devarena logo
Reading Time: 8 minutes


Motivation

Since the start of the pandemic (already year 3!), we have witnessed monumental changes in all aspects of our life. Major shifts towards much celebrated “work from home” culture and the consequent impact it has had on internal migration have led to a massive increase in demand for single-family homes across the US. We’ve all bore witness to the memes of New Yorkers taking over Florida and Californians taking over Texas. Albeit the sheer influx of residents to states like Texas and Florida have been well documented, other smaller states have also felt the jolt of the pandemic and the consequent internal migration inflow. Below is a quick summary of how all states have fared during the pandemic (report from February 2021).

 

RankStatePopulation change
18Alabama13,567
39Alaska-2,445
3Arizona129,558
22Arkansas9,537
49California-69,532
9Colorado49,233
43Connecticut-9,016
21Delaware10,141
29District of Columbia4,563
2Florida241,256
5Georgia81,997
41Hawaii-8,609
12Idaho37,853
50Illinois-79,487
15Indiana23,943
31Iowa3,965
34Kansas1,170
28Kentucky4,906
46Louisiana-12,967
30Maine4,371
35Maryland848
38Massachusetts-1,309
48Michigan-18,240
17Minnesota17,289
45Mississippi-11,441
19Missouri11,073
20Montana10,454
27Nebraska4,981
10Nevada47,488
26New Hampshire5,492
42New Jersey-8,887
24New Mexico6,685
51New York-126,355
4North Carolina99,439
33North Dakota1,585
40Ohio-3,290
16Oklahoma20,107
14Oregon25,391
47Pennsylvania-15,629
37Rhode Island-1,033
7South Carolina60,338
25South Dakota5,590
8Tennessee56,509
1Texas373,965
11Utah46,496
36Vermont-699
13Virginia33,921
6Washington79,588
44West Virginia-10,476
23Wisconsin8,074
32Wyoming2,212

 


Indubitably, states that saw an unprecedented population increase also faced inventory shortages in the housing market and a surge in average home prices. Internal migration has also caused the price of single-family homes to skyrocket in some regions. However, due to the influx of residential construction permits in the last two years and overall market exuberance, combined with the impending economic policy tightening to combat inflation and low-interest rates (FED Dual Mandate), I hypothesize that a large supply of newly-built homes will stabilize home prices and force investors to find specific trends in the market to avert unnecessary risks.

We’ve already seen how internal migration can cause prices to skyrocket (more on this below), but what about the historically low-interest rates? When looking at the relationship between interest rates and the housing market, we can confidently conclude that there is a negative correlation between the two. As interest rates increase, the housing market shrinks.

Economic Indicators

As we can see from the below graphs from FRED (Federal Reserve Economic Data), when the yield on 10-year bonds increases, indicating anticipated interest rate hikes, mortgage rates increase as well, thus increasing the cost of borrowing money and mortgage rates.

U.S. 10 Year Treasury (2016-Present)

Interest Rate (2016-Present)

30-Year Fixed Mortgage Rates (2016-Present)

Moreover, when applying the generally accepted business cycle model (below), we can also infer our current position within the business cycle.  As illustrated below by Fidelity, USA is currently in the mid-to-late section of the business cycle due to monetary policy tightening, moderate economic growth, and credit tightening. It is also logical to assume that as new constructions enter the market and increase supply, prices are bound to stabilize. Additionally, as global trade normalizes, we can assume some of the supply chain problems will abate.

 

Objective

I will be using industry knowledge mentioned above and the datasets I extracted from the United States Census Bureau to find construction trends in the United States for the past 2 years. I will extrapolate investors’ guide on how to navigate the real estate market for the next 1-3 years. I will attempt to find specific regions in the United States primed for real estate investments and determine whether flipping, short-term rentals, or long-term rentals will be more profitable for the next 1-3 years.

NOTE: This research only pertains to single-family (one unit) homes in the United States and is targeted at investors looking to buy, not build. 

Methodology

For this research, I extracted six separate datasets from the United States Census Bureau and performed necessary data cleaning and organization to make it effective for my research. A cleaned and organized version of the data may be downloaded from my Github page referenced above.

For my analysis, I extracted datasets covering the years 2014-2021 with a concentration on 2019-2021.  This method allowed me to clearly distinguish market trends in the pre and post covid economies. All demonstrated graphs will be summarized to showcase construction trends in the United States and their consequent impact on single-family home prices.

Dataset(s) & Visualization

To begin my research,  I wanted to find how home sales have changed across the US based on price. It is noteworthy that starting from Q4 of 2019, home sales in the more expensive brackets, $500K & above, have continuously increased, while home sales for lesser expensive units have plummeted. This is an indication of several things. For starters, this trend may be accredited to inflation. As home prices have increased across the US, the availability of lesser expensive units has diminished. Another reason for the aforementioned market shift could be accredited to the low supply of single-family homes due to supply chain obstacles caused by the pandemic. To investigate this further, we will analyze these trends by region (North-East, West, South, and Mid-West).

For the following graph, I analyzed home sales and sales prices in the South and Mid-West. Similar trends can be analyzed in these two regions. Home sales for more expensive units have been growing rapidly, while home sales of lesser expensive units have been subsiding.

The same thing cannot be said for the North East and the West. Whereas we are seeing clear trends for South and Mid-West regions, there is less trend uniformity for the North East and the West. This could be attributed to the shift in internal migration mentioned earlier.

As alluded to at the start of my writing, due to monetary policy tightening, I was also expecting to see a decline in credit applications/financing. As illustrated in the graphs below, this assumption is upheld. Across all major financing types, (Conventional, FHA, VA, Cash) gradual decline can be detected starting from Q1 of 2021.

As we zoom in to investigate this trend for the past three years, the same trend persists. For all categories of financing, we are seeing a huge spike in 2019-2020 Q1 and a drop of similar magnitude starting from Q1 of 2021. Again, this is in line with our hypothesis, as we exit peak economic growth, credit/mortgage demand is expected to subside.

Next, we will investigate some trends in the single-family construction market in 2021 to find additional insight.

  • Completed: Home constructions that have been completed in 2021.
  • Under Construction: Home constructions that started before 2021 and are under construction in 2021.
  • Started: Home Constructions that started in 2021.

Note:  Construction levels are in a count of thousands.

The above graph shows that for the entirety of 2021, we saw huge spikes in completed construction and a gradual increase in homes “under” construction. This implies that these homes will possibly enter the market in 2022. Moreover, we also see a decline in constructions “started.” This is a possible indication of waning market confidence. This means that starting from June of 2021, fewer permits were authorized and/or requested for single-family home construction. We can also observe that most of the construction activity across all categories is the highest in the South, making it a prime real estate market.

It is also imperative to analyze the market for expected future constructions of single-family homes. The below graph showcases the number of permits authorized but not started in the US for the period 2014-2021. This means that at some point in the next 1-2 years, these constructions are bound to start and eventually enter the market.  As we can see, there is a clear spike of permits authorized in 2021 with some decline observed towards the end of 2021. This is both, an indication of waning market confidence and the ramifications of an unsustainable market. This also provides more credibility to our reasoning for the decline in constructions ‘started’ in the previous paragraph. And again, the South is seeing the highest volume in permits authorized for single-family homes. 

Furthermore, since construction is prone to seasonality, I wanted to make sure my analysis isn’t bound to seasonality. Seasonality is a characteristic of a time series in which the data experiences regular and predictable changes that recur every calendar year. Any predictable fluctuation or pattern that recurs or repeats over one year is considered seasonal.

As seen in the graphs above, which uses autocorrelation to identify seasonality,  a low degree of seasonality is detected making our observations reliable and well-founded.

Conclusion

  • overall real estate market correction is expected in the next 1-3 years.
  • expect to see a massive market correction in the South followed by the Mid-West.
  • Investors are advised to buy investment properties for short-term/long-term rentals rather than wholesale real estate investing (flipping).
  • Patient investors should wait for 1-2 years until the market stabilizes.
  • As interest rates increase, there will be market opportunities for private lenders.
  • Due to construction volume, South region of the US is primed for property investments.

Future Analysis

For the future, I want to analyze micro-trends in the construction industry. Mainly, I want to concentrate on the exterior and interior materials used for single-family homes and how they influence home prices. To illustrate, one of the micro-trends in the industry is the material used for the facade of the house. As we can see below, there is a persistent increase in the use of fiber cement due to its non-flammable features and durability.

This is an ongoing research, periodic updates will be made on my Github page.

References

  1. Jeff Ostrowski (Feb. 12, 2021) 5 most and least popular states for Americans who moved during COVID (https://www.bankrate.com/real-estate/states-growing-most-during-pandemic/)
  2. FED (Oct. 20, 2020) The Federal Reserve’s Dual Mandate (https://www.chicagofed.org/research/dual-mandate/dual-mandate)
  3. FRED  Federal Reserve Economic Data (https://fred.stlouisfed.org/)
  4. DIRK HOFSCHIRE, CFA, SVP; JACOB WEINSTEIN, CFA, RESEARCH ANALYST, ASSET ALLOCATION RESEARCH; LISA EMSBO-MATTINGLY, DIRECTOR; AND CAIT DOURNEY, ANALYST (Feb. 18, 2022) Business cycle update: Mid-cycle expansion (https://www.fidelity.com/learning-center/trading-investing/markets-sectors/business-cycle-update)





Source link

Spread the Word!