Despite the recent challenges, first-timer buyers made a comeback last year, accounting for the 32% of market. (UBS)

Household formation to rise with aging millennials
We believe favorable demographics will help drive strong demand for housing over the next several years. Nearly 68 million Americans are in what's considered to be the prime first-time home buying age range. Historically, the typical first-time buyer is in their late-20s to early-30s, but in recent years this has been creeping higher due to several factors, including supply demand imbalances, higher house prices, and interest rates that have adversely affected affordability.


According to the National Association of Realtors, 70% of younger millennials and about 45% of older millennials are first-time homebuyers. Despite the recent challenges, first-timer buyers made a comeback last year, accounting for the 32% of market. This is up from the record-low 26% in 2022, but below the 38% average since 1981 and the peak of 50% in 2010 during the First-Time Home Buyer Tax credit.


Existing home inventory at historically low levels
There isn’t enough housing supply to meet the demand. Inventory for existing homes sits slightly under 1 million, well below the historical average of 2 million. That equates to 3.2 months of inventory versus the longer-term average of 5.5-6.0 months.


Lack of adequate investment in new housing stock since the fallout of the 2008/2009 Great Financial Crisis (GFC) and subprime mortgage collapse, and more recently high mortgage rates and the lock-in effect, have contributed to the shortage. Many homeowners who locked in low pandemic-era mortgage rates are reluctant to give up those loans. Before the GFC, housing surplus peaked at close to 3 million units.


But that has since declined each year and demand eclipsed supply around 2017. Estimates vary widely but Realtor.com puts the housing shortage at about 6.5 million units when comparing new single-family house construction rates to new households based on population growth. However, that estimate falls to 2.3 million when multifamily construction is included.


Low turnover has suppressed existing home sales, which account for most of the housing market and fell 19% in 2023 to 4.09 million units—the lowest full-year level since 1995 and below the 20-year average of 5.3 million units annually.


Lower mortgage rates may relieve some locked-in homeowners and unleash some supply on the margin. However, at the same time, they could increase demand as those homeowners look to buy another home.


Falling mortgage rates could spur housing activity
Mortgage rates have retreated from a 23-year high of 7.79% reached in October. The average rate on a 30-year fixed mortgage now sits at around 6.65%, and we expect it to move lower.


We forecast the 10-year US Treasury yield to fall to 3.5% by the end of year as the economy slows and the Fed cuts rates. The Fed funds futures market is currently pricing in 3-4 rate cuts for this year starting in June, roughly in line with our expectations. The spread between the 10-year Treasury and 30-year mortgage rate is currently about 250bps—well above historical levels of 175bps. We expect that spread to tighten a bit to 200bps as rate volatility eases further and spreads compress in agency mortgage-backed securities. Under those assumptions, the 30-year mortgage rate could get to 5.50-6.00% by year-end.


Housing affordability still low but poised to improve
With the labor market remaining healthy, falling mortgage rates should further improve housing affordability. Since the recent peak in rates in October, the National Association of Realtors affordability index has improved from the multi-decade low of 91.4 to 101.9 in December—but remains well below the 138 average since 1990. The index measures affordability based on single-family home prices, median family incomes and prevailing mortgage rates. Higher values denote better affordability.


However, if 30-year mortgage rates fall to 5.75%—the middle point of our expected year-end range—that could add over USD 100,000 to home seekers' purchasing power, assuming a house price of USD 400,000 and 10% down payment and compared with an 8% mortgage rate. This would push affordability within one standard deviation of the longer-term average.


Mortgage activity positioned to inflect higher
Lower mortgage rates should fuel a pickup in mortgage origination activity. Quarterly mortgage originations ballooned as interest rates fell during the pandemic, peaking at a historic USD 1.3 trillion in Q1 2021. Volumes have precipitously declined since then to USD 300 million in Q3 2023—near a decade low.


Mortgage volumes are unlikely to get back anywhere near their peak as refinances accounted for 70% of the historic total. However, volume should pick up with home sales, as typically over 70% of new home sales are financed with conventional mortgages.


Refi activity could marginally improve off low base
Refinancing activity has been at a near standstill for several quarters, as roughly 80% of outstanding mortgages were underwritten at rates below 5% and 65% below 4%. However, as rates fall, it could increase the attractiveness of refi for loans above prevailing mortgage rates.


We estimate about 10% of mortgages would be in the money to refi if mortgage rates fall to 5.50%. This could be incrementally positive for mortgage origination-related companies.


Home improvement spending has not kept pace with home prices
The US existing housing stock is old—the median age of a house is about 40 years. Older homes tend to require more repairs and remodeling.


Home remodeling and renovation (R&R) spending surged during the pandemic, with the growth in last-four-quarter spending jumping from as low as 3% in early 2020 to as high as 17% in late 2022. Growth has since been weak, despite existing home prices remaining elevated. Historically, home improvement spending is positively correlated with home price appreciation. The slowdown in spending can be attributed to a sizeable pull forward of projects during the pandemic and elevated inflation and interest rates. Many home improvement and furnishing retailers have cited pressure in big-ticket discretionary items and homeowners downsizing, delaying, or canceling projects. But they have also noted that roughly two-thirds of home improvement spending is nondiscretionary.


Main contributors: Nadia Lovell, Jonathan Woloshin, David Lefkowitz, Matthew Tormey, and Michelle Laliberte


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