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Real Estate Research provides analysis of topical research and current issues in the fields of housing and real estate economics. Authors for the blog include the Atlanta Fed's Kristopher Gerardi, Carl Hudson, and analysts, as well as the Boston Fed's Christopher Foote and Paul Willen.


January 24, 2018


Housing Headwinds

In a recent post, we described the outlook for housing growth in the Atlanta Fed's district as "slow and steady." In this post, we look at what other Fed districts are hearing about housing growth and attempt to reconcile those anecdotes with recent signs from the Atlanta Fed's GDPNow.

The most recent Beige Book characterized residential real estate activity as "constrained across the country." Of the 12 districts, only one (the Federal Reserve Bank of Chicago) raised its classification of the pace of residential construction, and five lowered their assessments. The other districts remained at little or no change, including San Francisco, whose pace was still strong despite shortages of land and labor. Indeed, several districts cited tight labor conditions as limiting new construction.

With labor and, to a certain extent, land market conditions holding back construction, we might expect the prospects for residential fixed investment (RFI) in the fourth quarter of 2017 to be dreary. However, recent releases of GDPNow indicate that residential fixed investment should make a relatively strong contribution to fourth-quarter real GDP growth after being a drag in the second and third quarters (see chart).

Interestingly, brokers' commissions are making the largest contribution to RFI, followed by permanent site (single and multifamily construction) and improvements. The increase in brokers' commissions reflects the increase in the real value of home sales that resulted from the acceleration of house prices as well as from a sharp increase in the number of existing and new home sales reported for October and November 2017 (see chart).

An increase in both house prices and the number of houses sold is consistent with strength in housing demand. We look to the supply of housing to understand the Beige Book's description of constrained real estate activity. Housing inventory provides an indication of supply conditions. Eleven Fed districts reported that residential inventory conditions were tight (the remaining district did not mention inventory). Several stated specifically that low inventory was restraining sales and that the low number of available houses is putting upward pressure on house prices.

Constrained residential real estate and construction activity does not mean that the sector is doing poorly. It just means that, the housing market's positive contribution to economic activity could be greater if land and labor market conditions were more favorable.

The national Beige Book comments are consistent with our view of housing sector conditions in the Southeast—specifically, that supply-chain constraints imply that near-term residential investment growth will be steady and measured.

Photo of Carl Hudson Carl Hudson, director of the Center for Real Estate Analytics


January 24, 2018 in Housing demand, Housing prices | Permalink

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January 03, 2018


Where Is the Housing Sector Headed?

One element that has distinguished the expansion following the Great Recession from expansions following prior recessions is the slow recovery of the housing sector. Recent data releases relating to home sales activity and new construction point to a housing market that continues to grow at a slow but steady pace. Single-family starts are increasing but remain low by historical norms. According to the U.S. Census Bureau, the 12-month moving average of multifamily starts has peaked after increasing steadily over the last several years. The data releases since the initial fourth-quarter GDPNow nowcast  on October 30 have, on net, brightened the outlook for residential investment.

These numbers tell us where we are but not what lies ahead.

To supplement official data releases, the Atlanta Fed collects anecdotal information from market participants. This information helps us detect shifts in trends and concerns that may influence the future direction of housing. Results from our recent industry forums and surveys indicate that (1) we should expect more of the same slow, steady growth, and (2) there are downside risks to the outlook.

On December 1, in conjunction with the Georgia State University Department of Real Estate, the Atlanta Fed held a Real Estate Industry Forum to discuss current trends and challenges facing the real estate industry. The good news from the panel of chief economists was that demographics—especially with millennials entering the age of household formation and house purchasing—and other underlying fundamentals, such as employment growth and tight inventory, continue to support an optimistic outlook for housing demand. The supply of housing is where most of the concerns sit.

The industry forum panelists noted that some geographies face supply constraints that will hinder the delivery of housing sufficient to match increased fundamental demand. Such observations are consistent with responses we received in our November 2017 Construction and Real Estate Survey. In the poll, most builders reported labor cost increases from the year-ago level; nearly two-thirds of respondents said labor costs had increased more than 3 percent. All builders said material costs had increased over the same period. Many continued to note that the amount of available credit for construction and development remained insufficient to meet demand. Builders said they expect construction activity over the next three months to be flat to down.

When asked if they would be able to meet a sudden spike in demand for homes, Southeast builders' responses were split: 46 percent said they would not be able to handle the spike in the demand, while 38 percent said they would. Most builders indicated they faced challenges with hiring and that it was affecting their ability to grow their businesses. Of those experiencing difficulty hiring, more than half attributed it to the homebuilding industry—that is, too much demand for construction laborers or too few workers. One-fifth attributed the labor shortage to workers lacking the necessary skills set. The responses to open-ended, follow-up questions reiterated these findings; respondents cited lack of skills and poor work ethic as the top challenges to finding quality workers.

One interpretation of builders' inability to grow their business or respond to a spike in demand is that the market is near equilibrium. That is, production is at a point such that increasing the scale of operations is not profitable, and scaling back production does not improve profitability either. Improving the supply of labor can be done, but will take time in terms of training and skill acquisition. The timing and extent to which the access to financing can be improved is less known. While underlying fundamentals support an optimistic outlook for the housing sector, supply chain constraints imply only measured near-term residential investment growth.

Photo of Jessica Dill By Jessica Dill, economic policy analyst in the Research Department and

Photo of Carl Hudson Carl Hudson, director of the Center for Real Estate Analytics


January 3, 2018 in Housing demand | Permalink

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September 29, 2017


Did Harvey Influence the Housing Market?

The August housing and construction data are starting to trickle in. So far, the data tell us that residential investment could be a drag on third-quarter gross domestic product growth. They also tell us that U.S. existing home sales were down slightly (-1.65 percent) from the month-earlier level but flat to slightly up (0.19 percent) from the year-ago level. Housing starts tell a similar story: total starts were down slightly (-0.84 percent) from one month earlier but up slightly (1.37 percent) from one year earlier. Year over year, new residential sales were down 1.2 percent.

The Atlanta Fed conducts a monthly survey of residential brokers and homebuilders in the Southeast to detect emerging real estate trends before the release of official statistics. In the most recent Construction and Real Estate Survey, many builders said they expect home sales to be flat over the next three months relative to the same period last year, while most brokers continued to anticipate slightly higher sales. A large share of builders expect construction activity over the next three months to hold steady or increase slightly.

The survey included a handful of special questions to give better insight into current market conditions and pressure points. The first question asked whether Hurricane Harvey had an impact (directly or indirectly) on their business. Most respondents said that Harvey did not.

Chart-one

Those who said they experienced some effects from Harvey (35 percent of homebuilders and 24 percent of residential brokers) were asked to provide more details. Some respondents said they have seen upward pressure on fuel costs, extended lead time on deliveries, and additional pressure on already tight labor markets. Several respondents cautioned, however, that it was too soon to assess the full extent of the impact.

We should note that Hurricane Irma passed directly through the region toward the end of the polling period. As a result, disentangling which storm the comments referred to was sometimes difficult. We will follow up on the impact of Irma in next month's poll. We hope that affected builders and brokers will be able to respond.

In the second set of special questions, we asked residential brokers and homebuilders to look ahead over the next 12 months and rank risks to their housing market outlook. Declining affordability emerged as the top risk facing the housing market, followed by supply-chain constraints and lack of for-sale inventory.

Looking ahead over the next 12 months, please rank order the following risks to your housing market.
Average Rank Order Score
Builder Rank Order Score
Broker Rank Order Score
Declining affordability
57 56 57
Supply chain constraints
51 64 38
Lack of available for-sale inventory
41 28 54
Waning consumer confidence
35 32 38
Other
21 27 15
Credit availability challenges
11 17 6

Note: Respondents were asked to rank order the factors. A rank of one scored 7 points, two scored 5 points, three scored 3 points, and four scored 1 point. No scores were assigned to ranks greater than 4.

Separating broker and builder responses shifts the top risks a bit. Considering broker-only responses, the top risks were declining affordability and lack of for-sale inventory. For the builder-only responses, the top risks were supply-chain constraints and declining affordability.

Anticipating that supply-chain constraints would, in fact, be one of the top risks to builders' housing market outlook, we also asked builders to complete the same exercise with supply-chain constraints. Builders said rising costs (of vacant developed lots, or VDLs, materials, and land) along with labor shortages topped the list of supply-chain constraints.

Looking ahead over the next 12 months, please rank order the following risks to your housing market.
Rank Order Score
Rising cost of vacant developed lots (VDLs)
43
Upward pressure on material costs
30
Labor shortages
23
Rising cost of land
22
Other
21
Dwindling lot inventories
19
Costly land titling process
17
Upward pressure on labor costs
14
Construction financing challenges
11
Burdensome/costly local ordinances
11
A&D financing challenges
7
Burdensome/costly federal regulations
3
Burdensome/costly state regulations
3

Note: Respondents were asked to rank order the factors. A rank of one scored 7 points, two scored 5 points, three scored 3 points, and four scored 1 point. No scores were assigned to ranks greater than 4.

The responses to these special questions confirm some of the anecdotes we've heard through other channels—that is, builders are worried about declining affordability and tight inventory levels. Also, importantly, supply-chain constraints remain a barrier to any acceleration in bringing new inventory to market. Interestingly, ADC (or acquisition, development, and construction) credit challenges appear to be less pressing now than in years past, while concerns about construction costs appear to have become more elevated. Views on labor shortages remain unchanged—they have been and continue to be a top concern.

We conducted this poll September 5–13, 2017. It reflects the views of 17 homebuilders and 18 residential brokers across the Southeast. View the Southeast Construction and Real Estate Survey results in more detail on the Atlanta Fed website.

Photo of Jessica Dill By Jessica Dill, economic policy analyst in the Research Department and


Photo of Carl Hudson Carl Hudson, director of the Center for Real Estate Analytics


September 29, 2017 in Housing demand, Housing prices | Permalink

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November 23, 2016


Commercial Construction Update: Third-Quarter 2016

The Atlanta Fed's Center for Real Estate Analytics conducts a quarterly commercial construction poll to keep a finger on the pulse of the industry as it relates to the performance of the economy. In this post, we will discuss a few of the more interesting results from our third-quarter poll. To view all of the results, please visit the Construction and Real Estate Survey web page.

Pace of multifamily construction appears to be slowing
After several years with most incoming reports indicating that the pace of multifamily construction activity had increased from the year-earlier level, it seemed noteworthy that indications from contacts were much more mixed in the third-quarter report. Half of respondents noted that activity had increased from the year-ago level, but the rest indicated that activity was flat to down.

These reports seem to align with the incoming Census Bureau data on multifamily starts through November 17, which, when aggregated to a quarterly frequency, reveal a slight decline (-6.2 percent) from the year-earlier level.

Available finance perceived to be sufficient to meet demand
Since about the second quarter of 2013, the majority of our commercial construction contacts have indicated that the amount of available commercial construction finance has been sufficient to meet demand. Interestingly, the share reporting that credit was insufficient to meet demand spiked in the first quarter of 2016 and remained high into the second quarter. The reports from our commercial construction contacts seemed to align closely with the results of the April and July Federal Reserve Board's Senior Loan Officer Opinion Survey (SLOOS) on the lending environment in the first and second quarters. The survey suggested that banks had tightened their standards for commercial real estate loans.

Interestingly, the most recent survey results deviated from the SLOOS. The share of contacts in our commercial construction poll that indicated credit was insufficient to meet demand continued to drop in the third quarter despite the fact that results from the October 2016 SLOOS indicated that banks continued to tighten their standards for commercial real estate loans. Granted, our commercial construction poll and the SLOOS pose slightly different questions to different types of respondents, but the divergence in results that have typically trended in a similar fashion seems notable nonetheless.

More hiring on the horizon?
Each quarter, we poll our contacts about their hiring plans. The majority (74 percent) in the third quarter indicated that their fourth-quarter hiring plans entail increasing head count by a modest to significant amount. This increase is more or less consistent with the entire history of responses; most respondents have always indicated their hiring plans were flat to up.

The last time such a large fraction of respondents indicated they had plans to increase their head count was more than two years ago, back in the second quarter of 2014. Since a large share of respondents answered the same way, can this be taken as a signal that hiring will indeed increase in the coming quarter? To investigate, we charted quarterly figures for construction new hires using the Bureau of Labor Statistics' Job Openings and Labor Turnover Survey to get a sense for what happened the last time contacts overwhelmingly indicated they had plans to increase hiring and used markers to call attention to second- and third-quarter figures of 2014.

It appears the number of construction hires did in fact increase between the second and third quarters that year, so perhaps this most recent result will serve as a leading indicator. We will keep an eye on this series to see if there is an increase in the number of construction hires in the fourth quarter of 2016.

November 23, 2016 in Housing demand, Multifamily housing | Permalink

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August 27, 2015


The Multifamily Market: Is a Hot Market Overheating?

Moody's/RCA National commercial property price index, which is based on repeat-sales transactions, has risen 36 percent over the past two years. Such increases in commercial real estate (CRE) prices have raised concerns that the market is overheating (see here). Multifamily is one CRE property type that for a couple of years has been attracting a great deal of lender interest and thus growing concern regarding potential overheating (see here).

Looking around Midtown Atlanta, it is easy to wonder if multifamily housing construction is getting ahead of itself. According to the Midtown Alliance, within just a 0.5-square-mile portion of Midtown Atlanta, 981 units have been recently delivered, 3,392 units are under construction and 4,732 are in various stages of planning. Dodge Pipeline reports that the entire Midtown/Five Points submarket has 4,865 units under way. For reference, peak activity in the Midtown/Five Points area from 2003 to 2007 was 4,636 units under construction with a total of 10,831 units completed. The question arises as to what extent are happenings in Midtown indicative of the broader market trend.

Yield spreads—the capitalization rate on recent apartment transactions (current rental income divided by sales price) minus the yield on Treasury bonds—serve as one indicator of optimism in a market. A narrow spread is consistent with reduced pricing for risk, which is associated with “frothiness.” According to Real Capital Analytics, apartment yield spreads in the second quarter of 2015 stood at 366 basis points (bps), which is around 250 bps higher than prerecession lows and in line with 2003–04 levels (see chart 1). So by this measure, apartment activity does not appear too frothy on a nationwide market basis.

Apartment-yield-spreadsApartment-yield-spreads

Of course, yield spreads vary significantly by market area and by property type. Breaking the U.S. market into six major markets (Boston; New York; Washington, D.C.; Chicago; San Francisco; and Los Angeles) and all others reveals that the major markets have seen yield spreads fall relative to all other markets. (The major markets account for 36 percent of transaction dollars with New York and San Francisco alone accounting for 20 percent of the U.S. total.) Though shrinking during the last several quarters, the current 150 bps gap between the major and non-major markets is wider than at any time since 2002. One possible explanation is that the anticipated rent growth of the projects sold in the major markets is higher than in nonmajor markets.

So what to make of this? While multifamily markets have been active during the postrecession period, this activity is not necessarily unjustified. Given that the population of 20- to-34-year-olds will continue to grow, demographics point to greater demand for rental property (see chart 2). Supply has not yet shown signs of deteriorating fundamentals since vacancy rates have remained low as new product has been delivered, and rent growth has held steady (see chart 3).

Us-population-of-key-apartment-renting-cohorts

Apartment-vacancy-growth

How long will preferences for renting persist? How long can real rents continue to grow? How is this new activity being financed? If new projects are penciled out using unrealistic rent growth assumptions and demand falls, rent growth expectations won't be met and the projects may look overdone in retrospect. Regardless of whether current activity indicates overheating, it seems important to keep a close eye on demand.

Photo of Carl HudsonBy Carl Hudson, director for the Center for Real Estate Analytics in the Atlanta Fed's research department

August 27, 2015 in Housing boom, Housing demand | Permalink

Comments

Great article on the rental market. As an investor, knowing where the market is going is the difference between losing your shirt or making a profit.

Posted by: Mike | February 02, 2016 at 11:18 AM

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February 25, 2015


Has the Pendulum Swung Back to Neutral? Looking at Credit Availability

Statements since March 2014 from the Federal Open Market Committee, including the last one, indicate that the recovery in the housing sector remains slow. Last year, when the Atlanta Fed looked at measures of housing affordability (see, for example, these posts from the Atlanta Fed blogs macroblog, SouthPoint, and Real Estate Research ), we concluded that in light of the still relatively high readings of affordability measures, it was likely that some other factor was the main culprit in dampening the housing recovery. Access to credit is not included in affordability measures, so in this post, we turn our attention to the question of whether financing might be a headwind to a more robust housing recovery.

The availability of credit is an important driver of housing market activity. During the downturn, our contacts often mentioned that the pendulum had swung too far in the direction of looseness when economic times were good. And during the recovery, they said the pendulum had swung too far in the direction of tightness. In this post, we'll discuss several indicators of credit availability and answer the question, where does the credit availability pendulum hang now?

First, let's look at the Atlanta Fed's monthly poll* of residential brokers and home builders. Beginning with the late 2012 poll, we occasionally included a special question for our panel of real estate business contacts about how available they perceived credit to be. When the Consumer Financial Protection Bureau's (CFPB) Qualified Mortgage (QM) rule went into effect in January 2014, we began asking the credit availability question every month to pick up on subtle changes in perceptions. (The dots on the blue line in chart 1 show the frequency of the question.)

Results from the latest poll suggest that mortgage credit availability is improving. A growing share of business contacts (three-fourths of residential brokers and two-thirds of home builders) reported that the amount of available mortgage finance was sufficient to meet demand. To track the direction of the trend over time, we charted the results in the form of a diffusion index (see the blue line in chart1). A diffusion index value greater than zero signifies that the majority of builders and agents reported that there is enough available credit to meet demand, while a value less than zero signifies that the majority do not believe available credit is sufficient to meet demand. The chart clearly shows that many builders and agents believe there is enough available credit.

Second, let's consider the Mortgage Credit Availability Index (MCAI) that the Mortgage Bankers Association produces on a monthly basis (the green line in chart 1). The MCAI is an index constructed using underwriting criteria from more than 95 lenders and investors. Even though the diffusion index is a qualitative measure and the MCAI is a quantitative measure, the series are highly correlated (ρ=0.73), and both suggest that credit availability has been slowly but steadily improving since early 2013.

Availability-of-credit

Third is the Federal Reserve Board's Senior Loan Officer Opinion Survey on Bank Lending Practices (SLOOS), which polls large domestic and foreign banks every quarter about demand for and the availability of credit. In the SLOOS, banks are asked to indicate whether credit standards for approving mortgage loan applications have tightened, remained unchanged, or eased over the past three months. The latest results, shown in chart 2, reflect recently introduced categories that align with the Consumer Financial Protection Bureau's qualified mortgage rule. Like the previous two series, seen in chart 1, the SLOOS also appears to suggest that lending standards have eased. Note that the net tightening response for prime lending is loosening by a similar or greater magnitude as it did some years during the boom—2006, for example.

Residential-mortgage-lending

So has the credit availability pendulum returned to its neutral resting position? It's hard to say for certain, but there is clearly evidence to suggest that it is at least slowly moving in that direction.

*The monthly poll of brokers and builders was conducted January 12–21, 2015, and reflects conditions in December 2014. Fifty-seven business contacts around the Southeast participated: 23 homebuilders and 34 residential brokers. To explore the latest results in more detail, visit the Construction and Real Estate Survey web page.

Photo of Jessica DillBy Jessica Dill, senior economic research analyst in the Atlanta Fed's research department

February 25, 2015 in Credit conditions, Expansion of mortgage credit, Housing demand | Permalink

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November 18, 2014


Can the Atlanta Fed Construction and Real Estate Survey Predict Home Sales?

The slow recovery in housing remains an item of note in statements from the Financial Open Market Committee. That it's still something of a concern means that many people pay attention to housing-related data releases, several of which are due out this week, because they can shed some light on the direction of housing and the economy. The builder confidence index, released today, got things off to a good start by showing a four-point rise, from 54 to 58 (values greater than 50 mean that more builders view conditions as good rather than as poor). House starts and existing sales are due Wednesday and Thursday, respectively.

At the Atlanta Fed, we conduct a monthly survey of regional builders and real estate brokers to get their perspectives of the market. In August, we began to look at the results a little differently to see if they could tell us anything about subsequent housing-market data releases. In that exercise, we investigated the correlation between the expectations of our homebuilder contacts for construction activity and subsequent housing starts. We found that our builders are on point, more or less, and we reported on that discovery in an August post. We recently repeated the exercise, this time to explore the predictive power of the outlook for home sales of our homebuilders and residential brokers for subsequent new and existing home sales data releases. We report on our findings in this post.

Brokers and builders expect new home sales to rise
The September home sales data showed us that existing single-family home sales increased by 1.9 percent from the year-earlier level and new home sales increased by 22.6 percent. This news is fairly consistent with the reports we received from our real estate business contacts about September sales activity; more brokers and builders noted an increase than noted a decrease in home sales activity from the year-ago level.

But what exactly did our survey respondents tell us about their outlook for home sales? Diving deeper into the data, we find that brokers' and builders' outlooks remain mildly positive and that the two groups have tracked each other fairly closely in recent years. (In the pre-2011 period, brokers and builders diverged more sharply.) Specifically:

  • Of builder respondents, 40.0 percent indicated that they expect new home sales to increase over the next three months, 32.0 percent expect activity to decline, and 28.0 percent expect home sales activity to remain about the same. The home sales outlook diffusion index value for builders was 0.08.
  • Of broker respondents, 22.5 percent indicated that they expect new home sales to increase over the next three months, 27.5 percent expect activity to decline, and 50.0 percent expect home sales activity to remain about the same. The home sales outlook diffusion index value for brokers was -0.05.

SE-Home-Sales

The chart below features two scatter plots of the diffusion index value for the broker and builder home sales outlook on the horizontal axis and the year-over-year change in the three-month moving average of single-family home sales (for Alabama, Florida, Georgia, Louisiana, Mississippi, and Tennessee) on the vertical axis. Given that we are asking contacts to be forward-looking, we lag the contact responses.

Broker-Home-Sales

Do home sales expectations correlate with subsequent sales data?

Three things stand out on this chart. First, if builders and especially brokers (who tend to be an optimistic lot) predict a decline, the subsequent home sales data release will probably be poor. Only a modest bit of net optimism is of little comfort—some of the worst declines occurred in years with net positive (albeit small net positive) outlooks.

Second, for builders, if the index is greater than 0.3, we find that sales generally grow—except for between August 2012 and April 2013, when sales did not match builders' optimism. When the broker index is above 0.3, sales either grow or decline by a smaller amount than when the index is negative. Like the builders, the broker panel missed the sales declines from August 2012 and April 2013. The brokers also missed the declining real estate market in 2006 to early 2007 (see the green triangles in the chart above)—despite a declining market, the broker index remained lofty until May 2007.

Third, the official statistics on housing sales could go either way when index values are between ‑0.1 and 0.3. This shouldn't come as a complete surprise, particularly because a diffusion index value near zero (regardless of whether that value is positive or negative) indicates that responses from contacts were mixed. And as we can see in the scatter plot above, large declines were much more likely given the time period covered.

A simple regression indicates that the outlook could explain just under 50 percent of the variation in sales measure, which indicates that our poll does a decent job of predicting subsequent sales. Given this finding, what do we now expect home sales to look like? The most recent downward trend in respondents' outlook puts the diffusion index in the center, suggesting that declines in seasonally adjusted sales over the next several months are just as likely as increases in sales.

The poll was conducted October 6–15, 2014. Sixty-five business contacts across the Southeast participated (40 residential brokers and 25 builders). To explore the latest poll results in more detail, please visit our Construction and Real Estate Survey page.

Photo of Carl Hudson By Carl Hudson, director for the Center for Real Estate Analytics in the Atlanta Fed´s research department, and

 

Photo of Jessica DillJessica Dill, senior economic research analyst in the Atlanta Fed's research department

November 18, 2014 in House price indexes, Housing demand, Housing prices | Permalink

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June 11, 2014


Signs Point to Slow but Steady Construction Growth

After bottoming out in early 2011 and following an upward trend for two years, national new house sales on a seasonally adjusted basis have been essentially flat since January 2013 and are at a pace about half that of 2000–01. Over the past month, speeches by Fed Chair Janet Yellen and Reserve Bank presidents John Williams, William Dudley, and Charles Plosser have included references to a slowing housing sector in the face of strong fundamentals as a source of economic uncertainty. They mentioned many reasons for the slow pace of housing´s recovery, including difficulties in increasing housing supply (that is, construction).

In the Southeast, we hear from our housing contacts that it remains difficult to acquire construction financing and that funding of land acquisition and development projects is extremely difficult. In the most recent Southeast Housing Market Poll, most builders continued to report that the amount of available construction and development finance fell short of demand (see the chart). Concern regarding the lack of readily available construction financing is not unique to the Southeast and may be part of the reason for the recent slowing in the housing sector. Fortunately, it appears that construction financing may in fact be getting a bit more accessible.

How Available Do You Perceive Construction

A key input to construction is the availability of financing. We explored construction lending trends in a few of our posts last year (here and here). The most recent bank lending data indicate several reasons to believe that banks continue to return to construction and development as a line of business.

Aggregate bank construction and development lending remains well below its 2008 peak (see the table). That said, more than half of the banks with a construction business line are expanding their single-family residential construction lending. Interestingly, the median March 2013 year-over-year growth rate in residential construction lending was positive, yet aggregate 1–4 family construction loans fell from March 2012 to March 2013, which means that lots of smaller lenders were growing. The good news is that the March level of 1–4 family construction loans increased in 2014 for the first time since the recession ended.

Bank Call Reports

Although banks appear to be lending for residential construction (the "vertical" part of homebuilding), we cannot say the same for lot development (the "horizontal" portion). The data is a bit less clear on this front because lending for raw land and land development is lumped together with loans for all construction that is not for 1–4 family structures. Aggregate lending for "other construction, all land development and other land" increased year over year, but the median growth rate was negative. That is, more banks are pulling back from this activity than are growing, but the ones that are growing are the ones with larger volumes. Considering that lenders have viewed multifamily construction favorably, it is more likely that the growth in lending is attributable to multifamily loans rather than to lot acquisition and development.

The Fed presidents I mentioned in the first paragraph were optimistic about housing in large part because population growth and household formation both point to an inevitable increase in housing demand. The evidence from bank construction lending supports this idea that growth will continue, but it also suggests that the recovery will continue at its slow and steady pace.

Photo of Carl HudsonBy Carl Hudson, Director, Center for Real Estate Analytics in the Atlanta Fed´s research department


June 11, 2014 in Credit conditions, Housing demand | Permalink

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May 16, 2014


Are Single-Family Rental Securitizations Here to Stay?

In the fall of 2013, private equity firm Blackstone LP issued the first single-family rental (SFR) securitization: Invitation Homes 2013-SFR 1. In March, Colony Capital released another SFR securitization. The Invitation Homes 2013-SFR 1 was backed by 3,207 single-family rental homes concentrated in Arizona, California, Florida, Georgia, and Illinois. Deutsche Bank arranged the deal. There are a variety of estimates of the size of institutional investors’ activity in the SFR market, but with numbers like 90,000 to 150,000 homes and 15 to 20 billion dollars invested, most agree that we can expect more securitizations like these in the future. So what exactly is this new asset class, and how did it obtain its strong credit rating?

In this post, we look at how the structure of the Invitation Homes SFR emerged and compare it to more familiar commercial mortgage-backed security (CMBS) and residential mortgage-backed security (RMBS) classes to better understand the triple-A rating. We also consider some factors that could determine whether the SFR security class will stick around.

(For a nice discussion about the entry of institution investors into the rental market, read this second-quarter 2013 EconSouth article.)

Please note that much of the information that follows is based on reports from the rating agencies:

Commercial or residential—or both?
This product took a long time to come to market. For nearly two years, the industry discussed how to structure this new security class. Discussions in 2012 and 2013 about the rating and pricing of an SFR security focused on three gray areas. The first was housing market risk. Would housing markets, and the underlying value of investor-owned homes, appreciate on a market-wide basis?

The second was property management risk. Could scattered-site, single-family homes be managed cost-effectively? And with a lack of historical data for scattered-site, single-family rentals, how could credit rating agencies predict vacancy rates, maintenance costs, and income streams with any precision?

Finally, there was confusion about how to structure an SFR securitization and what tensions and risks would exist in that structure. There was also some uncertainty about whether an SFR securitization would be more like CMBS or RMBS. Like RMBSs, the underlying assets of SFRs are single-family homes. And many risks—for example, home price depreciation and household income—are the same as in the homeownership market (Joseph Hu 2011). But like CMBSs, the borrower is a corporation, not a homeowner, and the cash flow comes from rental, not mortgage, payments. That means the payments come from highly variable net operating income, which is sensitive to vacancy rates, market rents, and maintenance costs unlike the fixed-income streams of mortgages, which are sensitive to repayment and default risk but otherwise fairly predictable. Also like CMBSs, the sponsor of the SFR deal would be responsible for maintenance, meaning they might have to keep some cash on hand.

Equity pledges or first-priority mortgages?
These issues influenced the structure of the security. High maintenance costs associated with the rental properties created a nontrivial conflict. Ideally, in a security, assets are owned by a tax-neutral, special-purpose vehicle (SPV), with assets and liabilities perfectly matched. However, retaining cash flows for maintenance jeopardizes that tax-neutral status. Early discussions favored a structure in which the borrower, not the SPV, would retain ownership of the properties and instead of mortgages, equity pledges would collateralize the securitization. While these equity pledges might be preferable for maintaining properties and would be less transaction-intensive than issuing individual mortgages, equity pledges would create a weaker claim than first-priority mortgages for investors in the event of default. Further, equity pledges were not deemed to be as bankruptcy-remote as mortgages. All this meant equity pledges could be vulnerable to material consolidation in the event the sponsor were to become bankrupt or if the sponsor were to mismanage the properties, either selling them or borrowing further and creating competing liens on the properties (Matthew Clark 2013). For this reason, Moody’s and Kroll stated that they would cap securitizations using equity pledges at Baa or A.



Ultimately, the Invitation Homes/Blackstone SFR security used first-priority mortgages, not equity pledges, and secured a triple-A rating. In structure, the security is probably more like CMBS than RMBS. Deutsche Bank compared the instrument to CMBS, and the ratings agencies also leaned this way—Kroll and Moody’s compared the security to CMBS on the forms where they express their expectations for representations and warranties. Aspects of the transaction itself suggest that it is more like a CMBS deal than an RMBS one. For instance, the special servicer, Situs Holdings LLC, specializes in CMBS (not RMBS) workouts. Still, the security remains a hybrid. Kroll used a CMBS model to determine the probability of default and an RMBS model to determine severity, working on the assumption that the income-based approach typically used in valuating CMBSs would not be appropriate for pricing the sales of single-family homes in a distressed housing market. Similarly, Morningstar used both Cap Ex and HPI stress tests to generate ratings of the various tranches, feeling that both an income/expense approach and a sales approach to valuation were appropriate.

The structure of the securitization reflects a priority for enhancing an investor’s ability to take ownership and sell the homes in the event of a default, rather than other structures which might have prioritized management of homes to enhance rental income. Moody’s did not base its rating on an evaluation of the income streams from the properties, because the agency did not feel it had the ability to evaluate with certainty vacancy rates, maintenance costs, and other key factors. Instead, it based its rating on the strength of investor claims on the homes in the event of default, and estimated sales prices of the underlying properties assuming a distressed housing market. Another factor in the triple-A credit rating is that the security is overcollateralized. That is, the value of the collateral ($638M) is well above the value of the loans ($479M)—Invitation Homes took a 25 percent advance rate on these homes.

Will they last?
Some negative commentary has surfaced in the five months since the Invitation Homes offering. And S&P has come out strongly against the triple-A rating, arguing that without historical performance data there is too much uncertainty about income streams. Recent appraisals noted that several tranches were trading below par, and that rents had declined 7.6 percent due to increasing vacancy rates. Firms that had hoped to make margin by “pushing rent” or increasing rents every year are now talking about keeping rents stable in order to minimize turnover and the associated vacancy rates. So with all of these issues, how much staying power does the SFR securitization structure really have? To the extent that these transactions are driven primarily by the value of the underlying collateral and not by rental income, they begin to resemble trades that will decline as home prices approach normal levels. Indeed, many SFR investors and managers say they ultimately intend to sell single-family rentals back into the owner-occupied market either 1) when maintenance costs begin to outweigh the potential of the asset’s income stream or 2) it appears that, in the medium term, home prices and mortgage markets have recovered—and thus the opportunity for this market to exist disappears.

Other commentators suggests otherwise: this asset class will grow, possibly driven by fundamental demographic shifts such as increasing labor mobility and shifting preferences for rentals. These attributes, combined with stagnant wages and tight mortgage markets, suggest increased demand for single-family rentals. They may also suggest that SFR securitization represents a new normal.

Photo of Deborah ShawBy Elora Raymond, graduate research assistant, Center for Real Estate Analytics in the Atlanta Fed's research department, and doctoral student, School of City and Regional Planning at Georgia Institute of Technology

 

May 16, 2014 in Housing demand, Rental homes, Securitization | Permalink

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March 27, 2014


Limiting Property Tax Assessments to Slow Gentrification

A recent New York Times article on gentrification discussed a number of cities—including Boston, Philadelphia, and Washington, D.C.—that are planning to freeze property tax assessments for long-time homeowners in gentrifying neighborhoods. The concern is that rising house prices will also raise property assessments, forcing low-income residents to move to escape the greater tax burden and thereby accelerating the pace of gentrification. Although the desire to protect existing residents from gentrification appears to be new, laws capping assessment growth for all property or all primary homes ("homesteads") have been around since Californians passed Proposition 13 in 1978. After California, a number of additional states passed laws limiting how quickly an individual property's assessed value could increase. The bulk of these laws passed in the early eighties to the mid-nineties, and advocates for the law were concerned, at least in part, with limiting the size of local government. If this tax backlash of the previous decades is uncorrelated with more recent gentrification pressures, this may be a good test of statewide assessments caps.

Using a data set of low-income central-city neighborhoods that Dan Hartley of the Cleveland Fed assembled from the 2000 census and the 2007 American Community Survey, we can look at the share of neighborhoods that gentrified in capped and uncapped states. Hartley shows that a central city moving from below-median-MSA house price to above-median house price is a good indicator of gentrification. Relying on the table of statewide assessment caps that Haveman and Sexton compiled, we identify 10 states and the District of Columbia (plus the city of New York) with the strictest limits. In these states, assessed value can increase only at the rate of inflation or by a fixed percentage ranging from 2 percent (California) to 10 percent (Texas). Table 1 presents the share of neighborhoods that gentrified in capped and uncapped states.

Table 1: Share of Neighborhoods that Gentrified between 2000 and 2007

Note that neighborhoods protected by assessment caps actually gentrified faster than those in states without them.

However, we might worry that the decision to impose statewide assessment caps was not random. In the case of Prop 13, rising home prices was certainly a factor in rising property taxes. It is possible that some underlying factor may drive statewide price up but also cause poor inner-city neighborhoods to appreciate faster than other homes in the metro area. One candidate is restrictive zoning laws that limit densification of already desirable neighborhoods. Such laws could both drive up aggregate house prices and push homebuyers into more marginal neighborhoods, causing them to appreciate relatively faster. However, assessment caps are only one possible response to rising property taxes. If voters wish to limit the growth in property taxes, they don't need capped assessments—they can restrict the growth in property tax revenues directly. At the same time, assessment caps that don't also cap the property tax rate don't actually constrain property taxes, but instead shift the tax burden from longtime owners to new buyers. In Table 2, we limit the sample to states that have a binding revenue growth cap or that jointly cap assessments and municipal tax rates. In this case, we assume that, conditional on imposing a tax expenditure limit, the decision to cap assessments rather than property tax revenue is random. We rely on the work by Hoyt, Coomes, and Biehl (2011) to identify various statewide tax expenditure limits.

Table 2: Share of Neighborhoods that Gentrified between 2000 and 2007 with some form of binding property tax limit

Limiting the sample to states that have chosen to constrain the property tax in some way, we still observe assessment caps seeming to accelerate gentrification rather than slow it. How can that be? One possibility is that because these are state-wide limits, the caps have reduced the turnover in more desirable neighborhoods, driving new homebuyers to marginal central-city neighborhoods. In that case, targeted assessment caps that apply only to currently low-priced neighborhoods could still be efficacious. On the other hand, the existence of an assessment cap may increase the long-run return from "pioneering" in a low-priced neighborhood.

So far, we have been using change in relative house prices as our definition of gentrification. However, advocates for assessment caps are plainly concerned about the ability of homeowners to stay in their home in the face of rising home values. While the in-migration of higher-income residents and house prices are highly correlated, we do not observe the duration of time that existing residents remain in their home. Unfortunately, there are few individual-level data sets with sufficiently granular geography to allow such an analysis. As an alternative, we can look at the change in median income of residents. This value is available at the census-tract level in the 2000 census and the 2007 American Community Survey. Table 3 presents change in median income for all census tracts and for gentrifying tracts with and without assessment caps. While median incomes rose in gentrifying neighborhoods (even as they declined nationally), they rose faster in tracts subject to an assessment cap. However, this difference is not statistically different from zero (p value 0.303).

Change in real income for gentrifying neighborhoods with and without assessment caps

Finally, assessment caps do nothing for renters, who may be impacted much more immediately by rising neighborhood quality than homeowners. It is possible that assessment caps could still allow a small share of long-time owners to stay, and the observed effects are just dominated by the movement of renters. If we had access to administrative data with finer geographic identifiers, we could look at whether neighborhoods that gentrified with assessment caps now exhibit more income or racial heterogeneity than neighborhoods without. However, looking only at aggregate data, property taxes do not appear to be a primary driver of neighborhood change, and concerns about gentrification do not appear to warrant interfering with the assessment process.

Photo of Chris CunninghamChris Cunningham, research economist and assistant policy adviser at the Federal Reserve Bank of Atlanta

March 27, 2014 in Housing demand, Housing prices | Permalink

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