Doug Duncan serves as SVP and Chief Economist at Fannie Mae, where he is responsible for forecasts and analyses of the economy of the housing and mortgage markets. Duncan also oversees strategic research regarding the potential impact of external factors on the housing industry. He leads the House Price Forecast Working Group reporting to the Finance Committee.
Fannie Mae's Economic and Strategic Research (ESR) Group recently revised some earlier predictions for 2021, upgrading its overall economic growth expectations for full-year 2021 to 7.1%, one-tenth higher than its previous forecast.
MReport had a chance to sit down with Duncan and discuss these revised predictions and the impact they may have on the housing marketplace.
How do you think housing is going to factor into inflation for the foreseeable future? What is the driving force in housing that is going to drive that inflation?
Duncan: Housing data gets into the Consumer Price Index (CPI) and the Personal Consumption Expenditure (PCE) through rents, whether it's owner's equivalent rent or actual rents. Owner equivalent rent is what it would cost you to rent the house that you are currently living in as an owner, so that's an estimated number.
The information is acquired on rent rolls through the apartment business, and now I think they've added in some single-family rental (SFR) information as well. But in the rental community, typically in the United States, leases are one-year leases, and so any increase in rents is revealed only over time. House prices rose 10.4% in 2020, and they've already risen 10% in 2021, so it probably means they're going to rise maybe another 5% over the course of this year and 15% total.
When you do the owner's equivalent rent on those, that number is going to rise on a lagged basis. We actually see housing making a bigger contribution in 2022 due to inflation than it will in 2021. Housing is a significant component of the Core CPI and PCE, because it is one of the largest consumption categories for households. With those significant increases, and rents also on the rise, the rental market has performed better than expected.
So rent is also factoring into this upward drive as well?
Duncan: I was sitting a few days ago on a panel with five private investors that were in the apartment space, and they said as they were working their deals over the past year, they had assumed rent increases were going to be in the 2% to 3% range. But in fact, what has happened is they are seeing rent appreciation of closer to 6%. That will eventually make its way into inflation numbers. We would agree that most of the increases, at least today, are transitory.
If you think of the airlines, for example, airline prices and flight tickets are going up. Part of that is simply the recapitalization of the airlines. They are still 20% below what was the normal trend line for capacity, but they had really tough times, so they are raising ticket prices as demand is beginning to pick up. When they get back to normal levels, they'll stop contributing to the growth of inflation.
Are there any additional transitory factors pressuring inflation?
Duncan: The chip issue in trucks and cars is well-acknowledged, and when chip production ramps up, we would expect to see the prices of used cars actually come down. So those things, reasonable to recognize those as transitory, but there are these underlying trends, such as in housing, and also the costs associated with disruptions in the supply chain. Some of the challenges that the shipping industry has faced, backups at some of the ports, container cargo being completely sold out, are things that will probably contribute to an underlying growth in sustained inflation. Our forecast has that being above the Fed's target for at least a couple of years, in terms of the part that is not transitory.
Is there a real-world solution to the housing inventory dilemma on the horizon? Does a solution exist at all?
Duncan: Building is the solution to it … creating more units. Our estimates are that we're on an annual basis producing 200,000 to 250,000 too few units, given where our demographics are. It's useful to keep in mind how we got here, and the roots of this supply shortage are in the meltdown of 2007 to 2009. We went from approximately 2.2 million starts at the peak, to around 600,000 starts at the bottom, so essentially, we destroyed 75% of the supply chain for the construction of housing, whether single-family or apartments. And when we got to that 600,000 range, we stayed at a very low level for something like three years. All the people who were in the other three-quarters of that supply chain found other things to do. They didn't just sit by the phone saying, “I wonder when they're going to order more PVC pipe or more electrical conduits?”
During that same time period, the millennial population was graduating from school. They were starting to get jobs. They were starting on the path that would head them ultimately to homeownership. We were watching our monthly survey data on consumers, and at the end of 2012, we said that the turn has come.
The bottom was in the 2009 to 2010 time period when we saw the share of households that were underwater get back to very normal or very low levels, so now growth became the path for housing. Two more years later, we saw the emergence of the early parts of the millennials, and we saw the size of that population group, and we saw the very slow pace at which supply was growing, and we said, now the problem is going to be supply because demand growth is moving faster than supply growth.
So the supply/demand issue we currently face is not just a product of the past year?
Duncan: What we saw was, starting in 2014, house prices actually started appreciating faster than their long-term rate as far back as 2014. That's the first piece that you have to have in place. This has been going on for quite a while.
What really got people's attention was of course the pandemic. That sort of supercharged the supply problem in the following way.
There was the collapse in March 2020, as well as a dramatic decline in employment, and everyone, including all of those same input suppliers, had to ask, “What's going to happen to housing?” There was no historical precedent for the pace and magnitude of which jobs were lost. Even in the Great Depression, jobs were not lost as rapidly as when the pandemic hit last year. And so everybody sort of paused.
On the supply side, it wasn't just a pause because of uncertainty about what demand was going to do, but it was also a pause for the safety of their workers. They had to reconfigure how they were going to be producing things keeping the safety of their workers in mind.
In the meantime, it became apparent pretty quickly that the employment categories that suffered the most losses were those which were dependent on discretionary spending by middle- and upper-income households—hotels, restaurants, sporting events, concerts, airplanes—all that kind of stuff. That's discretionary spending on the part of the household. Those impacted were hourly wage workers, and they're not typically homeowners. The homeownership rate in that group is only about 40%. Those who were salaried, they probably also got some stimulus payments, but they kept their jobs or were supported by the PPP until such time as those jobs were again self-sustaining. What they saw was interest rates plummeting to 3%, and then 2.5% percent for a 30-year fixed rate mortgage. This became the buying opportunity of a lifetime.
We saw this spike in demand, partially driven by that economic calculus, but also with millennials having been living in the urban core now seeing both a spur by a disease that feeds off of close proximity and density to others, and that economic opportunity. They said, “Now is the time!” They may have been waiting another year-and-a-half or two years, but now's the time to make the move. It started this out-migration. We can measure that from some of the major metros like New York, San Francisco, Boston, Chicago, and Seattle, and have seen that in our application data.
So that supercharged the demand side of the equation, and the supply side was another three or four months behind, because of what they had to do in terms of adjusting for the safety of their workers, so it just made the problem worse.
Is there any end in sight to this skewed supply to demand dilemma?
Duncan: What you saw was that increased imbalance between supply and demand meant much higher house price appreciation, which continues even now. Recent data on existing-home sales found that there are two major things to consider.
It marked the fourth consecutive month in which the pace of sales has slowed. Looking deeper, there are two things going on there. One is the affordability challenge. It's not really on interest rates. On the interest rate side, if you had a three-year calendar, 2019 to 2021, and you ripped 2020 out of the middle of it, and you went from December 31, 2019 to January 1, 2021, the interest rate would be exactly the same. It was just that 2020 was so exceptionally low that we had just never had seen anything like that.
COVID pulled some people forward in time and that the housing numbers were stronger because people were actually making the decision to buy earlier than they would have been expected to under normal circumstances. The fact that there is some slowdown in existing-home sales is not surprising to us. It's also still the case that the supply of existing homes available for sale is close to all-time lows. It's not at the low. There was a little bit of a pickup and inventory in this report, but that's really the dynamic that's underway.
The National Association of Home Builders said that the price of lumber tripled in the first quarter of the year. Where do you see stabilization in the price of materials? Inventory issues are also tied to a lack of skilled workers returning to the market to build houses. When do you see stabilization in that occurring?
Duncan: There are three pieces that a builder must balance in order to be profitable. They have to acquire developed land, so there's a price to that. They also need materials. You mentioned lumber, and there's a price to that. And finally, they need to find skilled labor, and there's a price to that.
If everybody is trying to expand, then you would expect that every survey of builders would say, what we're lacking in is skilled labor, because everybody's trying to expand at the same time and it takes time to build skill. That's exactly what the surveys show … a shortage of skilled labor. If everybody's trying to hire and expand, yes, there will always be a shortage, because it takes time to build and acquire that skill, but you cannot pay up for that unless the cost of the other two elements are falling, and they're not.
You made a point about lumber. I'm actually building a home myself, and in talking with my builder, he said, "Let me give you an example." He said, "It's nice working with an economist, because they actually know how markets work. Let me give you, for example, for a 2,000-square-foot standard house in January of 2020, the lumber cost alone for that house was $5,000. In March of 2021, the lumber cost for that house was in the $17,000 range. So 15 months later, it was $12,000 higher than it had been." That example alone gives you a sense of where the lumber market is.
If you're looking at lumber futures, they're actually down. What that means is the market expects that the lumber producers are ramping up production in response to that dramatic price hike, and you're going to see supply come on, and the lumber cost is going to decline. And that is true, but it's not only lumber, it's other things such as glass, appliances, etc. I asked my builder, and I'm just giving you this as an anecdote, but I've talked with others across the industry, and it's broadly true. The stove I like is a GE Monogram, so I had one in the house that I sold. He said, "We'll have to order that now, because it'll be a year before that gets here." The more complex the appliance, the longer the delay, because it probably involves chips, just like the trucks and cars involve chips.
If material costs are rising, then land costs would have to decline in order for them to pay up and have some sort of a breakout. And that's not true either as land prices have risen substantially as well. So they're pressed on all three points to maintain profitability, and they're growing as fast as they can, but the demographics of demand are growing faster.
Do you feel U.S. homeowners may need additional extensions in terms of forbearances and foreclosure moratoria to return to normalcy?
Duncan: It's an important question, and there are a few things to consider. First of all, about half or maybe even more than half of the people who initially took a forbearance have already closed that forbearance out. We actually surveyed people, and a lot of them took a forbearance just as a precaution. It was very simple to get access to, and they kept paying, but they had it as a reserve. And then when they saw that things were stabilizing, they simply extinguished the obligation. That gives you a clue to how some of this might work. There is still a smaller group of people who either had it as a precaution or have seen their income recover, brought the loan current, and have extinguished the forbearance.
There s is a second group whose income has partially recovered, but not fully. We at Fannie Mae, Freddie Mac, and others, will work with those households and restructure the loan to meet their ability to pay. If they are able to pay at a level that a restructured loan makes economic sense for both them and the holder of the mortgage, a significant share of homeowners will get a restructured loan. Then most all the homes across the country have some equity in them, so as long as the amount of equity in them is greater than the transaction costs and the payments of the mortgage and any arrearages, it's in the interest of the household to do a pre-foreclosure sale, extinguish the obligation, and walk away with some equity to reposition themselves. There'll be a significant share of distressed borrowers who will take that route.
Finally, there are some who don't have equity, or at least not the equity sufficient enough to pay off the entire obligation, and their income hasn't recovered. In this scenario, they would go through the foreclosure process. But we do not believe there will be, in the words of some of the reports we've seen, a tsunami of foreclosures out there. We don't see evidence of that, but we think that one of those other three solutions is more likely in most instances.