In 2019, mortgage rates fell while home prices and home sales increased in most areas of the country. What will 2020 bring? Freddie Mac’s Chief Economist, Sam Khater answers questions about what to expect in the year ahead.
Mortgage rates are expected to settle below 4% for the 30-year fixed-rate mortgage in 2020, which is a tad higher than the second half of 2019 but still very supportive of a continued rise in purchase demand. Mortgage rates reached a trough of 3.49% in early September and have since increased by about 25 basis points as the economy began to improve and the risk of a recession receded. The rise in mortgage rates since the early fall has not dented purchase demand at all, with purchase applications consistently rising between 5 and 10 percent above a year ago with no signs of a slowdown. As a result of the low mortgage rate environment and the strength in the labor market, we expect home sales to rise to 6.2 million in 2020, up from 6.0 million in 2019.
I think the lack of housing supply is one of the largest economic issues for the United States, and unless there are policy interventions, it is likely to worsen. There has been a significant reduction in the number of housing units added to the nation’s housing stock, with 9.8 million in the last decade compared to an average of 18 million per decade over the last 50 years. We estimate that around 1.6 million housing units are needed to meet the annual housing demand. Even though housing completions or new supply reached a 10-year high of 1.3 million in 2019, this still fell short of annual housing demand by about 300,000 units and that annual demand number does not account for the larger supply deficit from prior years. While there is a national deficit, there are large regional differences. According to forthcoming Freddie Mac research, the supply deficit is not confined to coastal markets but is now becoming an issue in interior states like Texas and Minnesota that have thrived because of their strong economy, but more importantly housing affordability.
Housing affordability is expected to worsen in 2020 as the demand for homes continues to outstrip supply. The major channels through which this will impact the housing market is through home sales activity, home prices and the homeownership rate. After a slowdown in 2018, existing home sales began to recover in 2019 but have since stabilized at around 5.4 million. It will be difficult for existing home sales to rise much higher than the mid-5 million range given that the months’ supply is 3.8 months, which is much lower than the 5 to 6 months normal range. In addition, the number of existing homes for sale is currently the lowest it has been over the last four decades. As a result, home prices continue to rise at a steady pace despite the affordability pressures that are building. While home prices continue to rise, the rebound in the homeownership rate has stopped. The homeownership rate hit a trough of 62.8% in Q2 2016 and began to consistently rise until it reached 64.8% in Q4 2018, where it remained as of Q3 2019. This means there are some prospective buyers who have the desire and willingness to own a home but cannot simply due to the lack of inventory.
While economic growth is slowing, the chance of a recession during 2020 is receding. Historically, there have been three drivers of a recession: policy mistakes, vulnerabilities and shocks. Prior to the 2000s, most recessions were caused by either the Federal Reserve overly tightening interest rates to cool off emerging inflation that often tipped the economy into a recession or geopolitical turbulence that was an unexpected negative shock. Since the early 2000s, the two major recessions in the United States were caused by financial vulnerabilities such as excessively high stock prices or home prices. Monetary policy will likely be on the sidelines for 2020, so the risk of a policy mistake is low. While there are vulnerabilities in lower-rated corporate debt and consumer debt, neither are, at this point, at levels that would tip the economy into a recession. Moreover, consumer spending continues to grow at a steady pace, and wage growth for the bottom half of the income distribution has materially increased over the last two years and will provide the economy momentum.
There are two sets of markets I will be focused on to gauge the housing market. The first set is large formerly hot markets, and the second is emerging markets. The key large markets to follow are places like Las Vegas, Denver, Austin and other similar markets that had been rapidly growing over the second half of last decade. Many of these markets have exhibited a pronounced slowdown in home price growth due to the run up in rates in 2018, and some have exhibited a medium-term trend of decelerating price growth due to affordability strains. On the other side of the spectrum are smaller cities that have seen rapid escalation in home prices and growth are typically in the “open west” interior mountain states. These emerging markets include not only markets like Boise and Salt Lake City that have been rapidly growing for a few years, but also smaller markets like Idaho Falls, Coeur d’Alene and Pocatello in Idaho, Spokane, WA, Cheyenne, WY and Logan, UT that have been red hot.
I think the increased interest from federal, state, and local entities in affordable housing and the need for new housing supply is the most important development in real estate for 2020. The increased interest is significant because it presents policymakers and researchers an opportunity to evaluate the myriad ways state and local governments are attempting to add more supply. The local solutions being deployed are diverse: while some localities have focused on accessory dwelling units, others have pursued transit-oriented multifamily development, or upzoning traditional single-family residential neighborhoods. The examination of these state and local efforts will help policymakers at all levels of government develop housing policy toolkits to help them be more successful in their initiatives.