Expect Any Housing “Recession” to be Short and Shallow

Are we on the verge of a housing recession? The Federal Reserve is intent on fighting inflation, and dampening appreciation in asset prices – including housing — is part of its plan. After torrid gains over the last several years, the residential real estate market does appear to be softening.  But rather than worrying, investors should be on the lookout for buying opportunities. Because the housing “recession” is likely to be short and shallow in most markets. U.S. housing supply and demand fundamentals make a nationwide price decline unlikely.

Due primarily to higher mortgage costs, U.S. home sales are down over 20% from a year ago. And last month, the median price for an existing home in the U.S. dropped from a record high of $413,800 to $403,800, according to the National Association of Realtors (NAR).

But given that median home prices have surged nearly 36% since the pandemic began, a 2.5% drop is hardly a “recession.” Despite decelerating price growth, median home prices are still up 10.8% from a year ago, according to NAR’s data.

Certainly, further housing price softness is possible. But “this isn’t a recession in home prices,” says Lawrence Yun, NAR’s chief economist. Though, for some local markets that experienced extraordinary price growth in the last couple of years — like in California — a decline in price is possible, says Yun.  But he believes that any price pullbacks are likely to be met by buying from potential homeowners who were priced out over the last couple of years.

There are several factors that suggest any housing recession will be short and shallow:

First of all, the economy remains strong. Job growth slowed in August but stayed solid, suggesting that rising interest rates and fear of a possible recession are leading companies to pull back on hiring — but that the labor market recovery remains resilient.

Most significantly, demand for homes remains strong, due in large part to demographics. Americans who are either Millennial-aged or younger make up half of the U.S. population, or 166 million as of July 2019. This is significant because first-time homebuyers represent the largest share (31%) of people purchasing homes, according to data from the NAR. And most first-time buyers are younger than 40, which means the buyer pool is deep–a good indication that demand will remain strong,

But while buyers wait in the wings for improved affordability and an increased supply of houses, building of new housing units continues to fall far short of demand.

Colorado exemplifies the current state of housing in the U.S.  One of the top performing metro markets in recent years, Denver housing prices were down 3.33% month-over-month in August, but are still up 11.04% year-over-year, suggesting that a more balanced market may offer opportunities to people unable to buy in recent years.

However, according to a recent report by Noranda Real Estate Investments, Colorado is still a seller’s real estate market with a positive price forecast for the next twelve months. Despite the increase in the number of properties for sale this year, there is still a lack of houses in Colorado. According to a January 2022 report by the Colorado Affordable Housing Task Force, 325,000 new homes will be needed over the next few years alone to restore the market to its historic balance. The problem is that Colorado has struggled to build more than 40,000 homes of any sort in a single year (see graph below).

In the Denver metro area, estimates of the housing deficit ranges between 64,000 and 129,000 units. In metro Denver, 10,570 new apartment units will be built by the end of the year. That’s according to a national study of apartment construction released earlier this month by RentCafe. In the first five months of 2022, plans for 3,243 single family homes have been filed, according to CPD statistics. If that pace continues, 2022 will be a record-setting year for Denver with 7,783 applications. But it would still fall far short of meeting demand.

In Colorado – and most of the U.S. – a significant pool of potential homeowners is waiting for an opportunity to buy. And with housing supply constrained, it’s hard to envision significant housing price weakness. Buyers will continue to compete for the limited number of homes for sale, and prices are more likely to rise than fall.

Aloha Capital continues to see solid demand for its lending products in Denver and other markets, despite the shifts occurring in the macroeconomic environment that are affecting real estate. This is true across all our lines of business, including bridge/value add, ground-up construction and DSCR/long-term financing. Colorado continues to be Aloha’s top state market, with Denver metro making up the lion’s share of lending originations. This is due both to Aloha’s proximity, with offices in Boulder and downtown Denver, coupled with the fact that we are believers in the Denver market story. It has become a top-tier city for job growth and a strong economic backdrop, drawing millennials and others from many directions. Denver/Boulder is also well known for its highly ranked quality of life, with Boulder recently snagging yet another ‘best places to live in the US’ title.

As we continue to wade through rate increases and the Fed’s intent to tamp down inflation, Aloha LTD Income Fund has proven its value as a low volatility, highly consistent investment opportunity. It has produced a distribution every month since inception for 7.5 years.