When it comes to the U.S. recovery, there are two questions of the utmost importance to Canada. The first is: When will Americans buy more of our stuff? This matters greatly because we’re running out of room to pump domestic growth without relying on foreign consumers—and our main customer by far is still Uncle Sam. The answer, according to the latest report by the Bank of Canada, is: “Soon but not quite as soon as we thought.” The second big question is: Will Americans buy more houses? This is relevant because we sell them some building material, such as softwood lumber, because construction jobs can put a sizable amount of people to work—who, in turn, will have money to spend—and because rising house prices tend to make people feel wealthier and in the mood for some shopping.
So, as America picks itself up after the latest fiscal shenanigans, is the U.S. housing market going to accelerate again? Residential real estate had taken on a healthy pace in late 2012 and early 2013 but has slowed since the Federal Reserve started talking about reducing its monthly bond purchase, which helps keep long-term interest rates low. Mortgage rates, which track the movements of long-term Treasury yields, rose by about a percentage point during the summer. They’ve since come down a bit, but the earlier spike has had a palpable impact. Existing home sales dipped 1.9% in September from the previous month, and residential construction has slowed as well.
I won’t attempt to predict where the market will go from here, which even economists have a hard time doing, but I can point to three reasons for optimism.
1. Interest rates: The bad news is that rates have nowhere to go but up. The Fed has put off plans to taper its bond-buying for now, but will likely do so in early 2014. The good news is that rates are unlikely to rise as steeply and as fast as they did last summer. Investors have had a long time to digest the taper news: Their reaction to the Fed actually shrinking the size of its bond purchases is likely to be smaller than their reaction in anticipation of such a move.
2. Affordability: Rates are up, and so are prices, but both had fallen to such lows in the recession that, overall, houses are still cheap by historical standards. The rule-of-thumb is that people can afford to buy a house when the sum of their principal and interest mortgage payments, plus taxes and insurances does not exceed 30% of their gross income. In June, TD economist Beata Caranci estimated U.S. housing affordability at 16.3%. “In the absence of other changes to our economic outlook, mortgage rates would have to cross the 7% threshold just to erode affordability back to its long-term average [of 23%],” she wrote. Right now, the average rate on new 30-year fixed-rate mortgages is hovering around 4.2%, so there’s plenty of upward room.
Slower price growth could also offset the impact of rising interest rates and slow the erosion in affordability. The supply of housing is still relatively tight and there were anecdotal reports that some builders were holding off on new construction in order to drive up prices. With higher rates making American families more cautious, though, there could be an incentive to put more new houses on the market in order to keep prices in check and lure reluctant buyers.
Of course, interest rates could also have the opposite effect on builders and discourage new construction for fear that more expensive mortgages will dampen demand.
Still, the overall point that U.S. housing can absorb sizable increases in prices and rates and still remain affordable holds.
3. The market for apartments and condos: So far, the main engine of the housing recovery has been the so-called multi-family sector, apartment complexes and condo buildings usually owned by investors and inhabited by renters. The great expectations among many U.S. residential real estate watchers is that, at some point, growth will turn away from condos and toward single-family housing, the traditional choice of America’s families, which accounts for a far larger share of the market. And the great worry is that young people, who traditionally provide the bulk of demand for single-family homes, are taking longer to leave their parents’ basement or bid goodbye to their roommates and buy a place of their own. The share of those between the ages of 25 and 34 who were employed in September was 75%—the same as September of last year and below levels seen before the housing bubble started inflating job numbers.
The positive twist in all this is that growth in the multi-family sector might last longer than people think. Low employment rates and stagnating incomes weigh on household formation, but will also direct some of those new households into the rental market. Thirty-five per cent of new households will rent rather than buy, according to TD. That should help tide the housing market over until the economy picks up some real momentum.