As 2020 ends, the star of the construction industry is clearly the housing market. New starts are up and home prices have soared over 15% year-over-year. The hot market has started to raise fears of an overheated market, but there is no evidence of anything like a bubble forming. In fact, the basic economics suggest that the hot streak will continue.
Price appreciation is being driven by a home inventory that has been steadily shrinking for five years or more. Too few empty nesters are selling their homes and new construction has been (and is) constrained by limited availability of land and lots. Demand for homes has been increasing as the Millennials buy homes at a brisker pace. And COVID-19 accelerated all these trends by the increase in work-from-home and the time spent sheltering at home since March 2020. Other factors, like home sizes increasing again and a surge in remodeling, have also pushed up prices. What hasn’t pushed prices is a surge in speculation such as we saw from 2003 to 2006.
Wells Fargo Economics Group pushed out a great commentary on the housing market yesterday. While it looks forward to the market in 2021, the commentary also contrasts today’s conditions with those of 2007, when the bubble burst and left millions of people in economic ruin. One of the points Wells Fargo highlights is the difference in lending environment between the two periods:
“Perhaps the greatest difference with what was seen in the bubble years is the greater discipline on the part of lenders. Mortgage underwriting tightened at the onset of the pandemic and remains fairly tight today. The average FICO score for conventional mortgages originated for the purchase
of a home was 758 in November, according to Ellie Mae.”
As context, the average FICO score in 2006 was around 630, although the median score was above 700. In 2006, it was also commonplace to find lenders that didn’t require income documentation and that lent 110% of the value of the home. There was no real credit justification for those kinds of practices but the robust annual price appreciation was a rationalization that all but the most disciplined accepted. Today’s appreciation levels are nearly equal to those of the bubble years, but the driver is real demand squeezing supply. Prices may level off or back up in the next few years. Father Time is undefeated and Baby Boomers will sell their family homes at some point. That should lead to an increase in supply that will soften prices. That trend may also unfold slowly, meaning that increased demand will keep up with the inventory growth. But, as long as lenders underwrite loans with the intention of being repaid, the supply and demand dynamics aren’t going to bubble over.
That’s great news for an economy finding its footing for recovery. We saw how a damaged housing market can drag recovery down from 2009-2014. Assuming the vaccination proceeds as expected, we’ll see a housing market that leads recovery in 2021.