Expect Starts of 1.3 Million in 2020, as Conditions Remain Conducive to Growth
Despite a slow start in 2019, building has picked up during the second half of the year, and we think the momentum will continue in 2020. Contractors are poised to break ground on 375,000 new multifamily and 925,000 single-family units, up 3.6 percent in total from 2019. The only change to our forecast is an increase in how many of these starts will be multifamily units. Land constraints and limited savings among many adults have sustained multifamily activity above our expectations in recent years, leading us to re-evaluate our near-term mix assumptions.
A disproportionate share of future growth should show up during the rest of 2019 and in the first quarter of 2020. Rising housing markets tend to achieve most of the incremental building during the offseason, when labor is less constrained. Positive sentiment among builders, buyers, and bankers gives us confidence that the recent momentum will be sustained, at least in the near term.
Our Long-Term Forecasts are Unchanged
There have been no structural changes that warrant revisiting our long-term housing forecast, which is driven by two key factors: more household formation among the working-age population and population growth.
The portion of adults age 45 and under who head a household should climb over the next five years as economic conditions and credit scores improve. The current inventory of vacant homes is too low to accommodate these new households, which should drive demand for new homes. Nevertheless, we still expect headship to fall short of levels seen before the global financial crisis, when lending standards were too relaxed.
Our forecast also assumes mild population growth, based on both census-forecast fertility rates and our internal immigration forecast. Immigration is poised to fall short of historical norms, with heightened restrictions imposed on illegal overland immigration and legal immigration from the Middle East.
Year to date, household formation has strengthened among younger age groups, giving us no reason to revise our outlook for households. Immigration policy was also stable during the third quarter, so we have left our population forecast unchanged. All told, our current forecast assumes that starts stabilize at 1.4 million units per year during midcycle conditions.
Homebuilding 2019: In Like a Lamb, Out Like a Lion
The year began on a low note. Adverse weather and tepid underlying demand left most investors wondering whether 2018 would be the cyclical peak for new-home construction. But surveys can be erratic, and demographic trends play out at a leisurely pace. As we expected, housing construction returned to year-over-year growth in the third quarter.
Annualized new-home construction accelerated through 2019; third quarter starts rose 3.9 percent over the prior year to 1.28 million. That momentum should carry starts higher over the next five years before leveling off around 1.4 million properties per year.
In 2020, we believe the foundation is laid for 1.3 million new homes. Public builders grew new orders by nearly 16 percent during the third quarter and are optimistic about the coming year. Land in inventory should give them the ability to meet our outlook for the year. Demand conditions are no slouch, either. Over the past few quarters, we estimate that underlying demand for new homes has averaged nearly 1.5 million units. Appetite is there, which will increasingly be filled by new construction instead of inventory reduction.
Acceleration in Single Family, Nearly Flat Multifamily Builders are Motivated and Able to Supply 3-4 Percent Unit Growth in 2020
A decade of building bigger, better homes has left the market in need of entry-level offerings. But over the past few years, a growing share of public homebuilders learned that new buyers have different needs. At first, only a few builders shifted to lower-price offerings, but their early success has encouraged more to follow suit. These units come with narrower gross margins but can generate comparable returns on capital through higher volume and faster construction. This gives builders plenty of reason to pursue additional lower-price starts in the coming years.
Over the past few years, public homebuilders have proved adept at growing new order volumes more than 10 percent per year when conditions are right. Management teams have inventoried land and the rights to purchase land over the past few years. As ordering picks up, the companies have been quick to deploy the requisite supplies and labor to job sites.
Finding capable construction workers has been the builders’ largest constraint. Tradesmen, such as electricians, plumbers, and carpenters, have been scarcer. However, higher pay and stable employment have caught the attention of discouraged workers. People who were newly searching for construction jobs drove most of the employment growth over the past 18 months. That means today’s low unemployment rates are unlikely to cap how many homes can be built each year. Average employment growth of 4-6 percent over the prior two years should support comparable growth in new-home construction.
Apartment Construction Will Remain Near Recent Highs
REIT managers have long warned investors that multifamily construction will slow. However, these companies do the bulk of their business in high-density U.S. cities, where rents are stretching budgets to a breaking point. But it’s important to remember that cities like San Francisco and New York make up only a fraction of U.S. apartment construction.
The suburbs and lower-density urban areas still constitute a huge source of total multifamily construction. Skyscrapers are in the mix, but the United States has an abundance of land, making low- and midrise projects more cost-effective. Builders have options in most cities. Over 75 percent of multifamily units are being built in metros that are less dense than the average U.S. city. High land costs in the urban core will drive most builders into the near-suburbs and along light-rail lines to control costs and keep rents palatable.
A Healthy Economy and Low Rates Will Sate Housing Appetites Slow but Steady, Headship Rates are Creeping Higher
Households collapsed indiscriminately across every age range following the global financial crisis. Foreclosures and merged living arrangements meant less construction was needed to house a growing population. This process of splitting apart or coming together is the single largest driver of demand for new homes.
Wages are now growing steadily, and unemployment is nearing record lows. A stronger economic backdrop should facilitate marriage, childbirth, and divorce – events that demand more residences and are often forgone when times are tough. Barring an economic shock in 2020, we expect the upward trajectory in headship to continue over the coming years.
Rising headship rates have caused demand to outstrip supply over the past five quarters, reducing the number of vacant homes and apartments. We estimate underlying demand at around 1.5 million units annually, well above starts, which remain below 1.3 million as some demand is met with the drawdown of existing homes. Diminished inventories typically lead to higher prices per square foot, encouraging builders to increase output.
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This feature appeared in the February 2020 issues of the ACP Magazines:
California Builder & Engineer, Construction, Construction Digest, Construction News, Constructioneer, Dixie Contractor, Michigan Contractor & Builder, Midwest Contractor, New England Construction, Pacific Builder & Engineer, Rocky Mountain Construction, Texas Contractor, Western Builder