Transcript
Dean Wehrli:
Welcome to the New Home Insights podcast. I’m your host, Dean Wehrli. Here at John Burns Research and Consulting, we monitor the residential space in every aspect. Rick Palacios Jr. Is, I think, the prime mover in that regard. He’s our director of research. He’s also managing principal here at John Burns Research and Consulting. I would go so far as to say, Rick, you put the research in research and consulting. That’s fair, isn’t it? Hi, Rick.
Rick Palacios Jr.:
How’s it going, Mr. Wehrli? Good to see you.
Dean Wehrli:
We are going to talk today about the state of the housing market, how we see it as potential for perhaps to some folks surprising growth in near term, what’s driving that, how the new home market plays against the existing home market. Resale supply is so critical to what’s happening right now. Also, how new home builders are tactically and strategically rising to the occasion. We’ll end with a little peak, just a little peak, Rick, into what we see coming up for the housing market in the next couple of years. How’s that?
Rick Palacios Jr.:
That sounds great. Good content, Dean.
Dean Wehrli:
Thank you. I hope so. Let’s find out. It’s all on you. Let’s kick it off though with some fresh findings. Let’s unseal some fresh findings from our very recent July survey of home builders. By the way, we’re going to upload this pretty quickly, but just for the sake of temporal context, Rick and I are recording this on August 7th. We just finished this survey of new home builders. How would you characterize how builders feel about the market right now?
Rick Palacios Jr.:
I would say much, much better than what they thought things would look like at this point in 2023 versus when we came into the year. I’ll get into some of the key findings from our survey that you just mentioned, which we sent that out to clients last week, and we’re recording this on August 7th. But I like to rewind the clock back to November, December of last year. Remember, let’s go back, mortgage rates were six and a half, 7%. Home builders are doing layoffs. They’re freezing their land buying, if not pulling it back considerably. A lot of deals are just, “Nope, we’re not going to do that.” The Fed’s jacking rates.
And so, if we were to tell home builders at that point in time, back in November, December last year, like, “Hey, let’s fast-forward to August 2023. Mortgage rate is going to be 7%, but your stocks, home builders, all-time high. Your margins are going to be quite healthy. They’ll be down from record highs, but still pretty healthy. Sales accelerating, starts accelerating. And oh, by the way, along that time, we’ve had a handful of bank failures,” I think every home builder would look at you and go, “Nope, you’re high, you’re on drugs. That makes zero sense.” But that’s the reality of where we are today.
And so you mentioned that survey, sales up in July, new home sales, 40% year over year, sales per community, which I think is really the best proxy for what demand is doing on the new home side, three plus a month. That’s 29% above what we would think of as a normal pace of sales in July from 2013 through 2019. Those are more normal years. So that demand proxy is quite healthy. Starts are accelerating. I think those are up about 15% year over year. And prices are steady, not really shooting through the moon by any means, but not collapsing. They’re just kind of flat-ish up 2% year over year. Most builders are holding prices flat on a month over month. So I think really what 2023 has become, it’s really a year of volume over margin and price appreciation. But any builder that you would talk to, if you painted that picture winter of last year, they would be like, “Yep, take that all day long.”
Dean Wehrli:
This is, in a sense, the second time in a row we’ve had the new home market be more resilient than expected. Going back to COVID where it seemed like for sure the sky was going to fall, and pretty quickly the sky did not fall, in fact, it rose to new heights. And now again, for all those reasons you just said, Rick, we expected conditions to be pretty significantly more negative than they have been so far in 2023. So now let’s get into the meat of it. I think we’re going to start with talking about sales and resales and normal sales. One of my clients recently asked me, “What are, say, the three most important reasons that the new home market has been a little more resilient?” And I said, “Supply, supply, and, oh by the way, did I mention supply?” By that I mean resale supply. In my mind, it’s everything right now. The new home builders have been able to carve a much bigger capture than they thought. So walk us through resale supply and how you think we maybe should reframe what we think resale supply should be.
Rick Palacios Jr.:
I think there’s so many moving parts to this. I was talking to somebody recently, and I think a really simplistic way of thinking about it in 2023 is builders are fishing with a much bigger net, and they’re fishing with a lot better juicier bait than the resale market right now. And so you think about the bait side of that, rate buy-downs have continued to move the needle considerably for home builders. They’ve given up some margin there, but it’s generating quite a bit of sales because today, market rates, like we were mentioning earlier, 7%, most builders, if you go to their websites, the big public builders and even some larger private builders, they’re getting those down to five and a half, six. So that’s a huge sales tool that builders have been able to ride that wave all of 2023.
And then you mentioned on the resell supplied, and I think about it like overall supply, demand, and again, trying to simplify things. Demand overall is not ripping and roaring, it’s not amazing. But I think you got to think about those two things together, demand and supply. So demand has come down, but supply, to your point, has come down considerably more than what demand has. You talk about the resale market, that is usually the biggest competition for home builders right now and forever, and there’s just not that much out there currently. There’s a variety of reasons that we can get into, and I’m sure we will, as to the drivers behind that. We do our client webinars on a monthly basis, and this exercise I did last month was we looked at, all right, well, let’s try to benchmark what normal supply in the resale market looks like going back all the way to the early 1980s. And so a normalizing way to do that would be to look at how many listings are there every month, every quarter, versus how many owned housing units are there in the system.
And so we ran that analysis going back 40 years or so. The ratio today of owned housing units for sale to total owned housing units, we’ve only got one million listings in the system and you got 86.1 million owned housing units in the entire US. That’s the lowest ratio right around that we’ve ever seen in the history of US housing. I think that right there is at the core foundational thesis or supporting point to why the new home space has outperformed. It’s because really they’re the only game in town in a lot of markets that home buyers are shopping in.
We talk about the lock and effect, and we can talk about that some more too, but roughly a third of housing demand comes from entry level buyers. They don’t have a mortgage rate that they’re bringing with them, so their recency bias is not what their existing mortgage rate, it’s just, “Hey, what are rents doing? Where am I at my life stage? Am I getting married? Do I need more space? Am I having kids?” Those are the things that really drive about a third of the market, and so builders have been able to really pivot there and provide more homes that are in this affordability price band through a lot of different techniques, dropping prices, lower square footages, all kinds of things. That’s at the core of why I think new home has outperformed on the existing side.
Dean Wehrli:
Let’s get into it. You mentioned ago a minute ago the why, but the why of it is really important. There’s more reasons. The golden handcuffs of very low existing mortgage rates is probably the single biggest part of it, but that’s not the only part of it, is it?
Rick Palacios Jr.:
No, no, there’s so many reasons. Let’s talk about the median tenure of an owner household. Prior to ’08, I think it was, it was about six years, and for the last two, three years we’ve been hovering around 10 years. That creates less churn in the system. 41% of all homeowners don’t have a mortgage, and so that’s a big part of it too. I’m looking down at my notes here because there’s a variety of things. You think about what drives home purchase activity and listings, well, mobility rates. We know from our demographics research, mobility rates are down for all age cohorts year after year after year. And then you dive into, okay, well, let’s look at mobility rates by different age cohorts and then think about who owns housing stock out there. You now have the majority of owner households are 55-plus, and so their propensity to retransact as you age, it goes down. So that’s another suppressor, if you want to call it, for churn.
Dean Wehrli:
Rick, that’s an interesting finding because I think that is counter to what most folks think. We think right now, all this migration happening, you think if you ask somebody what’s the churn rate right now compared to years past, I think a lot of folks would say it’s higher, but it’s not, it’s lower. And there’s a structural demographic reason for that despite the headlines, I guess.
Rick Palacios Jr.:
Yeah. You can see it too. That demographic retirement wave really kicks in 65-plus around 2012-ish. That’s right around the time that, going back to that ratio that we were talking about, listings to owned housing units in the system, that ratio drops considerably right around that time. There’s a variety of structural factors that are forcing this conversation.
I think another one of them that gets talked about in the press, but I think gets talked about perhaps in the wrong way, is the emergence of the single family rental industry. There’s now about maybe 3.3 million homes that came out of the for sale side of the equation into rental post global financial crisis. I know that industry gets painted with a broad brush, but we drill in and we look at, well, who is actually purchasing and are the owners of the investment properties. Quarter after quarter after quarter, the line share of that is small mom-and-pop owners. The institutions are a very, very small fraction of it. They get a lot of the blame, but it’s really just normal people that are investing in real estate and pulling homes out of the for sale side of the equation into rental.
I’m sure we could go on all different types of factors, but there’s another one that I think about too where the structure of the mortgage market has changed considerably post global financial crisis, namely around 2010 where you had Dodd-Frank come into play and put some guardrails around the mortgage industry that were definitely needed, made it more difficult to qualify for a adjustable rate mortgage. If you look at before 2010, anytime affordability got really bad, you had adjustable rate mortgages becoming about 20, 30% plus of all mortgages going out into the system, because that was really the tool that buyers would use and mortgage lenders would use to get people through the affordability squeeze when rates would go up.
They’ve been around five to 10% after 2010. Some of this too is because rates have been going down, down, down, but now that’s changing. The reason I bring it up is because as rates start to percolate higher, and they have been now for about a year and a half, traditionally, if you had adjustable rate mortgages rolling through the system, there is a window when they adjust, so five year, seven year, whatever it is. And if you don’t have that natural trigger or catalyst for somebody to look at the math and go, “Wait a second, my rate’s adjusting. Can’t afford this payment anymore. I got to sell. I got to move down. Maybe I’m going to go rent.” That doesn’t really happen in the system anymore, so just one more thing to think about as a reason for, hey, you can make an argument for less churn in housing. You and I, Dean, we both live… You still live in California, right?
Dean Wehrli:
I do.
Rick Palacios Jr.:
Okay.
Dean Wehrli:
So do you.
Rick Palacios Jr.:
Yes, I do.
Dean Wehrli:
So do millions of other people too.
Rick Palacios Jr.:
No, but the reason I bring this up is because there’s a lot of parallels, I think, between Prop 13, which caps homeowners the increase in their property taxes to 2% on an annual. That was going back to ’78. And so what does that do for California? You don’t want to let go of that tax basis. You don’t want to retransact, so you just ride that out. You ride home price appreciation. I say there’s a lot of parallels to now what you have with the lock-in effect where it’s not a cap on your property tax increases, but what it does is it creates a disincentive for people to retransact because they don’t want to let go of that super low rate.
Dean Wehrli:
We thought, too, for a hot minute it seemed like ARMs were going to come back and come roaring back as the obvious answer to these rising mortgage rates a year or so ago, let’s say. They really didn’t, and for the reasons you said. So that we’re going to avoid the future. Because remember back in 2007, it’s like, “Okay, well, we know x hundreds of thousands of loans are going to reset next year in ’08, and then more coming in ’09 and more coming in ’10.” We knew it was going to be bad for a while. We’re going to avoid that kind of supply glut this time.
Rick Palacios Jr.:
There’s a lot of good in it because you avoid that buzz saw of the rate shock. Especially if you get a severe recession where there’s not a lot of policy tools coming in to save the day for housing, for homeowners, and for the economy we saw in 2020, 2021, you would have gotten a huge wave of distress like we saw in ’07, ’08, but it just didn’t happen. And so yeah, if we don’t have those products anymore, then you probably have to think through your thesis a bit differently in terms of, okay, well, what could be the potential impact when and if housing does correct?
Dean Wehrli:
You’ve also studied and examined what the size of the resale market, the existing home market could be and should be. They’re pretty eye-popping some of these numbers of how big can and should and might the resale market get, and it’s pretty dramatic. Walk us through that.
Rick Palacios Jr.:
Yeah, so this was that exercise where you say, “Okay, well, let’s look at that ratio of listings to owned housing units in the system, and what would a normal amount be?” And so today, 1% of all the owned housing units in the system are listed for sale. Historically, that averages about 3%. And so I think you need to haircut that 3% to probably around two and a half percent for all the reasons we just discussed structurally that probably suppress supply. But the reality is you probably do need to come back to somewhat of a more normal ratio. And so to get it back to about two and a half percent of all owned housing units would be listed for sale, you would have to have listings roughly double from a million to just over two million units.
We’re clearly nowhere near that. We’re not seeing any signs of that happening right now. I think that’s been a big part of why the new home space has outperformed, is you’d never really got a resale supply bump this spring or for the matter this whole year. I mean, the last time that we had two million listings in the system, you’d have to go back to, I think it’s around 2016, 2017. Yeah, to get back to a normal level if you use that as your anchor, that’s a big jump in listings, which unless something is percolating out there that we have no visibility on, that’s not coming.
Dean Wehrli:
I want to ask you that, though. What are the factors that could pull people out of their golden handcuffs? I mean, could things like economic downturn cause distress? What could propel a surge in supply?
Rick Palacios Jr.:
There’s good reasons for supply starting to come on, and then there’s bad reasons for supply coming on. I think bad reason, what we put in that camp, is big, bad recession, ton of distress, waves of layoffs, government not stepping in to help on the consumer front or the financial markets front. In that scenario, you would get a big wave of supply coming into the system because those are the layoff listings that typically happen when you get a big, big downturn. Again, that was ’08, that was ’09 and ’10, and then millions of foreclosures for years after that.
Dean Wehrli:
When you mention the finance part, Rick, do you mean that government would not step in and lower mortgage rates? Wouldn’t that be the obvious way to help a situation you’re describing?
Rick Palacios Jr.:
I think what we’ve learned is that policymakers, they’re always fighting the last war. And so the lens that we think about with the stress and with housing is ’08, ’09. And so you fast-forward to the COVID crisis and 2020, 2021, and keeping people in their home, keeping people in their rental, quantitative easing, stimulus to the upper half of society as well as to the bottom and middle class, which really haven’t gotten it in past stimulus periods, and it was like, “All hands on deck. Let’s just save housing because we know what this looks like if we don’t.”
Again, that’s something that you have to think about. Okay, if that’s the framework that policymakers are going to use when they think about on a go forward basis, then what would it take to actually get what you would think of would be a distressed wave of supply coming into the system? Because, I mean, we had double digit unemployment this time around and no distress whatsoever, and home prices in the last four or five months are actually starting to recover again. But then I.
Dean Wehrli:
What would be the positive then?
Rick Palacios Jr.:
Yeah, and so then.
Dean Wehrli:
What’s the good argument for that?
Rick Palacios Jr.:
This is where good reasons for supply coming to the system. I think there’s a lot to be said if you look at history for stability, stability in rates, stability in the economy. You have incomes growing above the rate of inflation. We did a white paper on this back in, gosh, forever ago it feels like. But I think the big takeaway for us is if you look back last 40, 50 years, housing and interest rates, it’s the shock and awe period when rates explode that hammers housing, and especially if you’re in a huge inflation wave at the time. And so that’s what we saw ’70s, ’80s. We saw a glimmer of it in 2021, 2022, but like I said earlier, you had all these tools come in to save the day.
I bring this up because we’ve now had a year and a half of mortgage rates that are, call it, above five, above six. I mean 2023, the entire year has almost been above six and a half, 7%. And so the longer that rates stay in this range bound range of, call it, five and a half to 7%, the consumer who has transacted in that environment, the vintage of those loans, as we progress in time, it gets easier for people. I don’t want to say easier, but the mental anchor for them isn’t as drastic as it is for somebody who refied or bought at a sub three, sub four. And so I guess what I’m saying in a long-winded way is stable rates, time, growing economy, that’s actually a reason for housing to actually gain some steam here in terms of just overall transactions probably picking up.
I always think too about you have to put a framework around, well, why are rates dropping? Because I don’t think we want rates to go back to levels that we saw in really this zero interest rate period post GFC and then obviously during the COVID era, because the reason rates were that low was because things were really bad in the economy. And so, I actually think, knock on wood, if we get this soft landing, and we’ve taken the recession out of our forecast for 2023, you still have a mild one in 2024. But we could be transitioning into a period where the economy is slowly growing again, consumers are in a better spot, income growth is outpacing inflation, and income growth is actually somewhat in line with what’s happening with home price appreciation. So that’s a recipe for affordability getting back to hopefully a more normal-ish type of level.
Dean Wehrli:
Tell me what you think. I think there are some other unsung reasons that we could sort of escape some of the golden handcuffed effect. You covered all the basic core structural ones, that’s going to be the majority of the story, but there’s some little ones too like households that are motivated to move. Relocations is an obvious one, new household formations like you just mentioned. Are growing households, shrinking households? I told one builder client once that they should be in favor of divorce because it turns one household into two households. And when they thought about it, they said, “You’re right, and we’re going to start a new program called Ditch Your Spouse.” I’m making that last part up. But-
Rick Palacios Jr.:
They’re going to run that in their marketing?
Dean Wehrli:
I might’ve made that up. But there are those other reasons. Do you think those are important reasons? I’m honestly wanting to hear your answer.
Rick Palacios Jr.:
Oh, I think all of those are core reasons for people retransacting. I think one of the reasons that you didn’t mention there that helps the medicine go down with having to go into a higher mortgage rate is we’ve had massive home price appreciation over the last decade. We ran this at a national level, and the numbers are even more jarring at local markets, I mean, California, Texas, Southeast Florida, but this is at a national level. Let’s say you bought your home and you’re using the US median home price and you bought in 2014 and you’ve been paying down the principal, whatnot, you’re sitting on over $200,000 in equity. Those figures are double that, even higher, in a lot of markets like I mentioned, California, Texas. And so that’s where I do think there’s the, “Okay, yeah, I’m sitting on a 3% mortgage rate or a 4%, whatever it is, but I got a mountain of equity here that I can use to offset some of the pain on going up to a higher mortgage rate.”
I do think some of that is happening. It’s also a lot of cash buyers out there too. I think from our resale survey, you’re looking at 20, 25% of all resale transactions are cash right now, and obviously mortgage rates don’t matter to them. Which reminds me of, we were talking about early on, how coming into 2023 things were just so dark and dreary housing, mortgage rates, Fed, financial markets. Now, you fast-forward to August 2023, and talking about wealth and confidence, I mean look at what’s going on in the stock market. You’ve got the S&P 500, it’s about, I think 17, 18% year to date. NASDAQ, if you invested in tech because of all the AI euphoria and other stuff too, up 33, 34% year to date. There’s these sectors also that were drags on the economy third quarter, fourth quarter of last year. Housing I’d put in there, single family. Tech-
Dean Wehrli:
Tech.
Rick Palacios Jr.:
… got crushed.
Dean Wehrli:
Yeah, for sure.
Rick Palacios Jr.:
Europe in the northern California Bay Area, and it’s a very different conversation right now where there is more hiring. There’s AI euphoria I mentioned. And so that’s where you had these little rolling recessions in sectors, and now both of those sectors that we just talked about, housing, technology, have actually started to come back and are now positives. I think you can make the case for the economy.
Dean Wehrli:
So what do we see happening with mortgages? I mean, I know you’ve done some other analyses where you break down mortgages into different rate categories and what that means. Mortgages is such a huge part of the market. I know everybody knows it is, but it’s more than you might think. How do you see that playing out in the long term?
Rick Palacios Jr.:
I think you’re asking about what’s the prevailing effective outstanding mortgage rate for all borrowers that have a mortgage or living in their home versus current mortgage rates. Current mortgage rates, yeah, seven. Prevailing mortgage rates, so if you already own, is about 3.5%. This goes back to that conversation where that spread very wide right now. So that’s where it creates the hesitancy to retransact. But over time, the effective outstanding mortgage rate will start to trickle up higher because you have year after year of more people having to purchase at these elevated mortgage rates, call it, five, six, 7%.
I was writing this down earlier, so we’ve had mortgage rates above 5% since April of 2022. We’ve had mortgage rates above 6% since September of 2022. And we’ve been flirting with 7% or higher mortgage rates since May of 2023. And so that’s where I think, again, rates don’t have to collapse. I think rates can stay range bound, and if the economy stays range bound, is growing, that’s where you will get more and more people that are retransacting because their mental anchor is not a three, 4%, it’s like five, six. “Home prices have been going up and I’ve got my job, yep, let’s retransact.”
Dean Wehrli:
I was going to say, if there’s one thing that’s surprised me about this market this year, calendar 2023, it’s that the demand has been so resilient with mortgage rates going up, right? In January and February, mortgage rates came down, the market popped, made all the sense in the world. Mortgage rates started going up fairly soon back as you mentioned towards now with seven seven plus. And for all the reason we’ve just talked about is still there. I understand the reasons now, but that’s surprising from six, seven months ago.
Rick Palacios Jr.:
It goes back to that white paper we did on the impact of mortgage rates where if mortgage rates are going up because inflation is exploding, really bad for housing, really bad for the economy, it’s a bad reason. But if mortgage rates are trickling up or steady at a relatively elevated level but it’s because the economy is strengthening and you’re getting inflation coming in… I mean, look at what inflation has done. Inflation has come in from… I think it peaked out at like 9% year over year last year, 2022, and now we’re running at, call it, three and change depending on the metric that you look at. That historically is a backdrop for housing doing okay. I think based off of the metrics that we look at on the new home side, even on the resale side, I mean the resale side looks bad from a sales perspective just because there’s nothing out there to sell, but like I mentioned, prices are stabilizing if not rising across most markets, and builders are having a field day right now.
This is where I think what builders really recognized early on in 2023 was, “Okay, this is a nice fat pitch for us. Let’s take a big swing because we know for the time being there’s nothing out there, and we can get rates below market. And so let’s step on the gas here, lets re-accelerate starts, let’s go out and buy more land.” We just did our land survey, and land market’s heating up quite nicely. That’s exactly what they’re doing. But what I think is going to happen over time is that you will, like we’ve talked about, you will start to see more owners retransacting, letting go, because maybe they’re not letting go of a 3% mortgage, they’re letting go of a 5%, and the difference there is not massive.
And so I think the relative strength, the relative outperformance that home builders have had all through 2023 so far I think just naturally and intuitively you’ll start to see that minimize. It is not going to fall off a cliff, but I think you’re hard-pressed to make the argument that if those things happen and more supply comes into the system, that builders are going to be crushing it like they have been all year so far.
Dean Wehrli:
Weirdly, and maybe counterintuitively, is the best thing that can happen to the housing market a gradual reduction in mortgage rates because for whatever reason, if we went back to really low mortgage rates, even if that was absent a severe recession, you could potentially have this flood of inventory? Does that mean a gradual downward shift from seven plus is the best thing possible?
Rick Palacios Jr.:
I think Steady Eddy would be a nice supporting backdrop for housing, for the economy, for the consumer. Think about how volatile the last three or four years have been.
Dean Wehrli:
25 years.
Rick Palacios Jr.:
Yeah.
Dean Wehrli:
Really, I mean, seriously. Housing used to be thought of as that boring, mundane market. Since the, what, early 2000s, it really has been. We’ve been doing these cliffs and valleys, and that’s not the longer longer term norm.
Rick Palacios Jr.:
No. I was thinking about this too today. You bring up a good point on housing used to be boring. What happened when we had the global financial crisis, rates come down, I mean you had negative yields across most of the world, and everyone was chasing yield. “How can I get return in a low yield environment?” And so what do you think happens in an environment like that? People chase housing, borrowing costs drop. They’re going to go chase yield. That’s exactly what we saw happen for the better part of a good 10, 15 years.
And so I bring it up because I hope that we maybe are transitioning into a world where… I mean, look what I can get on one month, two month treasury bills. I can get 5%. I can lock in something close to that if I want to go even further out on the curve. And so I guess what that means is I don’t have to chase yield, I don’t have to speculate. And so maybe this does usher in a backdrop where savers can actually get a decent return that’s nice and they don’t have to speculate and chase on housing and other things to get that. And so, I hope that we go into more normalized type of backdrop.
Dean Wehrli:
I do too, but I don’t know. Just the American psyche, I am skeptical. There’s always going to be someone out there who wants to do something, wants to push that envelope, whether it’s in a good way or a bad way, and chase something special.
Rick Palacios Jr.:
You think it’ll be in housing?
Dean Wehrli:
It’s such a big sector, it’s done it before, I wouldn’t be shocked. It might not be, and it might not be for a half a cycle or a full cycle, but it’ll come back eventually.
Rick Palacios Jr.:
Yeah. What worries me a little bit is, because the theme of this whole conversation so far has been about people being locked in, they got a lot of equity, I worry about some sort… And there’s some products out there, some companies doing this, but I worry about something that comes out and figures out loopholes for consumers to just suck out a massive amount of equity out of their home and then we fall into a recession at some point in time because inevitably it will come, and then that would be the best recipe.
Dean Wehrli:
That would. Let’s transition, Rick, over to sales. You’ve analyzed the new home market versus the resale market, and you’ve made the argument that this could mean we have some pretty positive impacts on new home sales volume going forward. Tease that out a little bit.
Rick Palacios Jr.:
Yes, so what you’re talking about is the back half of 2023 and what could that look like under some very realistic assumptions for home builders. The exercise there is really rooted in the fantastic work that our builder survey team does. They’ve been doing this for, I think, over a decade now, so our sample size is fantastic, and we can run this. And so for me as an analyst, what I do once we get into May and June is I start thinking about, “Okay, what is our forecast for the year? What is it going to take to get there? Are we close or do we actually need to revise higher because of all the things that are moving now and the information we have?” The reality is we did have to take our new home sales forecast higher, we did have to take our single family housing starts forecast higher because of this exercise.
I mentioned earlier how home builders have been, just from a pure demand proxy standpoint, doing really well. And so that’s the sales rate per community. And so I come back to that often because if you were to look at what sales rates were doing January through June 2014 through 2019, builders were selling during that time about two and a half monthly net sales per community. This year, 2023, builders have been averaging, this was through June, over three net sales per community. So that’s significantly higher than what we would call norm. It’s about 28% above a normal sales pace.
And so you unpack that and you go, “Okay, well what in our thesis tells us that that should change anytime soon, especially in 2023?” We don’t expect the economy to implode. We don’t expect a huge amount of supply to come into the system on the resale side. So we should probably anticipate that that outperformance versus norm continues. And so if you just run that exercise, I mean you’re going to get new home sales rates on a year over year, July all the way through December that are going to range between, call it, 20%, upwards of 40, 50% year over year growth. That exercise, we ran it on our webinar end of July, and then I mentioned our builder survey results that just came in last week for what actually happened in July, and the exercise was almost spot on.
We would’ve modeled about 37% year over year growth. And the actual growth in July was 42%. So very, very close. That’s where you start thinking about, “Okay, the back half of the year, we can paint a pretty solid picture for home builders on their sales rates.” And then if you think community counts are going to be growing too in the back half of the year, and a lot of builders have been talking about this, well, that’s where you get total order growth. You just basically take sales per community and then you take community counts, you stack the growth on each of those, that’s how you get to total new home sales growth. Again, it is a pretty positive story for volumes for builders back half of this year.
Dean Wehrli:
And the beauty of that analysis I think is that you do account for seasonality. We’re hearing a lot now, and I’ve noticed it in the markets I work in, is that there has been a little bit of marginal slowing here very recently, and it’s logical to say, “Well, that’s seasonality.” The analysis you just described accounts for seasonality in the second half of the year, which is slower in most markets, so it’s a pretty robust finding.
Rick Palacios Jr.:
Yeah. We didn’t really see much of a seasonal drop from June to July. So the sales rate held pretty solid. Again, a lot of builders now publicly commenting on what they’re seeing in the market with their earnings and then guiding out for the third quarter of this year and some guiding out for the full year, and their guidance ties pretty closely to a lot of what this implies.
Dean Wehrli:
We rank markets, that is to say MSAs, every month in terms of the conditions not so great, conditions are relatively normal for that market, conditions are very good or very strong. Right now, characterize how we’re ranking those MSAs because, again, it’s a little bit surprising given what we’ve talked about.
Rick Palacios Jr.:
We’ve upgraded a ton of markets as the year has progressed, as we’ve revised up our forecasts on sales, new, and prices to reflect this. And so we do this exercise on a qualitative basis, on a quantitative basis from very slow all the way up to strong. We had the majority of the country in February of this year, there were no strong markets. We had majority of the country very slow, slow, to normal. And then you fast-forward to now July, August, and 37% of the new home markets that we rate are strong. 50% of them are normal. And then you’ve got a couple of pockets that are in this slowish category. But there’s a lot more green on screen, if you want to call it that, than what I think we anticipated coming into the year, on what our clients anticipated coming into the year.
You look across the country, “Well, where is this green?” Southern California, one of the least affordable places in the country, a big part of that is because we’ve been talking about not a lot of resale inventory out there, namely here in southern California. Dallas is green now. Strong, big markets in Florida, Tampa, Orlando, those are green, Charlotte, Atlanta. I mean these are markets that are really the meat of housing, big volume markets, Riverside, San Bernardino, and they’re all running pretty hot right now, which it’s been very nice, pleasantly surprising for a lot of our home builder clients.
There’s a stat that jumps out that I think really captures this where we were talking about earlier on how different the expectations were coming into the year versus how the year has transpired, and we asked in our home builder survey back in, I think it was November of 2022, we asked our home builder clients to tell us, “Hey, how do you think your sales are going to be for 2023?” I think the national figure was down double digits, like, “Hey, we think our sales are going to be down double digits.” Then we asked that question again in, I think it was around May-ish, and it almost flipped completely to where, “Oh, actually, now our sales are going to be up high single digits.” So that was a good signal, a good survey question that we were able to plug in there that really hit it on the head.
Dean Wehrli:
Are you worried at all about home insurance? I know that’s not just Florida, there’s some home insurance issues elsewhere as well, but Florida, it seems to be a major, major consideration right now. Is that worrisome?
Rick Palacios Jr.:
Yes. And that’s a question that we asked in our survey that just went out to clients last week. I think Florida gets a lot of attention for the right reasons, but it’s starting to become a conversation in a lot more pockets of the country. California, which you and I call home, there’s been a lot of insurers that have backed out. Some of that too, in talking to some of our insurer clients, that’s hard to say, is that here in California, they haven’t been able to raise rates all that much over the past I don’t know how many years. And so they’re at this stalemate where they’re like, “Look, we’re just going to bail. We’re not going to write policies anymore until you, the regulators, allow us to start raising prices again.”
And so I think we’re probably going to get there, to a point where there’s like, “Hey, yes, you’re going to be able to raise rates. There’s a lot more risk out there now, fires, floods, whatever you want to call it.” But it’s becoming something that people have to think about more so not only on the industry side, but the consumer side as well. I mean, you go into Texas, I mean, these things aren’t really going away anytime soon.
Dean Wehrli:
What about new home builders, what kind of strategies or tactics are they doing right now? You know we do a lot of work on land banking, we have different strategic relationships. What do you see builders doing in terms of changing strategies to accommodate these market forces we’ve been talking about?
Rick Palacios Jr.:
Yeah, I think first and foremost, builders have been very nimble. As soon as you saw rates explode back half, namely the fourth quarter of 2022, we started hearing and surveying and talking to our clients that floor plans were changing. They were going to de-spec homes, they were going to shrink square footages, because the reality is if rates continued to go up and home prices didn’t cool off at all, well, that’s really one of the only tools that I can use to get more buyers through the door. That has continued to happen. There’s a great stat that I tweeted out last week that was from our earnings call. So LGI Homes, 10th largest builder in the country, and I’m looking down at my notes because I want to get this right, so in the second quarter of 2022, 19% of their closings were for homes under 1,500 square feet. In the second quarter of 2023, 27% of their closings were for homes under 1,500 square feet. This is where we talk about new home versus resale, resale market can’t do that.
I mean, you can’t cut your home in half and go, “Oh, I’m going to sell that half or sell that third.” You’re stuck with what you got, and the only way to adjust down to what the market will accept is to lower your prices. And so that’s where I think the resale market hasn’t adjusted, as we all know. But home builders have been very proactive, very nimble here to do that. You talk about the general structure, I think too, of the home building industry. I mean, it is really almost night and day this cycle versus prior cycles. I mean, home builders historically, especially on the public side, it’s really live and die by the cycle. Rates go up, economy slows down, their business slows down massively. I think what has changed is they’ve created a lot of optionality in their businesses over the years, optionality with land banking, optionality literally with optioning more lots. That’s something that historically not a ton of builders have done in terms of the lion share of the lots that they control. But now more and more of them are doing it.
And when you hit a slowdown, that’s nice. That’s a nice backdrop to be in because you can just go, “Well, you know what? I’m going to walk away from these lots. I’m not going to have to build through them and just impair it the whole way through.” Those are all things I think that have worked out nicely for especially the big public builders. There was one other I was thinking about. I mean, market share is definitely a big part of it too. I mean, you look at what public builders are today, they’re 41% of the entire new home market. So there’s efficiencies of scale for sure.
I mean, you can go to certain markets, especially in Florida, but even some in Texas, I believe some Riverside that we were talking about earlier where just a couple of builders are upwards of 30, 40% of that market. So the market share dynamics have definitely worked to their advantage. And then just cost of capital, just like consumers that refied at super low rates and are sitting on 3% mortgages, I mean, a lot of the public builders, when rates came in before the Fed started to hike, they borrowed dirt cheap rates, pushed those maturities out as far as they could. And so what that does is it creates a lot of breathing room when you are in this backdrop of rates going up, the economy going sideways, was not really sure how things are going to shake out. All of those things have really worked pretty nicely for the setup structurally for home builders.
Dean Wehrli:
How about rental as well? We’re seeing here in California there’s a huge push for ADUs, accessory dwelling units, small units often on the same lot with a normal single family home. We’re seeing actually single family mom and pops put ADUs, build brand new ADU in their single lot if the lot is big enough to do it. Are we seeing new home builders start to partner with SFR and build-to-rent actors?
Rick Palacios Jr.:
Yeah, I mean that has been a going on now for a good five, six plus years. I think the builders that did it are very thankful that they structured those relationships. I mean, the market has been much better than what we anticipated this year, but if things would’ve done what they normally do in a recession and you get pockets of distress and rates explode, the retail buyer wouldn’t be there in full force like they are today. That goes back to, I think, the buzzword of really just creating optionality in your business. It means a lot of the biggest home builders in the business are continuing to lean into relationships there with scattered sites, single family rental investors, building rental communities themselves, getting them stabilized and leased up and then selling them off. It’s a pretty nice part of your business to carve out if you can, and a lot of the builders have.
Dean Wehrli:
Yeah, and you have a different user stream entirely, so it’s additive to your demand. It’s a great strategy, I agree.
Rick Palacios Jr.:
We’ve been talking about for sale this whole time, but one of the reasons that investors, both mom and pop and institutional like the single family rental industry historically is because it is one of those more Steady Eddy type of businesses in residential real estate. Rents don’t explode typically. They also don’t collapse. I was just looking at this today, I mean, our single family rent index across the 99 markets we look at, this captures all landlords, mom and pops, institutions, and the meat of it is mom and pops like I mentioned earlier. You’ve got rents going up about 4% nationally. That’s a pretty nice Steady Eddy business if you can get it.
Dean Wehrli:
Yeah. It’s kind of a floor and a ceiling, but it’s reliable. It’s very consistent. Before we go into a little sneak peek at our forecast, let’s talk about just one thing. I don’t want to end on a downer, so I want to end on a positive of our forecast–
Rick Palacios Jr.:
This has been uplifting conversation, I think.
Dean Wehrli:
It totally has, and we’re going to end it on uplift, I swear. But the downer is just this: what is the single biggest threat to this, more or less, pretty positive, pretty rosy scenario that we’ve laid out here for the last 50 minutes or so? Is it the economy? Is it just the obvious, a severe recession?
Rick Palacios Jr.:
There’s always risks, always risks, but I think if you had to force rank what some of those are, I think a re-acceleration in inflation would not be good. That’s what we saw in the ’70s. You had two energy crises, and the volatility in inflation was pretty bad. We had multiple recessions going through the early ’80s. I think when you look at the argument for a soft landing where the Fed has done what it’s done but the economy cools, doesn’t collapse, and we don’t get a recession, I think if inflation re-accelerate significantly, it could throw the soft landing argument into jeopardy.
Look at oil prices, oil prices have come up pretty considerably in the last month or two. And so my fear is that you get some sort of energy shock. When the consumer thinks about inflation, how it hits them on a day-to-day, what do we all see every single day almost? Look at what happens with gas prices. And so if gas prices are going up, up, up, up, it usually hits consumer psyche. And then obviously if that same thing is happening with food prices too. So that I think is the biggest risk to the overall thesis because it wouldn’t be good for mortgage rates if inflation started to shoot up again.
Dean Wehrli:
Yeah, gas, food, rent. So one of the things I worry about is affordability. We’re still on the whole pretty unaffordable from a historical perspective in most MSAs, so I worry that… We don’t want to give back more, I get it, but I feel like there might be a little more give back to happen, it just might be in the next cycle.
Rick Palacios Jr.:
Well, I mean, that’s where our forecast for home prices in particular, it’s muted. It’s not going to be super exciting because it’s going to take some time. This goes back to stability and time. We need some time for incomes to be accelerating at a pace that’s maybe in line or slightly above what’s happening with home prices if rates are going to stay where they are, because that’s really what’s going to help us solve the affordability equation. It won’t happen overnight, but it will happen over time. So yeah, that’s why after this conversation, if you’re like, “Man, they’re super bullish,” well, if you looked at our home price forecast, we’re not super bullish on the other years.
Dean Wehrli:
Okay, let’s end with that, Rick. I know you’re a little bit hamstrung on what you can and cannot share right now, what can you share in terms of a little peak at what we’re expecting here in the near term?
Rick Palacios Jr.:
Yeah, I’m thinking about this and the right way to answer it.
Dean Wehrli:
I know you’re pausing, you’re being circumspect, that’s good.
Rick Palacios Jr.:
I mean, you could tell by this conversation that for 2023… Do you want to just talk about 2023 or are you going to force my hand-
Dean Wehrli:
You know what, I would love to hear about ’24 because we’re more than half done with ’23.
Rick Palacios Jr.:
Yeah, so for 2024, it’s really a flat-ish, not too sexy or exciting, backdrop is really how we’re thinking about it. Part of that is because we just talked about affordability and something’s got to give there. So our view is, okay, incomes are going up, but home prices have to cool off somewhat, so flattish in a lot of markets. On the new home side, we talked about the relative strength of the new home space versus resale this year and how time will heal that as the vintage of loans starts to age and you get more visibility on the economy, maybe weathering this and the Fed threading that needle. So we do think that the resale market will actually start to see somewhat of a pickup in terms of transactions next year, kind of at the expense perhaps of the new home side. We think the new home side cools off relative to what we saw this year.
Talking about rents, our view on single family rents is that they’ll be up, I am trying to frame this right, low single digits. I mean, typically what we’ve seen historically in our single family rent index is that they tend to move roughly in line nationally with what’s happening on an inflation basis. And then you go into apartments, a different story. But even the apartment side has weathered this better than what I think a lot of people anticipated. We’ve got apartment rents that are going to be, I believe, flat to very low single digits is our thesis for 2024. Does that help a bit?
Dean Wehrli:
It does. It does. I think one of the key takeaways from that is that if you were saying this one year ago exactly, people would’ve been, “Oh my God, I will take that all day. Thank you. I feel so much better about myself.”
Rick Palacios Jr.:
Oh yeah.
Dean Wehrli:
So that is, if we got to put these things in perspectives and that is a massively better outcome on the horizon, we hope, than we would’ve thought not all that long ago.
Rick Palacios Jr.:
Completely. I remember it crystal clear. We were in January February this year and talking to a home builder and they’re like, “Hey, are you seeing this? Is it going to last? Do you believe this? How is this possible?” And so fast-forward-
Dean Wehrli:
And there was skepticism, wasn’t there? There was skepticism a little bit because pretty soon thereafter, again, that 6.10 became 6.40 I mean very quickly, and then-
Rick Palacios Jr.:
Very quickly.
Dean Wehrli:
… it crept up a little bit. So it’s been a pretty surprising run. But here’s the key, I think, tell me if I’m wrong, but it’s the sustainability of it. A soft landing– People were talking about a soft landing in 2006. That was delusional. A soft landing now is very realistic and very attainable, and it leads to a more sustainable, less volatile market going forward. On the whole, I think that’s a good thing.
Rick Palacios Jr.:
Oh, I agree, and I think the average consumer would agree. I think our clients planning their business much easier to plan your business to low single digit growth than to, “Wait a second, it could be down 20, it could be up 30? What do I do there?”
Dean Wehrli:
Yeah, flip a coin…
Rick Palacios Jr.:
Exactly.
Dean Wehrli:
… it’s your money. Well, Rick, this has been, as always, enlightening. In case our listeners don’t know, Rick, he does this, he breathes this every day, and he’s very thoughtful about his analyses. I think that leads to the kind of insights that he’s given us here today. Rick, thanks so much.
Rick Palacios Jr.:
Yeah, thanks, Dean. Appreciate it.
Dean Wehrli:
This has been Dean Wehrli for the New Home Insights podcast. We’ll see you again in a couple of weeks.
