The B&D Interview: Robert Dietz, Chief Economist, National Association of Home Builders

NAHB’s Robert Dietz explores the current market’s strengths and headwinds, and how affordability is shaping development trends

Builder and Developer Magazine: What is your general impression of the current homebuilding market?

Robert Dietz: It’s been a soft start for 2019. We’ve gotten data for the first half, and when you compare, for example, single-family permits for the first six months of 2019 compared to the first half of 2018, we’re down about six percent. Those declines are fairly broadly based; most states are facing declines, some more than others. California is a good example of a state that, depending on which estimate you look at, is 15-20 percent down compared to the start of 2018.

The reason for that is for years we’ve faced supply-side headwinds of growing costs and factors that were increasing construction cycle time and limiting the amount of land available for building. The most important of those would be the ongoing labor shortage, which persists, but because the unemployment rate is fairly low, the labor market is fairly healthy. We obviously saw lumber costs go up in 2018; that has come back down because of the softness in building. The other big one I would put at the top is regulatory burdens. We did an estimate a few years ago that found that for a typical newly built, single-family house, 24 percent of the purchase price was due to various rules at the state, local, and federal level that arose during land development and during home construction. In fact, two thirds of the impacts occurred at the lot development stage. So, a lot of it has to do with how we use land and how difficult it is to bring new land to the market for development.So, you have the supply side headwinds, and then in the second half of 2018, you add to that the demand side’s challenges.

For years, we’ve had home prices rising faster than incomes. That has brought down housing affordability. It came to a head at the second half of 2018 when mortgage interest rates reached near the five-percent level. Effectively, what happened is that the wind came out of the sails of the housing market. We had a lot of for-sale housing demand that retreated to the sidelines, and that impact has lingered into 2019 and is responsible for some of those production declines that we’ve seen. We had about two and a half years where the national homeownership rate was rising off of a post Great Recession low. The homeownership rate declined for years after the Great Recession. Then in 2016, it finally reached a kind of a low point, went up for about two and a half years, and then for the first two quarters of 2019, the homeownership has dipped back down. Not a huge amount, but you can see that some of the momentum that had been building because of housing demographics — particularly millennials, moving from their late 20s into their early 30s had built up momentum to the for-sale side.

Where we are right now is that a lot of local markets are either concerned about a slowing national economic growth – although it remains pretty solid, trade war consequences are having some regional impacts, particularly in the middle of the country, and then in most of the country you have housing affordability issues, due to the fact that those construction costs continue to go up, but buyers are limited in terms of what to afford. That means the hardest inventory to add to the market has been, and remains, that entry-level housing: smaller houses on smaller lots. It’s the hardest for builders to add, and that’s one of the reasons you see that kind of inventory experiencing the fastest price growth.

BD: What can industry leaders due to combat the increasing affordability issue?

RD: A couple things. I think, one, the industry has to work as a whole, ideally through local and state homebuilding associations — and I would include NAHB in that. Working through industry trade associations to really make the case that if we’re going to fight the housing affordability crisis — and it is a crisis, we’re near a 10-year low on housing affordability — and we’re going to add housing stock to markets where there’s population gains and good job growth, and we want younger households to stay in those markets, we’re going to have to add housing inventory. That can only be done by evaluating the local rules when it comes to land development and home construction. Fighting impact fee increases as an advocacy objective, looking at zoning rules and trying to improve them by reducing exclusionary zoning requirements that require more land to be consumed to build a given housing unit. That’s going to take the industry as a group to do it; it can’t be done by any individual builder or association without builders working on behalf of the industry.

The other thing, in addition to fighting those regulatory burdens, is more long-term, but we have to recruit people into the industry. That includes workers; it also includes tomorrow’s homebuilders, like the owners of small business. The labor shortage is a generational challenge. There’s no silver bullet to it. It’s going to require recruiting tens of thousands of new workers every year into the industry, training them (because it is a skilled worker shortage), and also working to add different kinds of construction techniques to the market. We should expect additional gains for panelized construction and modular construction. They’re relatively small shares right now; they’re going to go up. But no individual action is a game changer; it’s going to take action on a lot of fronts.

I’ll give you an example. Panelized construction, for example, where you’re building the frames of a house in a factory and then assembling them at the site after they’re delivered, that can save some of the demand for carpenters. But you still need electricians, plumbers, stone masons, and people working the land to build the house. So, there’s no single solution. It’s going to take a lot of effort. So that means, again, those leaders in the industry are going to have to work together to coordinate with trade schools, high schools, and community colleges to bring people into the local market’s labor force.

BD: What policy changes, specifically, do you think are currently affecting the market?

RD: Well, the biggest impact right now is from the Federal Reserve. The Federal Reserve, in 2018, raised the Fed Funds Rate, which is the short-term interest rate that the Central Bank sets. They raised it 100 basis points. There were four increases of 25 basis points in the course of 2018. If you think back to that time, the Fed was projecting a fairly aggressive set of rate hikes in 2019. Then, at the end of 2018, we had a number of market indicators that really indicated that the economy was at a risk of slowing if that kind of credit tightness continued.

A good example of that was the NAHB/Wells Fargo Housing Market Index (the builder confidence measure we do every month) had a pretty substantial drop in the fall of 2018. We immediately deployed that to policymakers in D.C. indicating that housing affordability headwinds are real, and as mortgage interest rates, for example, have increased, we are seeing a very measurable, significant impact on homebuying demand and it’s taking a toll on builder confidence. As a result of those concerns, the Federal Reserve at the end of 2018 and going into the start of 2019 has really accomplished a pivot on monetary policy. So they began the telegraph that this year was going to be a year of easing. At the end of July, we got our first Fed Funds Rate cut of 25 basis points, and it was the first cut in about a decade. It was an acknowledgment that 2018’s GDP growth was 2.9 percent. The NAHB forecast for this year is 2.5. It’s not a recession, but it is slower. Our forecast over the next few years is for continuing slowing growth, with a risk of a growth recession, which would be a period of time where the economy isn’t growing fast enough to keep the unemployment rate at current levels, and unemployment would rise. In order to stop that, the Fed is easing up on some of those credit conditions. There’s a debate now on whether we will see one additional rate cut, or even two additional rate cuts in 2019 as the Fed tries to engineer a soft landing at the end of the growth cycle.

So, I think that’s the biggest policy change having the most impact overall over all of the market. If you look at mortgage interest rates, they’ve gone from five percent last fall to today, where they’re averaging 3.75 percent. Because of the rate declines we’ve seen in some credit markets this week, they’ll probably be even lower than that. What’s concerning, of course, is that over the course of 2019, as mortgage rates have come down, we haven’t had the uptick in sales behavior that ordinarily you would expect with a, for example, 100-basis-point decline in mortgage interest rates. And that’s a reminder that it’s not just a question of lower rates, but that price-to-income ratio, or the consequence of higher development costs relative to local budget constraints.

Trade is having an impact, particularly in the middle of the country. The agriculture market of the U.S. economy has been hurting for about two years, and that is having an impact on land markets and homebuilding markets throughout much of the Midwest. I think there’s now a renewed focus on housing affordability as a key risk for the economy.

A month or so ago, the White House issued an executive order on housing affordability, basically instructing the Department of Housing and Urban Development, the Treasury Department, and a number of other agencies to look at ways that the Federal Government can help fight some of these supply side headwinds. That was a victory, by the way, for the homebuilding industry and NAHB, because that executive order did cite that 24 percent of the price of the home is due to the regulatory burdens research. They’ve made it clear that that research highlighting the “death by a thousand cuts” – you look at any of these regulatory burdens in isolation, some can be small and some can be large, but they all add up. That’s what that research project was intended to do, to highlight that this is a heavily regulated industry, and that if we’re really serious about fighting for housing affordability, we have got to find ways to reduce some of these burdens that get added into this system from raw land to home cost.

I think those are the big policy issues right now: the fed, trade wars – and the impact that has on building materials, and finding ways to reduce homebuilding regulatory burdens.

BD: What effect do you think the White House’s acknowledgement of the affordability crisis will have on the market for the rest of the year?

RD: So, the word is that the federal government is going to be doing their own analysis of looking at these regulatory burdens, maybe trying to produce their own estimates of what impacts this has on home construction. I think they’re going to look at ways that federal resources can be restructured or used to create incentives for local governments to reduce some of the burdens. So we could see certain kinds of grants, for example, tied to local jurisdictions showing measurable improvements in things like inefficient zoning pools. The federal government can use its resources to try to create these kinds of incentives for improvement.

We know that when markets have big declines in housing affordability and the trend lines have not been good in the cycle, ultimately what happens is you price out a number of households from that market, and they go find somewhere else to live. The way I put it from an industry perspective is that we’ve always been in kind of a debate with the NIMBY (Not In My Backyard) individuals, who are suspicious or cautious with new development. The industry has to ally itself with the YIMBYs (Yes In My Backyard), who tend to be younger households looking for a place to rent, or ideally to buy and establish roots in a community. And then we have to outright oppose what I’ve been calling the BANANAs (Build Absolutely Nothing Anywhere Near Anything).

The political economy of this is a little complicated, because when certain homeowners and communities oppose any kind of development, they increase scarcity of housing and push up the prices and value of their own homes. Not to put too fine of a point on it, but there is a bit of a generational element to that, which is that prior generations are already homeowners; they tend to make things more difficult for the younger generations. We definitely see strength in senior housing markets, and that’s because during this cycle we’ve had a lot of price growth in housing. In some markets, they’re going to have those bubble peaks, but in most housing markets, they’re above prior peaks. That means additional housing wealth, but only if you’re already a homeowner. That’s a bit of a challenge for homebuyers who want to get into homeownership.

BD: What changes in the market are we seeing as a result of Baby Boomers entering retirement?

RD: I think there’s a lot of strength, particularly at the higher end. The Boomers are one of the largest generations; millennials are the current largest generation. I’m in Gen-X, we’re a small generation.

[Boomers] tend to be wealthier. So, for builders, whether you’re building a retirement community or selling custom homes, that’s a good market to be in, because you’re dealing with buyers who will have more cash. They will not require high LTV mortgage, and so the demand is fairly solid and stable. There’s not a lot of potential for growth, except at the local level where you do have migration patterns.

It’s also a good market for remodelers. You’re going to have continued gains in things like aging in place and improvements for what is admittedly an aging housing stock. That doesn’t just mean fixing up homes; it also can mean growth in the teardown construction market.

We estimate about 7 percent of single-family starts nationwide are teardowns. That is, you’re building a home and taking a permit out based on the footprint of a previously occupied home. We think that’s a growing market, again, because of the aging stock, smaller, less energy-efficient, older homes in a lot of high-value commute locations that could be improved with a new home, and that’s likely to occur in growing numbers in the years ahead.

One thing you haven’t seen a lot of growth in [in senior markets] that was predicted a decade or a half-decade ago was the idea of Boomers selling their existing homes, downsizing, and maybe buying condos in center city areas, to kind of take advantage of their empty-nest characteristics.

The condo market remains fairly small. It really has not rebounded off post Great Recession lows. So that kind of activity, while you can find examples of it, it really has not been a big, noticeable trend.

For the seniors market, it’s really that idea that they’ve got a lot more housing wealth and don’t face as many of the headwinds that the younger generation of homebuyers face. The politics of that are a little complicated, because it means the kind of preferences and concerns that the Baby Boomers have about the housing market are very different than those the millennials have.

And Gen-X… The majority of new homebuyers are going to be Gen-X here in the next few years, so the new construction industry is going to be particularly concerned with those preferences, because we’re reaching the peak of our earning years, we have older kids, and that sort of thing, but we’re still a smaller generation.

BD: Is there anything else you would like to mention?

RD: The townhouse construction market is doing fairly well. It posted a 15 percent gain in 2018 when the overall market was only up two to three percent. The reason it was growing so much faster than the rest of the market – and not all townhouses are entry-level; there are plenty of luxury, high-priced townhouses – but that is a good example of how you can build more units on a given amount of space. If we’re facing land and developed land constraints, and knowing millennials want to become homeowners but that they want a little more walkability than prior generations… I think younger Gen-X’ers and millennials are quite happy to be in walkable communities. Townhouse construction is a good example of how local areas can add that housing stock.

The other element is single-family built for rent. That market is growing. It’s increasingly being looked at and participated in by larger builders, but it is still a small part of the overall market. We estimate that, currently, only about five percent of single-family starts are built for rent. Historically, that share has been a little under three percent. So it has elevated over its historical share, but it’s still a fairly small slice of the overall homebuilding market.