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June 30, 2014

Mid-Year Economic Update

Frank E. Nothaft
Frank E. Nothaft, VP Chief Economist

We, like many, expected more out of housing so far this year.

Existing home sales were down 6 percent while new home sales were unchanged during the first five months of 2014 compared with the same time last year. Single-family housing construction was lackluster too with building permits slipping 2 percent and housing starts up a meager 1 percent over this same five-month window. One of the few bright spots in housing activity occurred for multifamily rentals: starts of buildings with five or more apartments jumped 16 percent during January through May compared with a year ago, and vacancy rates on rental apartments tracked by Reis dipped to 4.0 percent in the first quarter, down from 4.4 percent a year earlier, and the lowest recorded by the firm since 2000. That's great for the rental industry, but also means your rent is going up.

The Economy: We expect GDP to grow at a 3 percent rate over the next couple quarters. However, because of the dismal first quarter reading (-2.9 percent) the economy will struggle to show another 2.0 to 2.5 percent real-growth rate for the year as a whole, similar to the last few years. Part of this slowdown in the first quarter came from lackluster housing activity. Housing's contribution to GDP declined by an annualized 4.2 percent in the first quarter, whereas in 2013 it contributed 0.33 percent to overall GDP growth.

Employment: On the jobs front, the news is a bit better. The unemployment rate now stands at 6.3 percent versus 6.7 percent when we started the year and we've had four consecutive months of over 200,000 job gains. In May 2014, total nonfarm payrolls surpassed the pre-recession peak for the first time. Construction jobs are picking up, especially in the residential building and specialty trade sector, averaging about 9,500 jobs per month since the beginning of the year. While the trends are encouraging, the labor market is not yet fully recovered.

Mortgage Rates: A main reason for the year-over-year decline in mortgage applications was the mighty gut punch mortgage rates delivered to the market last June: rates for the 30-year fixed-rate mortgage jumped by more than a percentage point to a high of 4.58 percent. This spike triggered the rapid decline in refinance originations and also stunted the purchase market. Since then, rates have come down and will likely remain where they currently stand before gradually moving higher as the economy picks up steam over the next six months. In fact, as of last week, mortgage rates are now cheaper than they were a year ago, averaging 4.14 percent versus 4.46 percent for the 30-year fixed.

House Prices & Rents: The Freddie Mac House Price Index for the U.S. was up 9.3 percent in 2013, but gains are expected to slow to 5.0 percent for 2014. Average apartment rents in the U.S. will likely continue to rise, about 3.0 to 3.5 percent in the coming year. A moderation in house price growth is welcome news as we move toward more stable and sustainable gains.

Home Sales: Home sales are likely to be a bit below the 5.5 million pace from last year. Inventory of for-sale homes remains limited in some markets as many sellers remain underwater or prefer to keep the very low-rate mortgage they refinanced into, holding back a full recovery in the overall sales market. Home purchase applications have picked-up a bit recently with the traditional homebuying season underway, yet they're still currently more than 10 percent below last year. Like we pointed out in the latest release of MiMi, our new housing stability index, many factors are moving in the right direction for housing, but purchase applications aren't one of them.

For-Sale Inventory: Real estate professionals in many markets have reported tighter markets, which will help to sustain house price and rent gains, but at the expense of affordability. The for-sale supply has almost entirely reversed from just a couple of years ago. The for-sale inventory as a share of households is extremely tight on the west coast and in Texas and Louisiana, but shows relatively more availability in the southeast. The trend in inventory has been down across the country since 2010. For example, in metro areas like Houston and Dallas, where there have been strong job gains, inventories are low and building has picked up. Conversely, in the Miami and Atlanta metro areas, for-sale inventories have been nearly cut in half. The good news: inventory is coming back. Compared with last May, the new and existing single-family for-sale inventory in May 2014 was about 150,000 larger.

Vacancy Rates: In the first quarter of 2010 the homeowner vacancy rate (the percent of owner-occupied homes that are vacant and for sale) was 2.6 percent nationally. In the latest data for the first quarter of 2014, the homeowner vacancy rate was down to 2.0 percent, still high by historical standards, but much improved. While the total number of vacant units has decreased by 4.2 percent from the first quarter of 2010 to the first quarter of 2014, the number of vacant units for sale has declined by 24.2 percent (485,000 units). Vacancy rates also vary considerably by geographic area, with low rates in most of the coastal markets and higher rates in the Midwest. (To explore homeowner and rental vacancy rates across the country in more detail, visit our interactive chart book online.)

The important question is how much further will prices and rents have to rise to give incentives for more existing owners to list their property for sale and developers to bring more supply to the market. Construction has rebounded over the past two years but is still significantly below the levels one would expect to see given projections of household formations.

Tight inventories will be further exacerbated by acceleration in job growth and household formations. The May jobs report was solid, with nonfarm payrolls increasing by 217,000.  Increased job growth will help to boost household formation, which has been lagging throughout the recovery. In the long run, household formations are almost entirely driven by demographics, but in the short run job and income growth are critical for a sustainable housing market.

Here's hoping we have a better second half of 2014.

* Frank Nothaft left his position with Freddie Mac in January 2015.

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