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Existing Home Improvement: U.S. Home Sales To Continue to Move Higher in 2020

Sri Thanabalasingam, Economist | 416-413-3117

January 22, 2020

Highlights ? Following a disappointing 2018, the U.S. existing home market picked up in 2019. Home sales saw a V-shaped recovery

as affordability increased due to lower mortgage rates and accelerating income.

? Home sales could have been even higher if not for constrained housing supply. Issues such as scarring to the homebuild-

ing industry following the housing crash in 2008 and labor shortages limited the pace of housing construction.

? In the year ahead, we expect existing home sales to continue to improve, but at a more subdued pace. While low mort-

gage rates provide a lift, deteriorating affordability is likely to mean a slower increase in housing sales. Home price growth should also moderate in 2020.

The housing market was one of the bright spots in the American economy in the latter half of 2019. After a sluggish 2018, the outlook for 2020 is decidedly more upbeat.

Residential investment ended its six-quarter slide in the third quarter of 2019, shooting up by close to 5% (annualized). Sales activity heated up in both the existing and new home market, with existing home sales making up the lion's share of the gains. Indeed, the recovery in this market segment has been V-shaped (Chart 1).

There were plenty of reasons for the pickup in existing home sales. Affordability improved considerably as mortgage rates declined and income growth pulled ahead of home prices. These conditions drew in homebuyers, who were keen to seize on lower mortgage payments.

Looking ahead, the recovery in the housing market is set to continue in 2020. Low mortgage rates are expected to remain supportive, however, income growth is likely to slow, deteriorating affordability and weakening the pace of sales.

With the market remaining relatively tight, home price growth is likely to remain positive, but also ease through 2020 and 2021, reflecting gradually slowing home sales.

Rising Affordability Boosts Home Sales in 2019

Following a disappointing 2018, the housing market turned the corner in 2019. A rebound in the resale market drove the recovery. After declining 4% from the fourth quarter of 2017 to the end of 2018, existing home sales rose by 6% in 2019. This contributed to a pickup in overall residential investment, which rose for the first time in six quarters in the third quarter of 2019.

Chart 1: Existing Hom e Sales Heating Up

Existing Home Sales, Y ear/Y ear % Change 10

8

6

4

2

0

-2

-4

-6

-8

-10 Mar-15

Dec-15

Sep-16

Jun-17

Mar-18

Dec-18

Sep-19

Source: National Association of Realtors, TD Economics



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Chart 2: Mortgage Rates Are Reflecting Longer Term Bond Yields

Rates, Percentage (%) 5.0

Treasury Yield ,% 3.6

30-year Mortgage Rate (LHS)

4.6

30-Year Treasury Yield (RHS)

3.2

4.2 2.8

3.8

2.4 3.4

3.0

2.0

2015

2016

2017

2018

2019

Source: Federal Reserve Board, TD Economics

Behind the housing market recovery are two main factors: one, mortgage rates fell sharply in 2019, making homes more affordable for Americans, especially those previously priced out of the market. And two, income growth rose at a faster pace than that of home prices in 2018 and in the first half of 2019, enabling more segments of the population to become homeowners.

The first, and most important reason for the housing market recovery is the drop in mortgage rates. Mortgage rates have been on a roller-coaster ride over the last two years. In 2018, the 30-year fixed mortgage rate rose by 70 basis points (bps), but in 2019, it declined by close to 100 bps. These swings reflect movements in longer-term government bond yields, which tumbled in 2019 (Chart 2). Last year, investors rushed into the safety of U.S. bonds as the China-U.S. trade war escalated, global growth slowed, business investment faltered, and the Federal Reserve reversed course and cut interest rates. This led to a sustained drop in longer-term yields.

The anxiety in other segments of the economy turned out to be a boon for the housing market. The 100 basis point decline in the 30-year mortgage rate, from 4.8% to 3.8%, implied a $125 reduction in the monthly mortgage payment on a 30-year loan for a home priced at the national average ($260,000). Keen to seize on lower mortgage payments, more buyers took the plunge, leading to a steady rise in home sales. According to our estimates, almost 50% of the increase in sales in 2019 can be attributed to lower mortgage rates.1

Prospective homebuyers were not only enticed by lower mortgage payments, they also saw improving economic conditions, enabling them to enter the housing market with greater confidence. Indeed, the U.S. labor market has been healthy over the last few years: the unemployment rate has fallen to a fifty-year low and more people have been drawn into the labor force. The increase in employment alongside steady wage growth (see report) led to an acceleration in disposable income growth, which reversed a trend, and rose faster than home prices through 2018 (Chart 3).

These developments set the stage for the recovery. Rising affordability helped unleash more pent-up demand, particularly in younger Americans. As we had investigated in an earlier report, there is a large and growing share of young people who have delayed forming their own households since the 2008 housing market crash due to unaffordability. Rising employment, faster income growth and lower mortgage payments, have all combined to boost homeownership among this important demographic. Through the first three quarters of 2019, the homeownership rate rose by nearly a full percentage point for the under-35 age cohort, the biggest increase of all age groups.

Given the demand, home sales could have been higher in 2019 if not for limited housing supply. Holding all else equal, if the number of home listings caught back up to its level in 2005, there could have been an additional 200,000 units sold last year.

Low housing supply has been a theme challenging the U.S. housing market for several years now. Housing construction plummeted during the housing bust and the following re-

Chart 3: Incom es Rose Faster than Hom e Prices in 2018

8 Y ear/Y ear % Change

7

6

5

4

3

2

1

0 2015

Median Sales Price Disposable Personal Income

2016

2017

2018

Source: BEA, National Association of Realtors, TD Economics

2019



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covery has only been modest. In fact, housing completions, which has typically been higher than new household formations, has lagged behind in the post-crisis period (Chart 4).

It appears that the housing crash has had a scarring effect on homebuilding, resulting in real estate developers more cautiously constructing homes after the crisis.2 The sector has also seen a labor shortage in recent years due to an increasingly tight labor market, which has weakened the pace of homebuilding. Zoning regulations have probably had an effect too, putting a limit on the number the homes that can be built in urban areas.

Increases in the stock of housing should help spur activity in the resale market. Residents can only list their homes for sale, if they can move into another home. Currently, the number of homes for sales relative to the stock of housing is near an all-time low.The lack of inventory has in turn put upward pressure on prices and constrained sales growth.

Housing Market to Continue Recovery in 2020

Looking ahead, we expect existing home sales to continue to post gains in 2020, albeit at a slower pace than in 2019. Low mortgage rates will remain attractive for some prospective homebuyers, but with incomes rising less quickly than prices, homes in the resale market may be more unaffordable for others.

Over the next two years, low mortgage rates should continue to provide support to the housing market. After declining through most of 2019, the mortgage rate is expected to rise modestly in 2020 and 2021. Relative to 2019, we

Chart 4: Housing Com pletions Have Trailed Form ations since the Crisis

2.5 Million Units

2.0

1.5

1.0

New Household Formations

0.5

Housing Completions

0.0 1988

1992

1996

2000

2004

2008

Note: New household formations is a smoothed 3-year average. Source: Census Bureau, TD Economics

2012

2016

Sales Prices

Table 1: Existing Home Market Forecast

(4th Quarter/4th Quarter Growth)

2018

2019

2020F

-8%

6%

3%

4%

6%

5%

2021F 0% 4%

F: Forecast, Source: National Association of Realtors, TD Economics

anticipate further increases of 35 bps over the course of 2020, and 40 bps next year. Although the rate is higher, the level is still historically low and is favorable for the housing market. We expect the 30-year rate to be 50 bps lower than its peak in November 2018 at the end of 2021, implying $60/month in mortgage payment savings for an averagepriced home.

Still, a slower rise in income relative to home prices, will offset some of the positive impact of low mortgage rates. With the economy reaching full employment, the pace of job gains is likely to slow, leading to a moderation in income growth. Meanwhile, constraints on homebuilding will continue to limit housing supply, pushing up home prices.

All told, we expect sales growth over the course of 2020 (fourth quarter to fourth quarter) to slow from 6% in 2019 to 3% in 2020, before flattening out in 2021 as affordability becomes more of an issue (Table 1). By the end of 2021, our forecast implies a level of sales consistent with the long-run average of the sales to household ratio, indicating that the resale market is roughly in balance. In the case supply constraints ease, it is entirely possible we could see stronger sales growth in the years ahead.

From a price standpoint, our forecast pencils in existing home price growth in 2020 and 2021 at 5% and 4%, respectively. While supply constraints put upward pressure on home prices, the feedback effect of weaker sales growth, should lead to a moderation in price growth over the next two years relative to 2019.

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Endnotes

1. To estimate past impacts and to produce housing sales and price forecasts, we construct a housing model that accounts for the endogenous interactions between sales, listings, and prices in the resale market.

2. The State of the Nation's Housing 2019 ( )

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