3.2%—but that applies only to higher priced homes. First-time buyers will still largely be left out of the equation, as the NAR doesn’t anticipate inventory of homes suited for first-time buyers to open up significantly until 2019.
While inflationary pressures and the Fed’s decision to reduce its balance sheet will result in higher interest rates this year—NAHB projects the interest rate for 30-year fixed rate mortgages will reach around 5% by the end of 2018—demand should remain healthy.
Danielle Hale, managing director of housing research at NAR, posits that new and existing home demand during 2017—despite significant price growth—wasn’t impacted due to low mortgage rates. Hale contends that alongside easing price appreciation, higher mortgage rates should not make affordability a major challenge, as long as rates—and wage growth—rise gradually over time.
The shortage of affordable single-family homes, new and existing, was a fixture of 2017. Household formation has returned to levels roughly in line with historical averages, but many potential buyers still can’t enter the market due to sky-high prices, and construction starts (especially for single-family homes) have been insufficient to quell demand.
NAHB chief economist Robert Dietz notes that the primary constraint for buyers (especially younger buyers) is qualifying for a mortgage and accumulating the money for a down payment. Need for single-family housing inventory that millennials can afford is becoming more immediate, as the largest portion of that generation will turn 30 in 2020.
According to Dietz, residential construction in 2018 will face three supply-side bottlenecks: labor, land, and lending. Labor continues to be the biggest issue because not only is the construction workforce smaller than it was prior to the recession, but there are also more open, unfilled jobs as a total share of that workforce.
Additionally, overall worker productivity for the entire economy has increased 30% since 1993, in contrast to worker productivity in the construction sector, which rose roughly 3% during the same period. The average construction worker is 41 years old, and as those workers decide to leave labor-intensive positions, the industry will be faced with a major generational challenge to attract younger workers.
“I think this represents a real business opportunity in the residential construction industry to find ways to substitute capital for increasingly scarce labor,” Dietz says. “We need to find ways of increasing productivity, maybe that means more factory-built components, more panel, [or] more modular construction, which only makes up 3% of single-family construction. We’re going to have to get more productivity out of our workforce, because the worker shortage really doesn’t look like it’s going to change much over the next few years.”