A version of this article originally appeared on institutionalinvestor.com on 17 April 2016.
Although many observers, including PIMCO, have reduced their forecasts for global growth, we remain optimistic on U.S. housing as one asset class that stands to benefit from low interest rates and the steep decline in energy prices. In fact, even in this volatile environment we expect home prices to continue growing at around 3%–4% per year.
The recent bursts in market volatility arose from fears around China’s policies and falling oil prices, but both of these factors are supportive for U.S. housing. Uncertainty in global markets has caused the Federal Reserve to slow its anticipated pace of rate increases and has precipitated further easing in Europe and Japan, driving rates on $10 trillion in government bonds negative. Foreign capital has flowed into the comparatively attractive positive-yielding U.S. market and kept interest rates low. This is positive for U.S. housing: Low mortgage rates combined with employment and income growth are strengthening consumer balance sheets, improving housing affordability and boosting home prices. Gasoline prices are down nearly 50% over two years, and although certain markets in oil-producing regions are negatively affected, homeowners overall will keep more money in their pockets (see Figure 1).
There have been some concerns that slower global growth, notably in China and Brazil, and a stronger U.S. dollar could weaken the housing market by reducing demand from foreign buyers who have been active (at least anecdotally) in recent years in regional markets such as New York, Miami and even our local Irvine. But nationally, foreign buyers account for only approximately 8% of transaction volume and 4% of sales according to the National Association of Realtors (see Figure 2), and these data include residents on visas or green cards whose decision to buy a home is independent of the economy in China. Non-resident foreigners, who would more likely be purchasing real estate as an investment, represent only half of foreign transaction volume.
At PIMCO we continue to carefully monitor the data in the markets most likely to be affected by reduced foreign buyer demand. Our analytics show some weakness at the higher end of the New York and Miami markets, but the middle and lower tiers, which support many housing-related investments, continue to perform well enough that aggregate statistics of home price growth are unaffected (see Figure 3).
The strongest case for continued appreciation comes down to simple supply and demand. Comparing expected demographics and anticipated household formations to the number of homes being built suggests that we could even face a housing shortage in the near future. Household formations are difficult to measure and forecast, but recent trends suggest about 1.2 million new households are being created each year. This is expected to rise to 1.5 million annual formations over the next decade. However, only around 1 million housing units are being completed per year, while about 250,000 homes are being demolished, leaving a net of 750,000 new homes annually (see Figure 4). During the first few years after the financial crisis, the excess supply from overbuilding and delinquency provided a buffer while household formations lagged, but that excess has now turned into a deficit. Longer-term demographic demand trends are very strong, and even indebted millennials need a place to live. You can’t build a house overnight to meet demand.
The ongoing recovery in housing has important implications for housing-related investment opportunities. PIMCO continues to monitor the impact of these market changes on the performance of collateral underlying legacy non-agency mortgages, while analyzing the effect of negative net issuance in the face of steady investor demand. In the current environment many borrowers are credit-constrained and underserved, but potential improvements in their fundamental financial health also have important repercussions for investments in whole loans or public mortgage real estate investment trusts (REITs). All of these have come under pressure and now trade at deep discounts to their book values; depending on how consumers respond to the current environment, there are exciting opportunities to purchase diverse portfolios of assets at a discount that offer attractive yield potential for investors.
Overall, we believe U.S. housing remains on a firm footing. While we do not expect home prices to appreciate at the same pace as immediately post-crisis, we believe the price growth trajectory will remain positive and stabilize around 1% above the overall rate of core inflation. In times of global economic turbulence, there’s no place like housing.