PolicyCast: Zelman the Contrarian

Kirk Willison, Arch MI’s Vice President for Government and Industry Relations:

In our first podcast of 2022, we learned how Ivy Zelman overcame considerable odds to become a standout as a housing industry equity analyst on Wall Street. Now, in the second part of our PolicyCast discussion with Ivy, we learned how she is standing out in a whole different way. In short, Ivy’s a contrarian and has the courage to stick to her convictions, even when pressured to brighten her forecasts. So what is her message to the homebuilding community today? To coin a phrase, Ivy is telling them, “If you build it, they won’t come.” Why does Ivy think we are building too many homes in the United States? Let’s find out.

Ivy, welcome back to the Arch Mortgage Insurance PolicyCast. You know, much of your renown comes from your willingness to be a contrarian. You know, before the housing market turned down in the mid-aughts, you were the lone wolf out there howling that there were problems on the horizon. Well, today, here you are warning of another downturn. In your new report, “Cradle to Grave,” your firm contends that the nation’s homebuilders are building too many homes. And you know, that’s really in sharp contrast to — whether it’s Freddie Mac or the National Association of Realtors® — [they] argue the nation is still anywhere from 3.8 million to 6 million units short of equilibrium. You say we don’t have a housing deficit.

Ivy Zelman, CEO Zelman & Associates:

We don’t believe we do. I think our work is really rooted in a very deep dive on the demand side of the demographics. And in the report you referenced, “Cradle to Grave” that we published in August, we’re really drilling down to the sobering message that the United States’ demographics are going in the wrong direction. And when we do this analysis and we see household growth has slowed to the slowest on record and population growth was the second-slowest on record behind the 1930s by 10 basis points or a little bit better. So, we’ve had, directionally, households and population going the wrong way. So, we don’t currently believe that we’re overbuilt. What we’re really trying to convey and, hopefully, help the industry navigate is that based on the latest 12 months [of] housing starts, what’s coming down the pike would put us in an overbuilt situation when those homes get completed.

And I think the real difference between our [forecast] — and it’s hard to know what other forecasters assumptions are — is that we really have a different view on just overall demand. I think that on the supply side, it depends on who you speak with. [They] say, “Well, we’re underbuilt because they’ll start counting in 2012 and they’ll say, We should have been building, you know, this number of units and we didn’t.” And I’ll say, “W why did you start in 12 and not in 2002?” Where do you start the clock? The supply side is really where at least the forecasters that we have had the privy to read have been [less] focused …  on the demand side. And frankly, not only are households growing at the slowest pace on record, but it’s happening throughout the whole nation. It’s not just one market. They’re all decelerating. Some are decelerating at a much faster rate than others.

Willison:

I was going to say housing formation did slow. I think everyone agrees after the last housing crash, but isn’t the actual lack of supply of housing holding back household formation. I mean, there are a lot of Millennials who were living with Mom and Dad in their basements because they couldn’t afford to rent or buy, and I think they’re starting to move out.

Zelman:

We  have data that we look at annually that is coming from the ACS (U.S. Census Bureau American Community Survey) and the  CPS (Community Population Survey) data. And what I would say is that every year throughout the decade, we can look at how many households [have formed and], how many young adults between the ages of 20 and 39 are still living at Mom and Dad’s. When we saw that go from — you can call it the  mid-16% in the 2000 timeframe to 19.7% in 2010 age-adjusted. That made sense because we were in a massive recession and young adults had to move back in with family for financial reasons. What was somewhat shocking was throughout the prior decade we just completed that the number actually went up, not down. Every year we get the data and we were puzzled by it.

We actually made a bullish call in January of 2012 expecting the unwind, which would incrementally drive  overall demand as young people left Mom and Dad’s. But, frankly, those numbers from 19.7% at the end of 2010 went up to 23.7% at the end of 2020. S, o where the unfold or unwind isn’t really happening  to the extent that pent-up demand is being realized. Not to say there aren’t Millennials and households that aren’t being formed. In fact, starting in 2016, the actual homeownership rate troughed and has been climbing ever since. So, we have to make sure we don’t assume … We’re not saying that households aren’t being formed, but the number of 20–39 year olds are not unwinding at the pace that you’d expect. And it’s actually been rising. And we asked “Why would that number being going higher?”

The numbers going higher could be a combination of many things. It could be …  people can’t afford [housing] … and  don’t have the money to leave their parents. Or it could mean the stigma of living in your parents’ home and their basement may not be as negative it once was. Or, having  young women that are pursuing a higher education at an accelerated level are delaying marriage and family formation. There are many other factors that might be attributing that multi-generational living that’s happening. But we get monthly data on it, and we are not seeing the numbers suggesting that we’re seeing this great sort of unwind of all that arguable  pent-up demand.

Now if you told me … the federal government decided that you could see homes being built that are going to be under [for example] $700 a month or $500 a month, then maybe you would [see housing demand rising], but,  today’s rental stock that’s being built and  single-family rental stock that’s in the pipeline has predominantly a $2,000 monthly rent. So, we’re not building the right product, Kirk, to really get those young adults out of their parents’ homes. I think  one of the challenges is  we’re building a lot of product, but are we building the right product to really help the affordability crisis?

Willison:

That’s an interesting point. So, you’re saying that demand for housing is likely still there. The affordability issue is what’s keeping the household formations from increasing to a level that would sustain a continued building of additional homes.

Zelman:

We’re saying, we’re still going to get 1 million new households formed annually on average from 2020 to 2030. I think that number is still, relative to what it’s been, it’s down from what might have been 1.3 million for 1.4 million. Then, you add  in demand for whatever needs to be demolished and replaced or an excess level of vacancy. When we come up with our total demand number, including manufactured housing, we’ve kind of been 1.3 million or 1.4 million, but other forecasters are closer to 1.7 to 1.8 million. That differential is just maybe the unwind that they’re assuming of that young adult [population]. But,  that young adult leaving Mom and Dad’s, whether you’re talking not just the 20 year olds living at home longer, it’s those up to 39 years old who are still living there, across every one of those cohorts within that [ages] 20–39 cohort is going the wrong way.

I don’t think it’s just affordability though, Kirk. I think that we can look at Europe and think about the number of families that live multi-generationally. As the population ethnicity is changing, where we are becoming where the Caucasians are pretty much going to be the minority, there’s more people, just culturally, that are fine living together. Whether you think about Asians or Hispanics that are leading the growth, that also has a lot to do why people are living multi-generationally. Now, what also is different, somewhat, with our view versus others is that we don’t have some level of excess vacancy for second homes. We really don’t have investors as part of our demand equation. Right now investors are kind of not wanting to  go back to 2005 when we did our report “In Gone Wild,” but investors are accelerating while primary buyers are now starting to moderate.

We see it in the numbers. We could see that the [state of] rentals to ownership over the course of the transactions that have occurred. When you look at 6.5 million transactions, there were almost 3 million that were renters who  became homeowners at the peak, which was up from 2.2 million. Now we’re back at 2.3 million. We’re actually seeing the number of renters converting to homeowners is decelerating, but the demand side for actual transactions is accelerating, which is investors. We bucket investors into a lot of different subcategories within what you could call it non-primary demand. That’s masking and clouding what I would say is true primary demand and, therefore, difficult to delineate.

Willison:

And I think we’ve heard those stories of people wanting to buy a home but being outbid by the investors who are often making all-cash transactions.

Zelman:

I do think that it’s like people even will ask “Why does she care if it’s investors? Investors are still driving the market higher.” I think that’s one of the things that we care a lot about because when you think about an investor, after … five years or seven years, they’ll be looking to monetize and flip within the first year. But the key difference is that they’re looking for a return. They’re looking to monetize and, therefore, the likelihood of them staying if the market starts to get a little challenging or we’re no longer in this upward trajectory. When home price appreciation starts flattening out, a lot of those investors might say, “It’s time to take some money off the table.” Take, for example, I buyers. They are in the market pursuing  an entry-level buyer box, and they’re going to buy those homes and put some lipstick on the pig I call it, and they’re going to turn around and sell it.

They’re helping to support home prices going higher because they’re in the market as buyers and they will be sellers. Therefore, they will also push home prices down at an accelerated level when they’re ready to sell. Especially as the market starts to go from a seller’s market to a balanced market to a buyer’s market. Investors have created the acceleration of the surge in home price inflation. We’re going to see investors will be the risk that home prices will decelerate at a faster pace than what otherwise would be the case. And it’s not just the I-buyers, there’s a whole slew of investors like that.

Willison:

But even if homes decline a little in value … if there’s still demand for the housing, it could help on the equilibrium side of again, allowing people to finally get affordable housing that doesn’t exist today.

Zelman:

Right. If you think about the number of homes today that you can actually purchase that aren’t set to be demolished because they’re just not livable, they’re obsolete. If you were to look at excluding those, the median home price today is $360,000, right? I think the lowest on the new home side is DR Horton at average prices in the high $300,000s. There were homes being built in the pre-pandemic period that were in the $200,000s. Those don’t exist anymore. So the builders can’t build a house in the $200,000s. They just can’t buy the land, which is inflated so much. Land inflation is one of the big concerns we have because as an industry that has to buy land and, assumingly put those units into their theoretical factory for a year or two later. The land values have gone up more than 30% year-over-year. So, they’re going to be bringing in more units at higher prices because they have to raise those prices to cover all the increase — not just land, but labor and materials, too. We’re bringing production on that’s going to be even more inflationary and more challenging from an affordability perspective. I wish we were building more affordable units to get people out of their parents’ homes.

Willison:

Is the over-building a nationwide problem or is it rather generally localized?

Zelman:

I think it’s more localized. When you just think about it simplistically, you can say it’s red states versus blue states, but that’s not necessarily 100% the case. It  feels like the predominant pipeline where we see overbuilding as a risk are in your smile states. We also call them sand states. So, Arizona, Texas, the Carolinas, Georgia and mountain states where population growth has grown faster than the U.S. average. If you just took the population growth and you then say, “Well, that doesn’t really translates to that 20-something-year-old leaving Mom and Dad,” so let’s look at where the household growth is. Texas builders will say to me, “We don’t have a problem here or in Utah. We don’t have a problem because household growth is growing double digits in our state.”

The question is not about absolute growth. What was the growth rate? Let’s say the growth rate in Texas from 2010 to 2020 is s running at 14%, but it was running at 18%. So, we are really focused on the incremental change and then we’ll say, “Well how much production in Texas is actually in the pipeline?” Well, that’s up 30%, so it’s relative. If your production was only up 5%, it’d be fine if you’re building because everybody is sort of pursuing the same strategy. In Pennsylvania, Michigan or in Ohio, we don’t have an overbuilding situation there. Household growth is slow, a much slower pace than the U.S. overall, but I think it’s going to be more concentrated. That’s the long-winded answer.

Willison:

Since this is called the PolicyCast, let’s jump into some policy. I’d love to hear your thoughts on some things. The Biden administration is all in on expanding homeownership opportunities, particularly for minorities and for low income residents. It’s proposing down payment assistance to first-generational buyers and offering financial incentives to cities to eliminate land use restrictions so more homes can be built. Are you suggesting that maybe those steps are misguided?

Zelman:

Well, I think it’s very difficult at a federal level to try to change zoning laws at a local level. You’ll get a lot of pushback. We’ve yet to see anything on  the federal level that’s been successful in doing that. If they were able to achieve that and you told me that the federal government is going to enable — whether it’s tax credit or somehow [incentivize] developers — to bring affordable housing, that could help. But to step on the gas and start giving down payment assistance and really trying to spur demand is just very inflationary and it’s just going to do the opposite. It’s going to keep more people that are maybe not ready for homeownership … It might be putting them in a situation where they actually are not financially capable of meeting all the obligations.

So, if you give them the down payment, great, but is their debt level too high? Are they going to be too levered? Are they going to be able to deal with property taxes and all the expenses of homeownership? It’s a lot more than just the down payment and we could be prematurely pushing on the gas to bring in more buyers when the demand side is really not the problem.

Willison:

Do you think policymakers should be focused on reducing the racial homeownership gap? And if so, what steps might be taken to boost minority home ownership?

Zelman:

I think it’s really about education and culture  about the importance of saving and an appreciation for the long-term benefits of homeownership. Education is foremost. Providing to young adults all of the, I think ingredients of why homeownership is important and what we could do to convince them that this is just [as beneficial] as getting a higher education … Programs that will enable people to say, “This is something that I need to start thinking about like whether I’m going to  have children someday. I’m going to put away in a 501-B plan and start saving for my kids’ college education.” A lot of non-Caucasians are not as focused on homeownership. It’s just not what they’ve been growing up to appreciate.

It starts, really, with education and should we be focused on  improving homeownership for all races? Yes, but it really is up to the individual to appreciate the benefits. We as a nation don’t have forced savings and there are other nations, globally, that do. The only way to really reduce the inequality gap is to have more people own homes because that is a form of forced savings.

Willison:

Do you have any concerns on the multifamily side since you’ve talked about the single-family building? Are we building too much on the multifamily side as well?

Zelman:

Well, the pipeline is not as severely overbuilt in terms of what’s coming. In single family we’re saying we’re looking at the current level of latest 12 month starts. We’re going to be overbuilding by about 20% and multifamily by about 10% to 12%. The multis continue to accelerate, but what I think is from a policy perspective is just thinking about a lot of concentrated supply is coming that is rental stock that is actually not affordable rental stock … Again, it all goes back to the land. Whether you’re an apartment developer or you’re a build-for-rent developer, the cost of land has surged. So they can’t deliver a product that would really meet what would be affordable for those … are sitting unfortunately in maybe less pleasing accommodations or living with their parents longer because what we’re developing is just not affordable. There may be a little bit now. We have some of the startups that are doing 3D printed homes, but even those homes are being done are in the hundreds [of thousands] as opposed to something below $100,000 a year.

Willison:

One last question. President Biden has re-nominated chairman Powell for the Federal Reserve. Assuming he gets confirmed by the Senate, what’s one piece of advice that you would give Chairman Powell?

Zelman:

Well, I think that he needs to reevaluate his current policy as it relates to purchasing $40 billion a month of MBS {mortgage backed securities]. This doesn’t make any sense to me. I think it’s terrible policy. Is there the need to taper sooner that you can’t keep just providing so much accommodation to an economy that’s already showing significant signs of inflation. If the homeownership rate is on a continued upward trajectory. and we have what is obviously a significant home price inflation by keeping rates artificially low. We’re just juicing it. It’s like everybody at the party and  Powell is the bartender. So the bartender needs to close the bar for a while and let the economy feel the pain that no one wants to feel. At some point it’s just like the asset inflation is just …. the asset bubble just gets bigger and bigger. I would tell Chairman Powell to pull his foot off the gas.

Willison:

Ivy, you’ve been a great guest for my first two episodes of the second year of the Arch Mortgage Insurance PolicyCast. Thanks very much for taking the time.

Zelman:

Well, thanks for having me.