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).

Figure 1 is a line graph showing owners’ equity in real estate superimposed with the price of gas, over the time period 1990 through 2016. Near the end of 2015, the owners’ equity is about $12.5 trillion, approaching its last peak of $13.5 trillion in 2005. At this time, the price of gas falls to about 180 cents a gallon, its lowest level since 2008. This area of the graph of is labeled “Feeling Rich?” with a question mark. In the decade before the financial crisis, the graph shows a period of “Feeling Rich!,” with an exclamation point, of when home equity wealth was skyrocketing and gasoline prices were increasing but still not too high.

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.

Figure 2 is a bar chart and line graph showing the annual sales volume and percentage of sales of foreign homebuyers for 2009 through 2015. In 2015, the dollar volume reached more than $100 billion, shown on the far right-hand side of the graph. This is more than double its volume of about $40 billion 2009. A line shows the percentage of foreign of sales reaching 8% in 2015, up from about 5% in 2009.

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).

Figure 3 uses two-line graphs to compare home prices in Miami and the United States as a whole, over the period 2001 through March 2016. On the left, a graph shows the top quintile for Miami declining roughly to 210 down from 230 in 2015, but the median was still on the rise, reaching about 150, up from a low of about 100 in 2011. A graph on the right shows that the top quintile for U.S. homes was still on the rise in 2015, almost vertical and reaching 240, up from its most recent trough of about 180 in 2010. The median price in the United States approached 120 in 2015, up from a low of about 90 in 2011.

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.

Figure 4 is a line graph showing household completions and formations over the time period 1968 through 2015. In the last year on the graph, household formations spiked to 1.8 million units before pulling back a bit, but still greatly outpaced housing completions, which were around 700,000. The two metrics roughly track each other over time, but for most of the 1980s, 1990s, and 2000s, housing completions outpaced household formations. The roughly 700,000 formations in 2015 were still below the lowest troughs pre-financial crisis.

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.

The Author

Daniel H. Hyman

Head of Agency MBS Portfolio Management

Emmanuel S. Sharef

Portfolio Manager, Asset Allocation and Residential Real Estate

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Disclosures

All investments contain risk and may lose value. The value of real estate and portfolios that invest in real estate may fluctuate due to: losses from casualty or condemnation, changes in local and general economic conditions, supply and demand, interest rates, property tax rates, regulatory limitations on rents, zoning laws, and operating expenses. REITs are subject to risk, such as poor performance by the manager, adverse changes to tax laws or failure to qualify for tax-free pass-through of income. Mortgage- and asset-backed securities may be sensitive to changes in interest rates, subject to early repayment risk, and while generally supported by a government, government-agency or private guarantor, there is no assurance that the guarantor will meet its obligations. Investors should consult their investment professional prior to making an investment decision.

This material contains the opinions of the author but not necessarily those of PIMCO and such opinions are subject to change without notice. This material has been distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission. PIMCO is a trademark of Allianz Asset Management of America L.P. in the United States and throughout the world. ©2016, PIMCO.

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