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The Factors Impacting Housing Trends

Editor’s Note: This feature originally appeared in the July issue of DS News.

This month, DS News sat down with Dr. Lynn Fisher to discuss the housing trends impacting the market. Fisher focuses her research on examining affordable housing, home building, and mortgages. Before joining American Enterprise Institute (AEI) in April, Fisher was VP of Research and Economics and the Executive Director of the Research Institute for Housing America at the MBA, and on the faculty of Washington State University, the Massachusetts Institute of Technology (MIT), and the University of North Carolina. At MIT, she was director of the Housing Affordability Initiative in the Center for Real Estate. She has been published in several academic journals, including the American Economic Journal: Economic Policy, The Journal of Urban Economics, Real Estate Economics, and The Journal of Real Estate Finance and Economics. Fisher has three degrees from Pennsylvania State University: a doctorate in business administration with a concentration in real estate finance, a master’s in business administration, and a bachelor’s in international politics.

Congratulations on your new role at AEI. One market indicator that AEI is known for is the National Mortgage Risk Index (NMRI)—can you share with our readers what the NMRI calculates and what it is currently forecasting for the market?

NMRI calculates the average expected stressed default rate for newly originated agency loans based on debt-to-income ratios (DTIs), combined loan-to-value (LTV) ratio, borrower credit score, loan term, and purpose.

The stressed default rate reflects the performance of loans originated in 2007 with the same characteristics. This measure shows that credit has been expanding over the past five years. Federal Housing Administration (FHA)-insured loans in particular—which are largely provided to first-time homebuyers and involve considerable risk layering—have increased in risk by 6 percentage points over this time in terms of averaged stressed default rate. The NMRI shows that if we have another stress event, like the one from 2007, more than 27 percent of FHA-insured loans would be expected to default.

The riskiness of loans securitized by Fannie Mae has also risen notably in the months following the decision in mid-2017 to allow DTIs over 45 percent without compensating factors. We have seen a recent 1 percentage point jump in Fannie’s NMRI driven by the fact that their share of newly originated loans with DTIs over 45 rose to more than 19 percent in January, up from just 6 percent of loans in September 2017. In mid-March, Fannie adjusted course and implemented an update to Desktop Underwriter to reduce risk layering. In the coming months, we will be able to track how effective the policy adjustment was in moderating risk.

Because inventories for sale are so low, any increase in the provision of leverage by the market—even if loans appear to be well-underwritten—serves to push home prices even higher, worsening the affordability problem.

Are there actions the industry can take to alleviate the inventory constraint?

Regarding low inventories of homes for sale, there is no easy fix, since potential home sellers are typically also prospective home buyers. If, as prospective buyers, households don’t believe that they can buy what they want for a reasonable price, they won’t put their home on the market in the first place, choking inventory. It will take time to add enough new homes to sufficiently expand the sales inventory and break out of this cycle.

As a result, our data shows that total home sales are decelerating at the national level. The combination of new and existing home sales increased by 9 percent in 2015 and 10 percent in 2016 before slowing to a pace of just 5 percent growth in 2017. According to the National Association of Realtors, the inventory of existing homes for sale has fallen to historic lows, and many forecasters expect growth in existing home sales to slow even further this year, perhaps remaining about flat relative to 2017 due to a lack of inventory. This means that purchase volumes will remain fairly flat for lenders but for the bump in volume they will see from rising home prices.

How do these trends compare to what we have seen historically?

Historically, credit policy tends to lean into house price booms, expanding credit and exacerbating price increases on the upstroke. This time is no different and credit policy is allowing prices to grow faster than incomes. The pricing correction, when it comes, could be large, and borrowers with high DTIs and high loan-to-value ratio mortgages will have less ability to withstand even a mild recession. Tax reform and increases in government spending have recently juiced the economy past sustainable levels, increasing the likelihood of a recession in about two years’ time. Mortgage professionals need to remain vigilant that they are not relying solely on continued house price growth as the basis of their expectations about future loan performance.

What can we expect to see in the housing market as we move into the latter half of 2018?

If the credit box continues to expand as it did in 2017, then there is no doubt that home prices will continue to climb for the rest of 2018. Real wage growth is also expected to add demand to the housing market by the end of the year. In combination, these trends will keep the pressure on prices without providing much relief in terms of affordability. Only expanding our housing stock will provide more affordable housing. However, the accumulation of local government restrictions on building will continue to impede the creative expansion of our housing supply, even in the presence of record-high prices.

How can lenders provide products to their borrowers to help insulate them from market fluctuations?

Lenders should seek to make their borrowers resilient and able to adapt to a changing economy and housing market. Faster amortizing mortgages—for example, a 20-year versus a 30-year loan— help households build equity faster and increase the possibility that borrowers can ride out a downturn in prices. At the same time, no individual or lender can hold back the rising tide of credit availability and the pressure that competition puts on your business. As an industry, lenders need to be speaking out and ask that government agencies hold the line on credit policy. It can be done. The Rural Housing Services, for example, has an NMRI score that is about flat over the last five years.

Ultimately, our housing supply is created locally. Lenders should also be part of their local process for regulating and planning for housing. They should educate local officials and help them find ways to expand supply. Although surprising to some, we don’t need subsidies to build “affordable” housing. We simply need to allow market actors, by right, to build economical housing in much greater quantities than we currently permit. Even incremental density increases—up-zoning from single family to duplexes or four-unit to eight-unit buildings—can make a big difference for the ability of a community to accommodate households at a wide range of prices and rents.

 

About Author: Kristina Brewer

Kristina Brewer is a graduate of the University of North Texas (UNT), where she received her Bachelor of Arts in English with a concentration in rhetoric and writing and a minor in global marketing. During this time, she served as Director of Philanthropy in the national women’s fraternity Zeta Tau Alpha, of which she is an alumna. Her passion for philanthropy continued after university when she was an intern at Keep Denton Beautiful, a local partner of Keep America Beautiful, where she drove membership, organized events, and led social media campaigns. Brewer honed her writing at the North Texas Daily, UNT’s student-run newspaper where she wrote about faculty, mentorship, and student life. Brewer also previously worked at Optimus Business Plans where she helped start-ups create funding proposals, risk assessments, and management plans. You can reach her at StaffWriter@DSNews.com.
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