Tendayi Kapfidze is Chief Economist at LendingTree, where he oversees the company’s analysis of the U.S. economy with a focus on housing and mortgage market trends. In his most recent previous role, he served as Director of Global Economics at Pfizer in New York City. He was responsible for developing Pfizer’s view on global macroeconomic trends and advising the leadership team on economic and financial risks. Prior to Pfizer, Kapfidze also previously served as Director of Economic and Capital Markets Research at Ally Financial and VP and Senior Economic Analyst at Bank of America.
What are the new market trends you have forecasted for 2018? The impact of the recently passed tax plan will be a major wild card going into the new year. The items that were passed— changes to the mortgage interest and property tax deductions—are estimated to save the government $670 billion from 2018 to 2027 by the Joint Committee on Taxation. Fundamental financial-asset analysis would suggest that the present value is included in today’s home values, which total about $30 trillion. Although the final plan is not as transformational as the initial proposals, it will still have an impact. Combined with the increase in the standard deduction, it meaningfully lowers the tax incentives for homeownership and nudges that eternal question “should I rent or buy?” more towards renting. There are many divergent views on what this means for housing, which illustrates the degree of uncertainty. Two interesting examples follow.
The American Enterprise Institute’s (AEI) Ed Pinto and Alex Brill are quite sanguine about the impacts, and posit that the housing market will be fine, even healthier. Pinto argues the housing market will add supply as builders focus on lower-priced homes when demand for high-priced homes falls. Brill points out that the mortgage deduction is not used by most borrowers and thus, the impact on home values will be minimal.
The AEI researchers both have reasonable expectations of the long-term impacts of housing-related tax changes. The question is how do we get from here to there? Danial Alpert at Westwood Capital is concerned about this transition. He draws historical parallels to the tax reform of 1986, which arguably led to the savings and loan crisis. Alpert warns that the tax plan “will have deleterious effects on the disposable incomes of households in the regions of the country accounting for the bulk of mortgage and other debt that will make the cost of carrying real estate on an after-tax basis significantly greater.” He goes on to make the connection from lower real estate asset values to disruption in financial and capital markets, an occurrence that brings up recent memories for most of us.
Many correctly point out that a large proportion of homeowners are not affected by these changes, and it’s a nonevent for the average homeowner. However, change in economic activity is driven at the margins; averages are just for measurement. The $670 billion can materially impact valuations in a small proportion of the housing stock, but could have economic effects beyond that. The GOP’s targeted strike at the blue states may come with a side of contagion and servicers may be among the first to see if borrowers become strained.
What do these shifts predict for the future of the housing market? While I am concerned about the transition, ultimately reducing housing subsidies in their current form could be beneficial. The mortgage tax deduction is a regressive tax expenditure, as its value to the taxpayer increases with income. It’s also questionable whether it influences the homeownership level. So, while it would be better if it had not been implemented, caution is required in removing it.
The reform would have been better if the savings were directed to supporting homeownership at the lower end of the scale. A first-time homebuyer’s tax credit would be beneficial as research has shown that down payments are major obstacles to homeownership. Further, homeownership is an important pathway to increasing financial security, something we value greatly at LendingTree.
Recent research findings revealed that while home appreciation lags equity markets, having a home and mortgage essentially constitute a forced savings mechanism for many borrowers who simply would not have had the discipline to put away the money saved by renting on a monthly basis. We see the results in reverse mortgages where the borrowers often do not have significant capital market assets. These borrowers would not have had an asset to access for support in their retirement years without the ownership of their home.
How do you feel potential homebuyers will react to the potential market fluctuations in 2018? Buyer sentiment is quite high amid a strong labor market. However, inventory will remain a challenge. I believe we will see buyers continue to work hard to give themselves an edge in the marketplace by ensuring they have financing in place when they house hunt. We have a metric that tracks such activity and have found that more borrowers look for loans before looking for a house in cities that have the tightest inventory and the biggest price increases.
At what point would rising mortgage rates start to significantly dampen buyer demand? The Survey of Professional Forecasters, released quarterly by the Fed, includes expectations for 10-year treasury rates. These were too high for 14 of the past 17 years. I say this not to disparage the forecast, but as someone once said, “prediction is hard, especially about the future.” This year may be the year for higher rates, but certain factors mitigate the potential rate rise. Global rates matter—and they are still low. U.S. Treasury rates are not only influenced by the domestic economy but also by those in other developed markets. The U.S. recovery from the financial crisis has been stronger and faster than the other major developed markets, which are still working to keep rates low. Global investors view European and Japanese bonds as comparable safe haven assets to U.S. Treasurys; thus, their low interest rates influence U.S. Treasury rates, which influence mortgage rates. Rates are also quite low in historical terms, and even a 100-bps increase would leave them below the average rates of the housing bubble. That said should rates rise, it’s a pretty linear path to lower affordability and buying power.
Reflecting on 2017, what housing trends do you think were the most notable? Home prices finally recovered the losses from the financial crisis. However, the aggregate numbers mask the dispersion when you look at more granular measures. The gains are concentrated on the coasts in the larger cities. Much of the middle of the country has not regained equity. This is a divergence evident in many other economic indicators reflective of the general increase in inequality in the country.
Another change that I think went under the radar is the reduction in the ratio of mortgage interest payments to income. The Fed releases the financial obligations ratio. The mortgage debt service as a percent of disposable income fell to 4.44 percent in Q2, the lowest since 1980. So households are in good shape and are well placed to meet their mortgage obligations.
Housing inventory, or lack thereof, has been continuous in the housing market. What do you foresee in the next year for the inventory narrative? More of the same, perhaps with a slight improvement. The tax bill could further dampen the propensity to move at the high-end as the reduction in the mortgage interest-deduction limit would grandfather outstanding loans. Thus, moving would entail incurring a new tax expense for some borrowers at the top end. However, that is a sector well-served by the homebuilding industry. In the broader market, new inventory should increase but is a fraction of existing inventory and not growing fast enough. The tax bill could be beneficial here as it's likely improve builders’ margins. Wider margins could be particularly beneficial for inducing supply for lower-priced homes where potential buyers face the acutest supply constraints. Optimism amongst builders is at very high levels, all that remains is for the ‘hard data’ of actual activity to follow this ‘soft data.’
There is a significant obstacle to the convergence of builder activity with sentiment. Although construction employment is trending upwards, it appears productivity is far lower. Residential construction payrolls are at the same level as 2002, yet we have 500,000 less housing starts. The same number of employees are seemingly producing far less homes. Could productivity really have declined this precipitously? This could be a measurement issue related to undocumented workers. The Pew Center estimates that the construction industry has the third highest rate of undocumented workers at 13 percent The regulatory environment could be making it more difficult to recruit these workers.