Housing Affordability Challenges and Predictions from Ivy Zelman

It’s incredibly challenging for today’s prospective buyers, not only with the monthly payment, with rates rising as much as they have, but home prices having continued to rise north of 5-6%. And even wage growth, although trying to keep up, we have other factors like homeowner’s insurance which is soaring and other incremental costs that are also weighing on consumer’s ability to buy. So I think it’s tough for people, and one of the things we saw during this higher rate environment is record cash purchases. So there’s more challenge as you’d expect at the lower end of the price spectrum and the more fluent higher end is still doing relatively well. But there’s a lot of sellers that, as we call it, have aspirational pricing—they want the peak pricing from COVID—so there’s holdouts, but I do think…where the healthiness of the market is the strongest is really at the high end.

Today, the lock-in effect, as we all know, with the free money that everyone was accessing during COVID, what we have is today roughly 80% of homeowners that actually have a mortgage are locked in below 5%…and it was over 90%. But with all the originations that we’ve been doing that are north of 6.5% to 7%, that number’s been coming down. But that lock-in effect has really disincentivized people to move. 

So, what would be the right number to get them to move is really what people talk about. And people think roughly 5-5.5% could be the magic number.

One other thing to contemplate, we have an inverted yield curve. As a result of the inverted yield curve, the spreads that typically we see—the 10 year versus the 30 year mortgage rate—is about a hundred basis points wider than normal. So, there is optimism that if you took that hundred basis points and you compressed it to normal, mortgage rates would be 5.5% right now…

Many people like to look at the comparison from apartment rentals to single-family purchases. And just to put that in context, we don’t necessarily think that’s the best analysis just because it’s a bit of apples and oranges, but just to stress the difference in affordability, it’s nearly 30% better to rent an apartment today than to purchase a home.

One of the slides that jumped out at me I’ve used—you’re talking about differences between rental and home ownership—was your tracking on rent growth. And it’s an amazing slide that shows where the CPI is tracking rent growth, and it’s this red line that’s way, way up. And then you all track seven other indicators of rental growth and they’re all dramatically below them. And you see this big lag in where CPI rent growth goes versus where all of the other indicators are. I don’t want to dive too much into the rabbit hole as it relates to why CPI is still giving us these sort of false prints on rental, but I thought that that data point…I mean if you took that slide and sent it to Jerome Powell and just sort of said, ‘The data you’re pulling out on your rent growth is way off of what we’re pulling out of actual market sources” is really quite something.

And it’s frustrating to many market participants given that the measure that they’re really focused on is the owner-equivalent rent (OER). So, OER is really the basis of how they’re determining CPI, which is 40% of shelter as opposed to actual rents. They’re sampling households…. But it’s not the same data that we have, which is actual rents, right? 

So we’re looking at not only new move-in rent rates, but blended rent rates that are showing that…overall rent growth has normalized for the most part, and we don’t expect much more pressure. In fact, the spring selling season in the last quarter especially showed that rents were actually stable to moving back up a little bit, which we think might be temporary just because the supply that still needs to be delivered could pressure rents in the back half of 2024. But the CPI is no question very much lagging and I think Jerome Powell knows that…

It’s been a rocket ship. I mean we’ve seen a tremendous spike in homes purchased that are valued over a million dollars and it makes sense given the fact that we have had so much home price appreciation. I mean I could tell you a home in Naples, Florida that might’ve sold for $500,000 is now well north of a million dollars. So, a lot of homes have doubled in value and even tripled in value in certain coastal markets. There’s no question that the inflation at the high end has just surpassed any expectations we would’ve had.

No…we think they’re very well positioned. And while Toll might be the only builder that’s really geared to building a million plus dollar homes in terms of their semi-custom homes, think about their market share. It’s negligible, and today’s buyer wants new—they prefer new. A lot of the stock today in the United States is very dated. The average stock is north of 50 years old, and we’re looking at the northeast and Midwest north of that. So when you have this old, dated product [and] you want a new home, Toll Brothers offers you that alternative. It is such a small number on a relative basis. I think they have plenty of room to continue to offer and see strong growth in the markets that they’re serving.

Well, I’ll put some context around it. When I started covering the industry in the early nineties, the market share for the public home builders was south of 10% and today it’s north of 50%. So it’s been a very strong growth story over time. In fact, when you look at Horton and Lennar alone, they account for 30% of new home sales. So they’re head and shoulders above the other public builders. But when you think about why, well the cost of capital is anywhere from 500 to a thousand basis points lower for the publics, they have scale advantages, whether it’s buying raw materials or they’re dealing with bulk deals with respect to land purchases, they’re making maybe more favorable terms. Certainly the perspective would be that they have access to capital that the privates don’t have. But I think overall it’s the scale and the purchasing power has been a big factor for them.

Now a lot of private builders that we interact with are doing exceptionally well and continue to have very decent growth despite the public’s gaining share. So I think it’s a story of if a private builder in a regional market, where they are dominant and they have a good reputation, I think they can continue to thrive. But I think that the publics are probably looking to buy that private at some point. And so they’ve also done it through acquisition. I do think that there’s a place for the private builder, but they do have disadvantages, especially when it comes to the access to capital, not just the cost of capital, but accessing capital—and banks when they’re pulling back and that’s their source, they’re at a disadvantage. The scale from purchasing, whether it building products, whether it be land, I think those are advantages that the publics will continue to derive, especially because in this market environment, land is the most significant land raw material and it’s getting harder and harder to buy land that you can get entitled and take through the process in a reasonable timeframe. In fact, land was the only thing that never came under pressure during covid. Land prices have not abated and have continued to increase and putting a lot of pressure on the overall industry. Another thing with the Biden administration is regulatory changes, code changes, energy code changes, puts pressure more on the private guys than it does the larger guys than on the public side.

Or does it make sense given NIMBYism, regulatory hurdles, entitlement hurdles, all that kind of stuff?

I think the land market is pretty tight and I think that it really goes down to the local municipality level. And so you have markets like in Phoenix where maybe starts historically peaked in the 50–60,000, they can’t, even if they want to, build more than 25,000 starts. And that’s a function of getting the land market, getting finished lots, getting approvals from municipalities. So the market is really strained and it’s also having to do with utility hookups, transformers, the water supply, there’s a lot of constraints that were not prevalent 30 years ago—nor were they prevalent during the GFC. So I think it’s going to keep land in that sort of more shortage situation. And the builders that have access to it will provide the volume of the product to the market, so that they’ll continue to gain share. So I don’t see any correction in land coming at the moment.

It goes back to the idea of how much land can you put into your assembly plant and wind up or your manufacturing plant so you can actually put it down the assembly line…That’s the problem. And that’s one of the reasons why even if you said rates were to fall dramatically, the builders would have a difficult time getting a number of new communities open… So, even if we said mortgage rates are going back to 4.5-5% and…everything’s great, the builders couldn’t supply it; they would just keep inflating the price of the home rather than trying to chase the volume.

There’s definitely startups that are attempting to do so but nothing significant that has tracks in enough that we should talk about. I thought about having one of those companies or anyone that’s sort of further along than the first inning to the housing summit that we’re hosting in September. And I was chatting with our friend Stuart Miller. He said, “No, Ivy, there’s nothing good enough to bring to the summit. There’s nothing that far along.” And I think that one of the industries that we’re looking at relaunching on—I used to cover it in the nineties—was the manufactured housing industry. And when you think about affordability, I think that that industry is sort of under the radar and has definitely built factory-built homes similar to what Katera wanted to do…I don’t think that people have really taken a hard look at those companies, but they’re providing what Katera was attempting to do. But they’ve been doing so for decades and it’s improved.