Home Sweet Home: 5 Trends Worth Watching in the US Housing Market

11.29.2017 - Carin L. Pai, CFA

The US housing market has been gaining momentum on a number of fronts; with home values rising, strong demand for starter homes and 30-year mortgage rates still near historic lows. But rising rates and tax reform could generate headwinds.

Although we do not invest directly in real estate, we always track these types of developments carefully as we research investment opportunities in home-improvement retailers, specific REITs and other businesses associated with the housing and real estate markets. Here is a quick look at some of the trends we are monitoring.

1. Millennials Are Moving Out

One of the most encouraging developments in 2017 was a decline in the number of young adults 18 to 34 years old who are living at home with their parents. The formation of new households, which is a key indicator of the housing market’s potential for growth, has been accelerating at a modest pace since 2010. Homeownership, which was in steady decline from 2006 to early 2017, has improved in each of the past three quarters.

2. Strong Demand for Entry-Level Homes...

The bad news for younger home buyers (and good news for some home sellers) is that price appreciation has been steepest for single-family houses at the lower end of the price range. Inventories are tight and the most affordable homes are selling quickly, spending an average of just three weeks on the market. These quick turnaround times indicate a strong pent-up demand from millennials who are eager to take advantage of relatively low interest rates and market prices.

3. ...But Tax Reform Could Hit High-End Homebuyers

On the other end of the price spectrum, buyers looking for higher-priced homes could be negatively affected by tax reform. House Republicans have proposed limiting tax deductions to interest on mortgages of less than $500,000, roughly half the current level of $1 million, which could discourage borrowers in high-end markets like New York and California. The GOP’s tax reform plan also calls for the total elimination of tax deductions for interest on home-improvement loans, which are most popular among homeowners in the upper tier of the price range.

4. Rising Home Values Drive Consumer Spending

One of the byproducts of rising home values in the US is that consumers tend to become more confident, make large purchases and take on debt. In general, consumer balance sheets are healthy, but we are watching several developments carefully: Total household debt increased for the twelfth consecutive quarter in June and was $164 billion higher than it was during its previous peak of $12.7 trillion in the third quarter of 2008. But the bulk of this increase is in the form of auto and student loans, not mortgages. We have also seen a recent uptick in consumer credit card delinquencies, but mortgage lending standards have recently begun to loosen up, making it a bit easier for prospective home buyers to qualify.

5. Good News for Home-Improvement Retailers

With all of these factors in mind, we believe certain parts of the US housing market still have room for expansion in 2018. Home-improvement retailers should benefit from a pickup in home renovations and remodeling, more spending on big-ticket items and the acceleration of millennial household formation. We expect the Fed to take a cautious approach to rate hikes, gradually ratcheting rates back to normal over an extended period, giving the mortgage and home-loan market more room to run. There is usually a significant delay between the time rates rise and any negative effects rising rates might have on home-improvement spending. And, negative effects could be tempered by a strong job market and stable economy.

Home improvement is also one of the few brick-and-mortar categories that has not been severely eroded by e-commerce. For now, even an online powerhouse like Amazon cannot match the in-store shopping experience the big home-improvement centers offer consumers. However, we are maintaining an underweight allocation to the broader consumer discretionary sector, where traditional retailers and apparel manufacturers face the biggest threat from online competitors. The consumer discretionary sector tends to perform best when the US economy is in the early stages of an expansion cycle, which is not the case today.

We also see more risk than reward potential among homebuilders, which tend be sensitive to the ups and downs of the housing cycle. Their stock prices are also influenced by headlines, which makes them too volatile for us to feel comfortable owning in our core portfolios. In private real estate, which is extremely localized, specialized fund managers can offer expertise in a particular project or geographic market.

Within REITs, Wireless Communications

As a side note, we are also underweight the real estate sector, which consists mainly of large commercial and industrial developers rather than residential homebuilders and suppliers. There is wide dispersion across this category, such as REITs focused on shopping centers, which are underperforming, and industrial REITs, which are providing much stronger gains.

Style-specific index funds coming in and out of favor in the REIT world also influence valuations and returns across the category. In early 2017, these funds held nearly 25% of all outstanding REIT shares.

On a more positive note, we are finding the most attractive growth opportunities among REITs that own and operate sites for multitenant communications facilities—wireless communication towers that meet the growing demand for broadband service and remote access to streaming data. We also look to REITs for their above-average current income potential, dividend growth and diversification qualities. REITs typically have a low performance correlation with other equity market sectors.

This analysis is provided for illustration and discussion purposes only and does not guarantee future results. Please speak to your Fiduciary Trust contact if you have questions or would like more information. This communication is intended solely to provide general information. The information and opinions stated are as of November 30, 2017, and may change without notice. The information and opinions do not represent a complete analysis of every material fact. Statements of fact have been obtained from sources deemed reliable, but no representation is made as to their completeness or accuracy. The opinions expressed are not intended as individual investment, tax or estate planning advice or as a recommendation of any particular security, strategy or investment product. Please consult your personal advisor to determine whether this information may be appropriate for you. This information is provided solely for insight into our general management philosophy and process. Historical performance does not guarantee future results and results may differ over future time periods.

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