Here are the top news flashes from last year’s world of housing. In 2020, single-family prices spiked 9.4%—their best performance in over a decade. Homes are selling at the fastest pace in years, and the biggest winners are the pricey picks. A flood of affluent millennials, seeking home offices and backyards, is the main force spurring the market. The irresistible force of the buying boom is meeting the immovable object, years of super-depressed construction, pushing inventories to historic lows. Something’s gotta give, and it’s prices that rampaged last year and will keep roaring in 2021.
The low-tax, job-rich Sunbelt regions where building is a lot less constrained than in the coastal metros will nevertheless see the best price performance this year, along with suburbs of gateway cities such as New York and L.A. The near-miracle is that a steep drop in mortgage rates has more than offset the jump in prices, meaning you can buy a bigger, costlier colonial, ranch, Cape Cod, or mid-century modern this year than you could last year, and still pay the same monthly nut.
Those are some takeaways from an excellent new report by the Amherst Group, a real estate investment, development, and operating firm with $8 billion in assets under management, including a property management arm that owns and operates more than 30,000 single-family rental homes in over 30 cities across America. “A confluence of special forces has created one of the best housing markets in years amid an economy that’s struggling more than at any time since the Great Recession,” says Sandeep Bordia, who authored the study. Here are the main findings that explain that seeming paradox, taken from both the report and interviews with Bordia.
WFH benefits housing
Bordia opens his analysis by sketching the broad economic picture. His observations encompass both the depths of the downturn, and how the crisis is “fundamentally changing” the way people and companies use real estate. He notes that national income shrank 2.9% last year, a swing of five-plus points from the 2.3% expansion in 2019, and that some 8 million to 9 million jobs, 40% of those lost during the pandemic, have yet to return. The vast bulk of the newly unemployed, however, are lower-wage workers in service industries such as hospitality and restaurants, who lean heavily toward renting apartments. Employees earning $75,000 or less pre-COVID accounted for 80% of the losses through April.
Bordia documents the enduring shift to work-from-home. One sign is that mass-transit usage has dropped dramatically in major metros, with subway and bus travel falling over 40% in New York and 70% in San Francisco. Office occupancy has tumbled from nearly full in most cities to 35% in Dallas, 25% in Phoenix, and just over 10% in New York. City residents are still spending 10% to 20% more time at home than before COVID transformed their lifestyles.
Prices rose, but homes got more affordable
According to Amherst’s statistics, home prices grew 9.4% in 2020, the best performance since 2005. You’d think that a jump of that proportion would make houses a lot less affordable today than at the start of 2020, before the upward march began. But Bordia illustrates how the payments buyers must make each month based on the home’s price, their incomes, and the rates on their 30-year mortgages have shifted considerably in recent years, as all three of those factors have changed. When the payments get too high relative to the family’s income, housing is deemed overpriced; when they take a smaller share of mom and dad’s paychecks than in most periods, the market swings to undervalued. “The benchmark is the share of their income a family historically spends on housing,” says Bordia.
During the craze from 2004 to 2007, those payments, relative to family income, jumped to the point where housing prices hovered 38% above their “fundamental value,” meaning they were unaffordable by almost 40%, although millions of homeowners kept paying by deploying adjustable-rate mortgages (ARMs) that later reset to much higher rates, triggering a cascade of foreclosures.
But the housing collapse in the Great Financial Crisis drove values so low that from 2008 to 2017, homes were generally underpriced by 5% to 10%. Until the onset of the pandemic, the market was toggling close to fair value. Amazingly, by year-end, following the almost double-digit romp, those prices stood 3% to 4% below the “affordable” line.
The factor explaining that apparent miracle was the sharp drop in the cost of carrying the same-size mortgage. Since the start of 2020, rates on the Freddie Mac 30-year home loan has fallen from 3.7% to 2.7%. “Every one-point drop in that rate increases fundamental home prices by 10%,” says Bordia. “That means the family can buy a bigger, more expensive home and make the same payment as before rates fell. The real big driver for the improvement in consumers’ ability to afford homes is the drop in rates.” He adds that during the housing crisis, rates were even lower, but prices were so inflated that cheap borrowing did little to cushion the collapse.
What happens to home prices if rates start rising? “If rates rose by one point back to 3.7%, and I don’t expect that to happen anytime soon, it wouldn’t happen in isolation,” says Bordia. “It would happen because economic growth would rebound, increasing family incomes.” As a result, Bordia predicts that a 100–basis point increase in rates would cause housing to swing from 3% or 4% underpriced to overvalued in a similar range.
Higher-income millennials are the drivers
Bordia notes that the key drivers are families buying their first homes, and that they have significantly higher incomes, more education, and better credit, than last year’s crop. A surge in first-timers gives an outsize lift to prices because repeat buyers usually sell a home and buy another, so they’re not adding “net” fresh demand. The maiden purchasers, on the other hand, are moving from apartments and not adding a home they just left to the unsold inventory. In Q3 and Q4 of 2020, mortgage originations for the newcomers jumped from 29% and 47%, respectively, from the same quarters in 2019. By the fourth quarter, the FICO scores for the new buyers had risen to 723 on average, 14 points higher than in Q1. The new demand is coming from a group with excellent characteristics for buying homes, meaning they can afford to pay more.
Why are these well-paid families suddenly rushing to buy? For Bordia, the trend is a combination of a pull-forward in buying that without the pandemic would have occurred two or three years later, and a permanent shift in demand as the work-from-home ethic takes hold. “Many families wanted to move as quickly as possible from a city apartment to a home in the suburbs where they have more space,” he says. “They simply took the step sooner,” he adds.
But Bordia also thinks that COVID changed the real estate world for good by lifting the desire for a home office and backyard to a new level: “The crisis created permanent demand as well. People realize they can do the same work from a three-bedroom house in Columbus they were doing from an office in Chicago. So they left their two-bedroom in the city for far more space,” he notes. That family probably pays less per month on the colonial or Tudor than they spent on those cramped quarters in the city.
The outlook for 2021
At the same time these well-paid millennials are flocking to where the houses are––the suburbs––the stock of properties for sale has hit historic lows. That’s the legacy of a dearth of new building that has endured since the catastrophe of 2008 and 2009. In the past decade, says Bordia, America has built 3 million fewer homes than the number needed to keep pace with household formation. The shortage forced sundry families into the rental market and drove prices upward, although low rates kept monthly payments reasonable. The buying surge in 2020 drove total listings 18% below 2019 levels by year-end. At the current rate of sales, inventory stands at an an extraordinarily low two months, versus three months at this time in 2020.
Another extraordinary feature of today’s market, one that’s keeping listings so slim, is the jump in the velocity or pace of sales. In 2019, 37% of all listings sold in 60 days. This year, it’s 47%. Over two-thirds sold in 90 days post-COVID, versus 54% in 2019. Most surprising is that the rate of increase is a lot greater for the pricier properties. Around 65% of the homes both in the most expensive quartile, and over 2,500 square feet, sold in 90 days or less in 2020, compared with around 45% last year.
The big question is which geographies will fare best this year. The hottest, measured by a blend of their super-small inventories and high rate of sales, are in states such as Texas, Florida, Utah, Colorado, North and South Carolina, and inexpensive metros in the Midwest, including Indianapolis and Kansas City. Those places benefit from both a big influx of refugees from the cities and slim inventories. “Employment is moving to the Sunbelt cities in a big way,” says Bordia. “Think of Oracle going to Austin, HP to Houston, CBRE to Dallas, and financial services companies to Florida. Once you get to critical mass in those locations, it’s much easier for talent to move there. There’s no looking back for those cities.”
But he also unveiled some surprises. “Most people leaving the major urban gateway markets don’t leave their roots completely,” he explains. “They’re much more likely to move 50 to 100 miles away from the city they were renting in to buy in the suburbs.” Hence, he expects to see continued good times for housing in the tree-lined neighborhoods around gateway cities such as Los Angeles, San Francisco, and New York. Flagstaff, Ariz., could benefit from the outflow from Phoenix; California’s Modesto and Stockton from the San Francisco exodus; and Washington’s Bellevue and Tacoma from families leaving Seattle. If you had asked most sharp observers at the start of 2020 to predict what would happen to housing if joblessness exploded and the economy cratered, few would have foreseen a boom in which prices jumped but at the same time houses got cheaper to carry. And yet the unlikeliest of unlikely scenarios not only happened, it’s still racing on strong legs.