Consumer confidence dips slowly in December but still at elevated levels

Consumer confidence continued to slowly sink in December, with most of the decline among lower income households. The extent of the decline was minor, with the December figure just below the average for 2017 (95.9 versus 96.8). Indeed, the average in 2017 was the highest since 2000, and only during the long expansions of the 1960's and 1990's was confidence significantly higher. Tax reform was spontaneously mentioned by 29% of all respondents, with nearly an equal split between positive and negative impacts on economic prospects.

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A Look Ahead to 2018: All systems go, but tax reform impact unknown

In 2017, we saw an economy and a housing market gaining momentum, for one of the longest rebounds in modern history. For 2018, the International Monetary Fund (IMF) is projecting global growth of 3.7 percent, for a slight improvement over 3.6 percent in 2017.

Here in America – and due to a second half of 2017 that was much stronger than the first – the Federal Reserve is projecting the U.S. economy to grow by 2.5 percent in 2018 after finishing 2017 with the same growth rate.

For housing, although tax reform is likely to negatively impact the housing market in both high-priced and second-home markets moving forward, both the overall U.S. economy and new home sales are expected to continue strengthening in the year head.  To combat future inflation, the Federal Reserve is planning on three more rate hikes in 2018, and has stated that it sees some moderate additional growth of about 0.4 percentage points in GDP resulting from tax reform.

However, what may be good for housing demand in terms of low unemployment has also meant tighter labor market conditions, especially for skilled construction trades.  As of October 2017, open jobs in the building industry rose to nearly 230,000, likely setting the stage for higher wage growth ahead.

In addition, the cost of building materials continues to rise, especially for wood products and for Canadian lumber subject to a 21 percent excise tax.

Although an analysis funded by the National Association of Realtors has suggested that tax reform could lower housing prices throughout the country, a larger problem may be that it could discourage existing homeowners from selling to take on pricier non-grandfathered mortgages, or even stay in place for five rather than two years to save on capital gains taxes.  In both of these scenarios, the pace of sales could slow at a time when more supply is needed.

Of course one question mark will be the mindset of Millennials, some of whom are now at that age where they’re starting to form new households, and even leaving urban areas in search of more affordable options in the suburbs.

According to NAR’s 2017 Profile of Buyers and Sellers, the share of sales to first-time buyers averaged 34 percent during the year, down one percentage point of 35 percent.  Still, given that the share of first-time buyers since 1981 has averaged 39 percent, builders have a unique opportunity to fill in the gap by focusing more on the Milllennial cohort.

One way builders are responding to Millennial demand includes building smaller single-family homes, with the median size falling by nearly four percent to 2378 square feet between the third quarters of 2014 and 2017. For multi-family homes, median home sizes fell by 1.5 percent during the same time period to 1168 square feet.

Even with these changes, however, the industry is still catching up from the Great Recession in many areas.  According to the National Association of Home Builders/First American Leading Markets Index (LMI) for the third quarter of 2017, markets in just 58 percent of the 337 metro areas nationwide returned to or exceeded their last normal levels of economic and housing activity, for a net gain of about 40 markets over the previous year.  Nationally, the index stood at 1.03, meaning that the nationwide average is running at 103% of normal economic and housing activity.

Nonetheless, the individual components of the LMI have not recovered equally: While employment has reached 99 percent of normal activity and home prices have rebounded to 155 percent of normal, single-family permits are running at just 56 percent of historic norms.

In order to address this disconnect between supply and demand, the Rosen Consulting Group recently conducted its own study for the NAR.  In its recent white paper “Rebuildingthe American Dream: Strategies to Sustainably Increase Homeownership,” Rosen’s team identifies 25 ideas to bolster homeownership.

While some suggestions are repeats of past ideas – such as addressing restrictive zoning laws, offering down payment savings programs, tackling the burden of student debt, and a nationwide counseling program for homeowners who previously experienced foreclosure and may be hesitant to consider buying a home again – others are more focused on emerging technologies in the industry or even re-thinking land use strategies.  These include promoting more pre-fabricated or modular housing, boosting training and apprenticeship programs, and more liberal use of Accessory Dwelling Units (ADUs), such as granny flats, on single-family lots in high-cost areas.

With new supply seemingly under assault from multiple causes, multiple solutions will likely be required.

2017 in Review: A Gradually Strengthening Economy Meets Higher Construction Costs

At this same time a year ago, I wrote about an economy that was improving enough that the Federal Reserve was about to raise interest rates for the second time since 2006, followed by up to three more hikes in 2017.  However, there has also been a consequence of this growth in the form of higher costs for land, labor and materials, making it challenging for builders to build the types of affordable housing at a time when new home starts are predicted to jump sharply in 2018.

U.S. GDP growth – which averaged about two percent in both 2015 and 2016 and was just 1.2 percent in 1Q 2017 ---- surged to three percent in the second and third quarters, due mostly to increased consumer spending, inventory investments, exports and federal government outlays.  Current forecasts are suggesting this rate of growth to improve even further to 3.3 percent in the final quarter of 2017.

Job growth, which rose by 261,000 in October, averaged 169,000 per month through the first ten months of 2017 (down 12.2 percent from the same period of 2016), and would likely have been higher without the negative impacts from a particularly harsh hurricane season.  Had job growth stayed on track with the average through August, job growth through October would have been closer to 185,000 jobs per month.  Moreover, October’s official unemployment rate of 4.1 percent is the lowest reported since December 2000.

Not surprisingly, consumer confidence from both The Conference Board and the University of Michigan surveys has risen to the highest levels since the early 2000s, boosted in large part by the strengthening job market.  In turn, wages have come under increasing pressure, with average hourly earnings up 2.2 percent for the 12 months ending in October.

Still, because the Federal Reserve-preferred PCE price index rose by just 1.6 percent per year through September, it’s not clear just how many interest rate increases we’ll see in 2018.  Complicating matters further are higher inflation indicators from both the Producer Price Index and Consumer Price Index, which rose by 2.6 and 2.2 percent per year through September, respectively.

Certainly one area in which we’ve seen higher inflation is in the cost for building a new single-family home, which as of September 2017 was up by 5.2 percent year-on-year and 29.2 percent over the previous five years.  Combine that increase with tight supply in most markets, and the result has been a decline in home affordability.

As of 3Q 2017, the NAHB/Wells Fargo Housing Opportunity Index fell to 58.3 percent, for the lowest rate since the same quarter of 2008, and down sharply from the last peak of 77.5 in 1Q 2012.  Since 3Q 2008, median national home prices tracked by the same report rose by 26 percent.

Single-family new home sales, which dipped in July and August, rebounded by nearly 19 percent in September to 667,000 per year, and were up 17 percent year-over-year.  So far in 2017, new home sales have averaged 609,000 per month, up nine percent from the same period of 2016.    At current sales rates, existing inventory would take 5.0 months to sell, down slightly from 5.1 a year ago.

For existing homes, lack of inventory at the lower end of the market and rising prices have recently stunted sales, with September’s pace down 1.5 percent from a year ago and the share of first-time buyers declining to 29 percent from 34 percent.

Although September’s inventory did rise slightly to 1.90 million homes – or a timeline of 4.2 months at current sales rates -- it has fallen year-over-year for 28 consecutive months. While pending home sales in September were flat from August, they were still down 3.5 percent from a year ago, and have fallen on an annual basis in five of the past six months.

Thankfully, there does seem to relief on the horizon.  Looking ahead to 2018, FreddieMac is predicting home builders to take up much of this slack in overall housing inventory.  Annualized housing starts, which averaged 1.19 million for the first nine months of 2017, are forecast to rise by another nine percent to 1.33 million in 2018, with total single-family home sales rising by about two percent to 6.30 million units even as mortgage rates trend slowly upward.

As for potential consequences of tax reform on the housing market, given the high level of push-back from multiple interest groups, and with the Senate and House versions still far apart as of mid-November, that analysis must wait for another day.

June Small Business Optimism Index fell 0.9 points, little euphoria for rest of 2017

The Index of Small Business Optimism fell 0.9 points to 103.6, but sustained the surge in optimism that started the day after the election. The Index peaked at 105.9 in January and has dropped 2.3 points to date, no doubt in part due to the mess in Washington, D.C.

Progress is being made, but poorly communicated, and the biggest issues, healthcare and tax reform remain stuck in the bowels of Washington politics. Economic growth in the first half of this year will be about the same as we have experienced for the past three or four years, no real progress. There isn’t much euphoria in the outlook for the second half of the year.

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