Silicon Valley

The U.S. Housing Market: Despite a Demographic Push, Proceed With Caution


With California housing markets having decidedly shifted since the summer, the looming question is what comes next. Since 2014, Pacific Union has partnered with John Burns Real Estate Consulting to forecast the market for the upcoming three years. At our November 2017 forecast, we suggested that the John Burns Home Value Index would reach a plateau in 2018 (which we named a “table top”) and maintain that level through about 2020. The major difference between the current peak and the previous peak seen in the mid-2000s is that the current peak resembles a table top, while the last peak was characterized as a “mountain peak” — a peak followed by a large decline.

Source: 2017 Pacific Union Real Estate and Economic Forecast

A lot has happened since our last forecast, but our predictions remain similar.

While our annual forecast event has been postponed to the first quarter of 2019 as a result of the merger with Compass and the wildfires, I recently attended the JBREC annual summit in New York City, and here are the key takeaways.

  • While concerns over the housing market’s strength are rising, the major tailwind is the demographic force. With U.S. millennials numbering 44 million, that generation’s largest age bracket (4.7 million people) will turn 32 years old over the next couple of years, thus creating a huge wave of potential homebuyers.
  • Online buyer behavior suggests that sales will remain solid in markets in the South (such as Charlotte, Houston, Raleigh, and Atlanta) but will decline in West Coast markets and some Northeastern markets, with California home sales expected to post a 2 percent to 7 percent decline over the next six months.
  • Interest-rate hikes following strong price growth over the last year took a large bite out of affordability, making it the biggest concern for California housing markets.
  • While technological advancements have the potential to reduce construction costs, supply constraints outweigh any potential savings in the short term.
  • Affordability constraints are likely to drive builders to pivot down in price to smaller, higher-density, lower-specification homes in slightly less desirable locations. Also, builders are more likely to construct single-family rental properties.
  • Average annual price growth in six California metropolitan areas is projected at 6 percent in 2019 and 3 percent in 2020 before declining by 0.3 percent in 2021.

Long-Term View

Demographic Trends Are Propping Up Long-Term Demand

  • With U.S. millennials numbering 44 million, that generation’s largest age bracket (4.7 million people) will turn 32 years old over the next year, which is the median age of first-time buyers in the U.S. Considering a combined total of about 6 million new and existing homes sold annually in the U.S., millennials have the potential to create a huge wave of first-time homebuyers and account for a much larger share of total housing demand. First-time buyers currently comprise about one-third of all homebuyers.
  • These demographic forces suggest that 1.25 million more households per year over the next 10 years will need housing, which means that 1.375 million new units per year need to be built to meet demand through 2025 (including owner-occupied properties, second homes, and replacement of teardowns).
  • However, after 2025, America’s aging society will reduce the need for housing production since seniors create supply when they pass away or move into assisted-living facilities or their children’s homes. Thus, the net growth of new homes will decline to 230,000 units per year.

But Supply Constraints Make Homes Increasingly More Expensive

  • At the same time, meeting current demand has become increasingly more difficult, as builders take a large risk when buying raw land to entitle in their respective regions.
  • Based on a JBREC survey, buying raw land is perceived by builders as twice as risky as buying a few home-builder stocks, leading to fewer builders willing to make purchases in the current housing cycle.
  • In addition, builders face large labor shortages, which will not abate considering the nation’s aging demographics and immigration restrictions, both of which will lead to much higher construction wages.
  • However, technological advancements in the construction industry — such as building information modeling software, 3D printing, robotics, off-site technologies imported from overseas, and smart homes — have the potential to reduce costs dramatically.
  • Still, many costs will continue to increase:
  1. Lot shortages will keep land prices high.
  2. Labor shortages will keep building costs high.
  3. Inflation and potentially tariffs will keep materials costs high.
  4. Regulation-related costs are high in California.
  5. Significant off-site cost reductions for nicer single-family homes are years away.

Short-Term View

2018 Slowdown

  • Nationally, sales of newly built homes have been slowing all year, with a 13 percent year-over-year decline in October, bringing annualized sales to 553,000 new single-family homes, or 40 percent of the projected 1.3 million needed to meet demand.
  • What led to 2018’s slowdown:
    • Mortgage rates rose by 88 basis points this year, from 3.95 percent in January to 4.83 percent in October, resulting in at least an 11 percent increase in payments without accounting for price appreciation.
    • With price appreciation, Californians’ monthly mortgage payments are up by as much as 25 percent year over year:
      • Silicon Valley, up by 25 percent
      • San Francisco, up by 19 percent
      • The East Bay, up by 17 percent
      • Los Angeles, up by 14 percent
      • Nationwide, up by 13 percent
  • Each 100-basis-point increase in mortgage rates reduces borrowers’ purchasing power by about 7 percent.
  • The impact on affordability is vast, as 44 percent of American households earn less than $50,000 per year and the median U.S. income is $63,000.
  • In the Bay Area, the current minimum annual income required to purchase a median-priced home is more than $202,000, up from $90,000 in 2012. The median household income in the Bay Area averages about $100,000 in the eight local counties excluding Solano.
  • In Los Angeles, the current minimum annual income required to purchase a median-priced home is more than $112,000, up from $54,000 in 2012. The median household income is Los Angeles County is currently about $65,000.
  • Newly constructed homes cater to affluent homebuyers, with 60 percent of public builders across the U.S. now constructing homes with average prices higher than $400,000. In Los Angeles, the median new home price is $682,000, while in the Bay Area, it ranges from about $760,000 in Sonoma County to $1 million in Silicon Valley.
  • Only 24 percent of American renters can afford the median-priced new home today, and just 31 percent can afford a resale home.
  • And while there have been more listings on the market in recent months, inventory is still below average across all price tiers, especially for the most-affordable range, which is almost 50 percent below the average.
  • Lastly, the housing market’s performance and the current slowdown is not a nationwide trend — sales of existing home remain strong in the relatively affordable South.

What to Expect in the Months Ahead

  • The economy will remain healthy, boosted by low unemployment, continued hiring, and wage increases, but the rate of growth will slow.
  • Mortgage rates will likely reach 5.5 percent by the middle of 2019, leading to fewer home sales.
  • Historically, increases in mortgage rates when the economy was strong have generally had a small impact on activity, leading to a 7 percent to 10 percent decline in sales.
  • Online buyer behavior suggests that sales will remain solid in the markets in South (such as Charlotte, Houston, Raleigh, and Atlanta) but will decline in West Coast markets and some Northeastern markets, with California home sales expected to post a 2 percent to 7 percent decline.

What to Expect Beyond 2019

  • Rising rates will slow move-up homebuyer activity, with an 11 percent decrease in total home sales.
  • Mortgage availability has improved, though credit scores and proof of employment play a critical role (unlike during the early 2000s).
  • Affordability constraints are likely to drive builders to pivot down in price to smaller, higher-density, lower-specification homes in slightly less desirable locations. Also, builders are more likely to construct single-family rental properties.
  • The risk of a recession increases, with a 48 percent probability of a downturn within two years and a 64 percent chance within four years. Fifty-nine percent of economists forecast a recession in 2020.
  • However, housing risks vary by market:
  1. California housing markets generally rank normal to higher risk, with no market nationally categorized as very high risk.
  2. Affordability is the primary risk.
  3. A huge upside in the current housing market is homeowner equity, currently at $190,000 inflation-adjusted per U.S. owned household.
  • Other risks:
  1. A rapid acceleration in interest and mortgage rates shaking consumer and business confidence
  2. A decline in foreign buyer activity due to immigration policy or emerging market factors (such as currency, trade policy, local stock markets, or economic fluctuations)
  3. Immigration restrictions: There has already been a pull-back in H-1B visa approvals, which are critical for the tech sector in California; holders of these visas are also participants in local housing markets
  4. Excessive debt burdens (government, corporate, and consumer); if interest rates spike, they would have trouble repaying debt
  5. A stock market correction that could rattle consumer confidence and result in in job losses
  6. A “black swan,” or an unforeseen geopolitical event that triggers significant volatility in financial markets and the economy

California Outlook

  • The chart below shows the John Burns Home Value Index four-year outlook for median home price appreciation in six California metropolitan areas and/or divisions. The numbers indicate the average annual rate of growth or decline.
  • Because of affordability pressures, all six markets are projected to see notably slower price growth over the next three years.
  • Four of the six markets are forecast to see negative growth in 2021 of no more than 1.3 percent. However, all markets will see at least a 5 percent additional cumulative increase in 2019 and 2020 before the reversal in 2021.

Source: John Burns Real Estate Consulting

Taken together, with input from JBREC and the nation’s largest home builders, our final takeaway is that buyers and investors should proceed with caution but proceed nevertheless.

Selma Hepp is Pacific Union’s Chief Economist and Vice President of Business Intelligence. Her previous positions include Chief Economist at Trulia, senior economist for the California Association of Realtors, and economist and manager of public policy and homeownership at the National Association of Realtors. She holds a Master of Arts in Economics from the State University of New York (SUNY), Buffalo, and a Ph.D. in Urban and Regional Planning and Design from the University of Maryland.

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How Long Will a Home Purchase Impact Californians’ Credit Scores?

  • The average American can expect their credit score to decline by 15 points after buying a home, with the total recovery time taking about 10 months.
  • San Jose and San Francisco homebuyers have exceptionally high credit scores but will need to wait roughly a year before their ratings return to normal.
  • Making on-time mortgage payments will help boost new homebuyers’ credit ratings, as will the diversification of their accounts by owning real estate.

San Francisco homebuyers have some of the best credit scores in the country, but they also face one of the longest roads to recovery after completing their real estate purchase.

A new analysis by LendingTree Chief Economist Tendayi Kapfidze examines how much buying a home affects credit scores in 50 major American metropolitan areas and the length of time that it takes ratings to return to their prepurchase averages. U.S. buyers can expect their credit scores to decline by an average of 15 points after they buy a home over a period of nearly five months. After that, the recovery begins and takes another five months for credit scores to return to the baseline.

Of the six California housing markets included in the report, San Jose fares the best when it comes to credit recovery. Before buying a home, San Jose residents boast credit scores of 725, the highest of any of the cities included in the study. Post-purchase, Silicon Valley credit scores fall to 711 for an average of 149 days before taking 173 days to recover, ranking it solidly in the middle of the country.

San Francisco homebuyers have almost as good of credit as their counterparts to the south, at 724, and they can also expect their scores to dip to 711 over a period of almost exactly six months. Once the 196-day recovery time is factored in, San Franciscans will need to wait one year and 10 days for their ratings to normalize, ranking it near the bottom of the list at No. 47.

The other Golden State cities included in LendingTree’s analysis also appear in the lower half of the rankings when it comes to total credit-recovery time: No. 39 Los Angeles (347 days), No. 40 San Diego (348 days), No. 44 Sacramento (357 days), and No. 48 Riverside (375 days).

As Kapfidze explains, the reason that Americans’ credit scores fall when they purchase a home is fairly logical: As the biggest purchase that most people will ever make, a real estate transaction adds a large amount of debt to one’s balance sheet. Once new homeowners have proven that they can swing the monthly house payments in a timely manner, their credit ratings gradually improve, boosted by the fact that having a mortgage helps diversify a credit portfolio.

Of course, having a good credit score is key to getting a home loan in the first place, and younger homebuyers could stand to improve their ratings to maximize their chances. Another recent LendingTree study reports that millennials have average credit scores of 634, the lowest of all generations. And earlier this year, Experian published an analysis finding that more than 60 percent of millennials lack a prime homebuying credit score.

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Which California Neighborhoods Are Millennials Flocking To?

  • Downtown Los Angeles’ Historic Core neighborhood saw its millennial population nearly double between 2011 and 2016, the highest rate of growth in the U.S.
  • In San Francisco, The Castro and Glen Park are among the top 20 neighborhoods in America to experience the largest millennial population growth.
  • More than 30,000 millennials live in Los Angeles’ South Park neighborhood and San Francisco’s Mission Bay.

Millennials walking in a cityThe Golden State is home to the nation’s largest share of millennials, and they are gravitating toward Downtown Los Angeles and neighborhoods in southeastern San Francisco.

Between 2011 and 2016, Los Angeles’ 90014 ZIP code, also known as the Historic Core, saw its millennial population increase by 91.4 percent, the most of any area in the 30 largest U.S. cities included in an analysis by RentCafe. During that time period, 3,300 millennials — defined here as those born between 1977 and 1996 — moved to that part of Downtown Los Angeles, which the company identifies as America’s fastest-gentrifying neighborhood since the turn of the century.

Millennials are also beginning to gentrify Los Angeles’ 90013 ZIP code, otherwise known as Skid Row. That neighborhood had the nation’s second-largest increase in millennial residents in the five-year period — 60.0 percent, which translates to 4,700 people.

Two San Francisco ZIP codes rank in the top 20 for millennial population growth: 94114 (The Castro) and 94131 (Glen Park). The former enclave saw 37.4 percent (12,500 people) more millennials set up shop, while the latter posted a 35.5 percent increase (9,000 people).

San Francisco’s booming Mission Bay neighborhood ranks among the top 20 U.S. neighborhoods with the largest share of millennials, where 3,800 residents of that age group comprise nearly two-thirds of the population. Millennials who call Mission Bay’s 94158 ZIP code home are almost certainly earning handsome paychecks; according to a separate RentCafe analysis, it’s the second most expensive neighborhood in the Bay Area for renters, with monthly payments averaging $4,336.

New York and Chicago ZIP codes dominate the rankings of the 20 U.S. places where the most millennials live, but two Golden State neighborhoods make the list. In Los Angeles, 33,500 millennials reside in the 90011 ZIP code (South Park, just south of Downtown), while 30,500 live in 94110 in San Francisco’s Inner Mission.

Despite the Bay Area’s sky-high home prices, millennials have gained a surprisingly large foothold in the real estate market. According to a February analysis of Pacific Union data by Chief Economist Selma Hepp, homebuyers aged 35 and younger accounted for more than one-third of purchases in San Francisco and Silicon Valley between August 2017 and January 2018.

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First-Time Buyers Score Nearly 1 Million Homes in 2018

  • New buyers purchased 985,000 homes in the first six months of 2018, the highest such activity since 2005.
  • First-time homebuyers accounted for 2.1 million home sales in 2017, higher than the historical annual average of 1.8 million.
  • Given rising mortgage rates, first-time buyers who entered the market in June 2018 paid 67 percent more for a home than they would have five-and-a-half years ago.

Though first-time homebuyers face multiple challenges in today’s housing market — including rising interest rates, strong appreciation, and critically low inventory levels — that group was busier than it has been in 13 years in the first half of this year.

That’s according to a report from Genworth Mortgage Insurance, in which company Chief Economist Tian Liu said that first-time buyers purchased 572,000 U.S. single-family homes in the second quarter, up 1 percent year over year to account for 36 percent of transactions. And while that increase might seem insignificant, first-time home buyers were responsible for 985,000 home purchases in the first six months of this year, the highest such activity since 2005.

First-time homebuyer activity is now slightly above its historical average of 35 percent but quite a bit shy of the 46 percent peak recorded in the mid-1990s. In 2017, new buyers scooped up 2.1 million homes, breaking out of the cyclical depression to move above the historical annual average of 1.8 million. That buyer pool is getting a boost from the nation’s thriving economy, with the unemployment rate for 25-to-44-year-olds at 3.5 percent in the second quarter, the lowest in more than 17 years.

A shortage of homes for sale — particularly those priced at the lower end of the market between $150,000 and $300,000 — continues to prevent more first-time buyers from getting in the game. The nation’s inventory crunch helped push up home prices by 6.5 percent in the second quarter on an annual basis, putting a dent in affordability for potential new buyers.

Further hindering affordability for first-time buyers is the impact of rising mortgage rates. That segment of the market took out 30-year mortgages that averaged 4.77 percent in the second quarter, meaning that first-timers paid an average of 12.6 percent more each month than they would have at the same time in 2017. A longer view presents an even more telling picture of the effect of higher rates, with June 2018 first-time buyers spending a staggering 67 percent more than they would have in January 2013.

Despite the Bay Area’s well-documented housing affordability issues, first-time buyer activity in the region appears to be in line with the national average. In a February analysis of Pacific Union transaction data, company Chief Economist Selma Hepp found that buyers age 35 and under were responsible for about one-third of transactions in Alameda and San Francisco counties and Silicon Valley over the preceding six months.

While Liu calls the uptick in first-time homebuyer activity “remarkable” given difficult market conditions, he notes that such buyers have historically depended on obtaining mortgages with less than the conventional 20 percent down payment. In the second quarter, new homebuyers took out two-thirds of low down-payment loans.

“When policymakers, lenders, and housing advocates discuss ways of increasing homeownership, down payment affordability should be an important consideration,” he wrote.

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Bay Area Cities Rank as Best in the World for Future Momentum

  • Half of the world’s top 30 cities that are best prepared for the future are in North America.
  • San Francisco and Silicon Valley rank a respective No. 1 and No. 2 on the list of “future-proofed” metropolitan areas.
  • Los Angeles and San Diego also rank among the world’s top 10 future-proofed cities.

The Bay Area’s real estate market and high-performance economy are currently running at full steam and appear poised to carry that momentum over the long term.

Jones Lang LaSalle’s fifth annual City Momentum Index ranks 131 global cities based on potential for long-term socio-economic and commercial real estate market success, a term it calls “future-proofing.” Factors used to gauge a metropolitan area’s chance for future momentum include innovation capacity, quality of universities and colleges, number of startups, and public infrastructure and environment quality.

North America accounts for half of the world’s top 30 future-proofed metro areas. Six of the top 10 future-proofed cities are in the U.S., and four of those are in California.

San Francisco takes the top spot on the rankings, followed by Silicon Valley at No. 2, both due largely to the Bay Area’s global position as a technology powerhouse. Those two Bay Area regions have the planet’s largest number of startups and have also created the most tech unicorns — private startups valued at more than $1 billion — over the past 15 years.

In Southern California, Los Angeles and San Diego rank a respective No. 6 and No. 10 on the future-proofed cities list. Jones Lang LaSalle points to Southern California’s excellent higher-education institutions, which produce plenty of highly skilled technology workers. Both cities employ more computer and mathematics workers than any other job market on the West Coast, and both rank in the top five for the most international patent applications.

So why is future-proofing an important measure of a real estate market’s potential to thrive? Investors use the metric to determine whether technology innovations will result in a market’s ability to hold its value and appreciate over time. For developers, the concept of future-proofing allows for understanding a city’s capacity for economic growth, thereby allowing them to plan and build sustainable communities.

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Labor Shortages, Materials Costs Increases to Drive Up Home-Remodeling Costs

  • A recent survey found that remodeling firms expect labor shortages to worsen this year, while worker and materials costs will increase.
  • More than nine in 10 remodeling businesses report a shortage of carpenters.
  • About 70 percent of home-improvement companies will pass increased labor and materials costs on to customers.

While most American homeowners and prospective buyers probably do not ponder the construction sector on a regular basis, current trends in that industry could affect their wallets in the coming months.

Houzz’s new State of the Industry 2018 report, which coincides with National Home Improvement Month, found that respondents from all seven construction and remodeling subsectors it tracks expect the availability of skilled workers to tighten this year. General contractors, designers, and builders are projected to be the most in-demand types of workers, with about half of those polled expecting the labor market to get tighter.

All seven subsectors also project that labor costs will increase, again led by general contractors (56 percent) and designers and builders (57 percent). About half of architects and specialty renovators and landscapers think that the aforementioned lack of skilled workers will cause job costs to rise in 2018.

That trend again persists when it comes to the cost of remodeling and building materials, which are expected to increase across the board. The number of remodeling professionals who believe that materials costs will be higher this year than last ranges from 60 percent of general contractors to 47 percent of landscaping firms.

Houzz’s survey dovetails with research published earlier this week by the National Association of Home Builders, in which more than 90 percent of home renovators reported a shortage of carpenters, with about half calling the situation serious. Other types of remodeling professionals that are in the highest demand include framers, bricklayers, drywall installers, and concrete workers.

About three-quarters of remodeling businesses told NAHB that a lack of skilled workers is leading them to pay higher wages. The impact on homeowners is nearly the same, with 71 percent of firms reporting that they pass their increased costs along to clients.

Bay Area homeowners who are considering a home-improvement project should check out Remodeling’s 2018 Cost Versus Value report, which estimates average costs for 21 popular jobs in 149 U.S. metropolitan areas, including San Francisco, San Jose, and Santa Rosa. The report also offers information on home-renovation returns, which are particularly sunny in Silicon Valley, with 18 of the 21 tracked jobs expected to turn a profit this year.

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