Affordability Sets the Foundation for Housing Stocks

Dan Oppenheim
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Dan Oppenheim , CFA

(415) 889-5617

doppenheim@ssrllc.com

April 18th 2019

Affordability – the Driver of Housing Activity – Sets the Foundation for Housing Stocks

  • Affordability back to better-than-average levels. The combination of declining mortgage rates, rising household incomes, and slowing home price appreciation has resulted in improved affordability. We estimate that 2Q19 national affordability is at the most favorable 2Q level since 2Q16. In addition, we estimate that affordability is better than its historical average, with 18.0% of income needed to cover housing costs in 2Q19, better than the 19.0% long-term average. Historically, affordability has been the key driver of housing demand, with improving affordability driving higher turnover – a positive for home improvement spending.
  • Largest metro areas have favorable affordability, supporting home improvement. Of the 10 largest metropolitan areas, we believe affordability is favorable (in line or better than the individual metro area’s long-term average, or at least more affordable than the national average) in nine of the ten largest metro areas, with only Miami having what we would describe as stretched affordability. We look at the 10 largest metro areas and not just the largest markets for home construction, as much of the home improvement activity takes place in these population centers, not just in the growth (new construction) markets. This favorable – and improving – affordability supports transaction activity and resulting home improvement, bolstering activity at retailers such as Home Depot and Lowe’s, and also building products companies.
  • New home construction markets also show general affordability, but also sensitivity to rates. In addition to the largest metro areas, affordability is generally favorable in the largest markets for new construction, with five of the ten largest markets for single-family construction having favorable affordability. We would much prefer to see all of these markets showing favorable affordability, but the markets with less favorable affordability – Austin, Nashville, Orlando, Phoenix and Tampa – are in most cases only slightly worse than the national average, with housing costs representing approximately 20% of income. This limits our concern about affordability in these markets, but it also highlights the sensitivity to mortgage rates, as a meaningful increase in mortgage rates would quickly bring many of these key construction markets to stretched affordability, which would then likely result in reduced construction and sales activity.
  • Affordability challenges in west coast markets are moderating, and already reflected. The stretched affordability in west coast markets such as San Diego, Orange County, the Inland Empire, San Francisco, Seattle, Portland has moderated given the decline in mortgage rates, rising income levels, and easing home price appreciation. The improving (but still stretched) affordability in many of these markets will limit the decline in construction activity and reduces the risk of severe price declines. In addition, as we continue to believe that the valuations of homebuilders with significant exposure to west coast markets (TOL, KBH, WLH, and LEN) more than reflect the slowing conditions (see “Finding Value in the Golden State”) .

Shifting preferences to for-sale related sectors, Neutral on rental sectors. We prefer those sectors with exposure to the for-sale housing market (building products, home centers, homebuilders, and mortgage insurers) based on the more favorable affordability and are Neutral on the sectors more tied to the rental market (multi-family REITs and single-family REITs). We have a Neutral stance on the real estate brokers, largely due to the limited publicly-traded companies in the sector and the geographic concentration of RLGY.

Exhibit 1: SSR’s Preferences Among Housing-Related Sectors
Source: SSR analysis

National affordability returns to better than long-term average levels. We estimate that affordability is better than its historical average, with 18.0% of income needed to cover housing costs in 2Q19, better than the 19.0% long-term average. This 2Q19 affordability level is relatively favorable for potential homebuyers, as the percentage of income needed to cover housing costs is lower than at most times aside from during the initial years of recovery after the housing crash, with bottoming in 2011. We view affordability based on the percentage of monthly income needed to cover housing costs, rather than the ratio of home prices to incomes as the latter metric ignores the impact of mortgage rates. Given that most homebuyers obtain mortgages, with this being especially true for the incremental homebuyer, we think it is better to view affordability through housing costs (including mortgage payments, real estate taxes, and insurance) relative to incomes, rather than simply looking at home prices to incomes. Historically, affordability has been the key driver of housing demand, with improving affordability driving higher turnover – a positive for home improvement spending.

Exhibit 2: Housing payments represent 18% of median income in 2Q19, less than the 19% long-term average
Source: Freddie Mac, HUD, National Association of Realtors, S&P Capital IQ, and SSR estimates

Nearly all of the most populated areas have favorable affordability. We estimate that nine of the ten most populated metro areas have favorable affordability in 2Q19. We deem affordability in a market to be favorable if: 1) it is the same or lower than the market’s long-term average, or 2) the affordability is worse than the market’s long-term average, but is still better (lower) than the national average. We believe that it is appropriate to include this second case (worse than the market’s long-term average, but better than the national affordability) as these represent markets such as Atlanta, Dallas, and Houston that are shifting from exceptionally affordable markets to reasonably affordable markets since the affordability is still better than the national average. Of the ten most populated metro areas, only Miami has affordability that is both worse than its historical average and also worse than the national average.

Exhibit 3: Nine of ten largest metro areas have favorable affordability
Source: Census Bureau, Freddie Mac, HUD, National Association of Realtors, S&P Capital IQ, and SSR estimates

Key new construction markets also have healthy affordability levels. Affordability is generally favorable in the largest markets for new construction, with five of the ten largest markets for single-family construction having favorable affordability. We would much prefer to see all of these markets showing favorable affordability, but the markets with less favorable affordability – Austin, Nashville, Orlando, Phoenix and Tampa – are in most cases only slightly worse than the national average, with housing costs representing approximately 20% of income. This limits our concern about affordability in these markets, but it also highlights the sensitivity to mortgage rates, as a meaningful increase in mortgage rates would quickly bring many of these key construction markets to stretched affordability, which would then likely result in reduced construction and sales activity. To this point, Austin and Nashville both had the most stretched affordability in the history of those markets until the relatively recent decline in mortgage rates at the end of 2018.

Exhibit 4: Key new construction markets generally affordable, but with more stress in Southeast
Source: Census Bureau, Freddie Mac, HUD, National Association of Realtors, S&P Capital IQ, and SSR estimates

Affordability in key housing markets

Exhibit 5: Atlanta: Still Favorable from National Standpoint, Back to Pre-Crisis Levels
Source: Freddie Mac, HUD, National Association of Realtors, S&P Capital IQ, and SSR estimates
Exhibit 6: Austin: Affordability Worse than Typical for Austin, Sensitive to Mortgage Rates
Source: Freddie Mac, HUD, National Association of Realtors, S&P Capital IQ, and SSR estimates
Exhibit 7: Boston: Better-than-Historical Affordability
Source: Freddie Mac, HUD, National Association of Realtors, S&P Capital IQ, and SSR estimates
Exhibit 8: Charlotte: Affordability in Line with Historical Norm
Source: Freddie Mac, HUD, National Association of Realtors, S&P Capital IQ, and SSR estimates
Exhibit 9: Chicago: xxAffordability in Line with Historical Norm
Source: Freddie Mac, HUD, National Association of Realtors, S&P Capital IQ, and SSR estimates
Exhibit 10: Dallas: Still Affordable Relative to Other Markets, But Toward Upper End for Dallas
Source: Freddie Mac, HUD, National Association of Realtors, S&P Capital IQ, and SSR estimates
Exhibit 11: Denver: Lower Mortgage Rates Helping to Restore Some Affordability in Denver
Source: Freddie Mac, HUD, National Association of Realtors, S&P Capital IQ, and SSR estimates
Exhibit 12: Houston: Affordability Slightly Above Historic Level, But Still Affordable
Source: Freddie Mac, HUD, National Association of Realtors, S&P Capital IQ, and SSR estimates
Exhibit 13: Las Vegas: Slightly Less Affordability than in Past, But Far Better Than ‘05/06
Source: Freddie Mac, HUD, National Association of Realtors, S&P Capital IQ, and SSR estimates
Exhibit 14: Los Angeles: Affordability Near ’03 Levels; Higher Rates or Prices Would Stretch Affordability
Source: Freddie Mac, HUD, National Association of Realtors, S&P Capital IQ, and SSR estimates
Exhibit 15: Miami: Affordability Back to Normal Levels, But Risk of Getting Stretched
Source: Freddie Mac, HUD, National Association of Realtors, S&P Capital IQ, and SSR estimates
Exhibit 16: Minneapolis: An Affordable Market, with Housing Costs at Typical Levels
Source: Freddie Mac, HUD, National Association of Realtors, S&P Capital IQ, and SSR estimates
Exhibit 17: Nashville: Affordability at Risk of Becoming Stretched
Source: Freddie Mac, HUD, National Association of Realtors, S&P Capital IQ, and SSR estimates
Exhibit 18: New York: Affordability Better than Long-Term Average
Source: Freddie Mac, HUD, National Association of Realtors, S&P Capital IQ, and SSR estimates
Exhibit 19: Orlando: Affordability Modestly Worse than Long-term Average
Source: Freddie Mac, HUD, National Association of Realtors, S&P Capital IQ, and SSR estimates
Exhibit 20: Phoenix: Affordability in Fair Shape Following Rebound
Source: Freddie Mac, HUD, National Association of Realtors, S&P Capital IQ, and SSR estimates
Exhibit 21: Portland: Lower Mortgage Rates Have Helped to Restore Some Affordability
Source: Freddie Mac, HUD, National Association of Realtors, S&P Capital IQ, and SSR estimates
Exhibit 22: Riverside San Bernardino: Affordability at ’03 Levels; Risk of Becoming Stretched
Source: Freddie Mac, HUD, National Association of Realtors, S&P Capital IQ, and SSR estimates
Exhibit 23: Sacramento: Affordability in Line with Historical Norm, but Sensitive to Rates
Source: Freddie Mac, HUD, National Association of Realtors, S&P Capital IQ, and SSR estimates
Exhibit 24: San Diego: Affordability Slightly Better than Historical Norm, but an Expensive Market
Source: Freddie Mac, HUD, National Association of Realtors, S&P Capital IQ, and SSR estimates
Exhibit 25: San Francisco: Difficult Affordability, But Similar to Past
Source: Freddie Mac, HUD, National Association of Realtors, S&P Capital IQ, and SSR estimates
Exhibit 26: Seattle: Affordability Modestly Worse than Historical Norm
Source: Freddie Mac, HUD, National Association of Realtors, S&P Capital IQ, and SSR estimates
Exhibit 27: Tampa: Affordability a Bit Worse than Long-term Average
Source: Freddie Mac, HUD, National Association of Realtors, S&P Capital IQ, and SSR estimates
Exhibit 28: Washington, D.C.: Affordability in Line with Historical Norm
Source: Freddie Mac, HUD, National Association of Realtors, S&P Capital IQ, and SSR estimates

©2019, SSR LLC, 225 High Ridge Road, Stamford, CT 06905. All rights reserved. The information contained in this report has been obtained from sources believed to be reliable, and its accuracy and completeness is not guaranteed. No representation or warranty, express or implied, is made as to the fairness, accuracy, completeness or correctness of the information and opinions contained herein.  The views and other information provided are subject to change without notice.  This report is issued without regard to the specific investment objectives, financial situation or particular needs of any specific recipient and is not construed as a solicitation or an offer to buy or sell any securities or related financial instruments. Past performance is not necessarily a guide to future results.

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