Real Estate Updates // December 8, 2024

I would like to share a few headlines and a brief analysis of the Real Estate and [Housing] Development industry from the last few days. I hope you find them insightful:

• New York City Council members have passed the "City of Yes" plan, aimed at creating up to 80,000 housing units by making certain zoning changes. Among other provisions, the plan calls for reducing parking minimums and could clear the way for more office-to-residential conversions. The measure aligns with Mayor Eric Adams' goal to add 500,000 homes to the city in a decade.

• The U.S. multifamily housing sector is confronting challenges of overbuilding and overpaying, particularly in the Sun Belt region. Short-seller Carson Block highlights that many multifamily properties in this area are facing significant issues, a concern that has not been fully recognized yet. Despite these challenges, the multifamily sector is not expected to face a downturn as severe as the office sector. However, the current dynamics underscore the importance of careful market analysis and strategic planning to navigate the complexities of overbuilding and overpaying in the multifamily housing market.

• Multifamily development has continued to decrease, with new construction starts falling to an annualized rate of 325,000 units, according to Yardi Matrix 's third-quarter forecast. Construction starts have fallen significantly compared with 2022 and 2023, but the overall pipeline remains sizable, partly as a result of lengthy completion timelines. Completions could stay elevated in 2025 before moderating in the second half of 2026.

• Multifamily vacancy rates declined to 5.3% in the third quarter, closer to the long-term average of 5%, as demand outpaced new deliveries, according to 世邦魏理仕 . Year-over-year rent growth remained steady at 0.3%, with the Midwest experiencing the highest growth at 2.7%. Net absorption reached 153,300 units, the second-highest tally for the quarter since 1985.

• In the second quarter of 2024, the U.S. multifamily housing market experienced a significant increase in apartment completions, reaching 118,600 units - the highest quarterly total in recent years. This surge in supply has led to a decline in absorption rates, with only 55% of new units rented within three months of completion, down from a peak of 75% in the third quarter of 2021.

The trend of rising completions and declining absorption rates is evident across various time frames:

• Six-Month Absorption: For units completed in the first quarter of 2024, 75% were rented within six months, down from 88% in Q3 2021.
• Nine-Month Absorption: Units completed in Q4 2023 had an 83% absorption rate within nine months, a decrease from the 96% peak in Q3 2021.
• Twelve-Month Absorption: For units completed in Q3 2023, 93% were rented within a year, below the 98% peak in Q3 2021.
• This pattern suggests that the rapid increase in new apartment supply is outpacing demand, leading to slower absorption rates across multiple time frames. The data indicates that the multifamily housing market is adjusting to the influx of new units, with absorption rates declining as completions rise. This trend underscores the importance for developers and investors to closely monitor market dynamics to align supply with demand effectively.

• In the year ending October 2024, U.S. apartment retention rates increased, with just over 54% of market-rate renters renewing their leases, a 120 basis point rise from the previous year. By encouraging renewals, operators aim to maintain occupancy levels, allowing new leases to contribute directly to net absorption. Historically, renewal rates averaged 50.7% nationally from 2010 to 2019, peaking at around 57% during mid-2022 due to pandemic-related factors. Overall, the trend indicates a concerted effort by operators to "keep the back door closed," ensuring that new leases bolster occupancy rates amid a competitive housing market.

• The apartment supply market is experiencing varied trends across major US metros, according to a RealPage, Inc. analysis. About half of the largest metros are six months to a year from peak supply, while a dozen have already passed it. Meanwhile, in urban Los Angeles, the supply peak may not be reached until 2026 or 2027.

"Housing Cost Burdens Climb to Record Levels (Again) in 2023"

• In 2023, housing affordability in the U.S. worsened, with a record 42.9 million households - approximately 30% of all U.S. households - spending more than 30% of their income on housing costs, marking a 2% increase from the previous year. Additionally, 21.5 million households were severely cost-burdened, allocating over 50% of their income to housing, also an all-time high.

• The majority of this increase was among homeowners, whose numbers rose by 650,000 in 2023, totaling 20.3 million cost-burdened households. This surge is attributed to rising housing costs and stagnant incomes, with median monthly costs for homeowners increasing by 6% in 2023 to $1,327, an 18% rise since 2019. For homeowners without a mortgage, costs have escalated by 28% since before the pandemic, driven by higher insurance premiums and property taxes.

• Housing Becoming Unaffordable for First-Time Homebuyers: Only 24% of homes purchased at the moment are bought by first-time homebuyers. This is the lowest level on record, see chart below.

• According to a recent analysis by Realtor.com, five major U.S. metropolitan areas offer the most affordable housing, with over 60% of households able to purchase a median-priced home. In contrast, less than 30% of households can afford homes in the least affordable metros, such as Los Angeles, San Diego, San Jose, and New York City. These affordable metros provide significant value for potential homeowners, offering reasonable home prices relative to local incomes.

Families Must Spend 38% of Their Income on House Payments

In the third quarter of 2024, the National Association of Home Builders (NAHB)/Wells Fargo Cost of Housing Index revealed that a median-income U.S. family, earning $97,800 annually, needed to allocate 38% of their income to afford mortgage payments on a median-priced new home. Low-income families, defined as those earning 50% of the median income, faced even greater challenges, requiring 75% of their earnings for the same mortgage.

• These affordability pressures were consistent across both new and existing homes. Notably, there was no change in the percentage of income needed to purchase a new home between the second and third quarters of 2024. However, affordability for existing homes improved slightly during this period, with the income share for median-income families decreasing from 39% to 38%, and for low-income families from 79% to 75%.
• Regionally, certain metropolitan areas exhibited severe cost burdens. For instance, in San Jose-Sunnyvale-Santa Clara, California, a typical family needed 85% of their income to afford a median-priced existing home. Other notably burdened areas included Urban Honolulu, Hawaii (75%), and San Diego-Chula Vista-Carlsbad, California (70%).
• These findings underscore the persistent housing affordability crisis in the United States, highlighting the disproportionate financial strain on low-income households and significant regional disparities.

Construction Spending

• Total construction activity for October 2024 ($2,174.0 billion) was 0.4 percent (+/-1.2 percent)* above the revised September 2024 ($2,164.7 billion).
• October 2024: +0.4* % Change
• September 2024 (r): +0.1* % Change
• Construction spending climbed 0.4% in October, according to the Commerce Department, surpassing the expectations of economists surveyed by Reuters. Despite an increase in mortgage rates, spending on residential construction projects increased 1.5%, with single-family project outlays growing 0.8%. However, public construction spending declined 0.5%.
• In October 2024, U.S. multifamily residential construction spending rose slightly by 0.16% month-over-month to $125.4 billion but declined 6.8% compared to October 2023, reflecting a year-long downward trend. Previous estimates for multifamily spending were also revised downward, highlighting consistent reductions. In contrast, single-family construction spending increased by 0.79%, continuing its upward trajectory. Residential improvement spending grew more significantly, with a 2.7% month-over-month rise. Total private residential construction spending, including new builds and improvements, reached $934 billion, a 6.4% year-over-year increase. The multifamily sector shows potential stabilization but remains below peak levels, emphasizing the need to monitor broader housing market trends.

• In October 2024, the U.S. construction labor market showed signs of easing. The number of open construction sector jobs decreased from a revised 258,000 in September to 249,000 in October, down from 413,000 a year earlier. This decline reflects reduced demand in the construction industry. In contrast, the overall economy saw an increase in job openings, rising from 7.37 million to 7.74 million in October, though still below the 8.69 million reported a year ago, indicating a softening labor market. The construction job openings rate fell to 2.9%, and the layoff rate decreased to 1.2%, the lowest in the data series since late 2000. These trends suggest a cooling in the construction labor market, aligning with broader economic indicators.

• New Residential Construction: Privately-owned housing starts in October 2024 were at a seasonally adjusted annual rate of 1,311,000. This is 3.1 percent (+/- 11.6%)* below the revised September 2024 estimate of 1,353,000.
• October 2024: -3.1* % Change
• September 2024 (r): -1.9* % Change
• Construction Industry Braces for One-Two Punch: Tariffs and Deportations

In October 2024, the Producer Price Index (PPI) for inputs to new residential construction - excluding capital investment, labor, and imports - decreased by 0.2% from the previous month. However, on a year-over-year basis, this index rose by 0.3%, reversing a 0.1% decline observed in September.

The goods component of this index, which accounts for approximately 60% of the total, increased by 0.3% in October compared to September. Within this segment, prices for inputs excluding energy - primarily building materials - were up 2.0% year-over-year, marking an acceleration from the 1.4% increase noted in September. Conversely, energy input prices continued their downward trend, falling by 13.1% over the same period, marking the third consecutive annual decline.

At the commodity level, significant price movements were observed in key building materials:

• Ready-Mix Concrete: Prices increased by 0.3% in October and were up 6.5% year-over-year.
• General Millwork: Prices rose by 0.2% for the month and 3.1% annually.
• Paving Mixtures and Blocks: Prices saw a 0.1% monthly increase and a 2.4% annual rise.
• Sheet Metal Products: Prices remained unchanged in October but increased by 1.8% over the year.
• Wood Office Furniture/Store Fixtures: Prices decreased by 0.1% for the month but were up 0.5% year-over-year.

These trends indicate a complex landscape in the construction industry, with building material prices experiencing modest increases, while other input costs, particularly energy, continue to decline. This dynamic suggests a nuanced impact on overall construction costs, influenced by varying price movements across different input categories.

• US mortgage rates have fallen for a second consecutive week, with the average for a 30-year fixed loan dropping to 6.69%, according to Freddie Mac Multifamily . Meanwhile, "purchase demand has notably improved," says Sam Khater, chief economist at Freddie Mac , even though rates remain above September levels.

• Mortgage application volume was up 2.8% last week as the average rate on a 30-year fixed-rate mortgage declined to 6.69%, according to the Mortgage Bankers Association.

• There was a 59% increase in commercial and multifamily mortgage loan originations in the third quarter of 2024 compared with the same period during the prior year, according to the Mortgage Bankers Association . Nearly all property types saw an increase in loan volume, with health care loans gaining 510% year over year.
• President-elect Donald Trump’s administration may revive plans to privatize Fannie Mae and Freddie Mac, the government-backed entities supporting 70% of U.S. mortgages. While supporters argue privatization could transform the companies and benefit stakeholders, critics warn it could raise annual mortgage costs by $1,800–$2,800, disproportionately affecting low-income borrowers. Privatization would likely remove government guarantees, making mortgage-backed securities riskier and driving up borrowing costs. The housing market, already strained by high mortgage rates, tight inventory, and soaring prices, could face further challenges. Proposed tariffs on imports may also fuel inflation, keeping borrowing costs elevated.
• Next year, Fannie Mae and Freddie Mac will raise their conforming loan limits, allowing them to back mortgages of up to $806,500, representing a 5.2% increase.

The 2025 housing market is poised for notable changes under President Donald Trump's administration, as outlined in Realtor.com's recent forecast. Key projections include:

• Mortgage Rates: An average rate of 6.3%, with a slight decrease to 6.2% by year's end.
• Home Prices: A 3.7% increase, continuing the upward trend since 2012.
• Inventory Levels: An 11.7% rise in existing home inventory, marking the highest availability since December 2019.
• New Construction: Single-family home starts are expected to grow by 13.8%, reaching 1.1 million units—a level not seen since 2006.
• Read more here.

• The National Association of Home Builders/Wells Fargo Housing Market Index climbed to 46 this month, up 3 points, marking the highest reading in seven months and surpassing the estimates of economists polled by Bloomberg. The survey also found that 31% of builders have lowered prices to attract buyers.

• Housing markets with pre-pandemic inventory levels have seen softer price growth or declines over the past two years, while markets with persistently low inventory have generally experienced stronger price growth. According to ResiClub, Nationally, active listings have risen significantly (+26.2% year-over-year as of November 2024), granting homebuyers more leverage and even creating buyer’s market conditions in some regions. Despite this increase, national inventory remains 16.6% below November 2019 levels, with tight conditions persisting in some areas. In contrast, markets in parts of the Sun Belt and Mountain West are no longer experiencing the same inventory constraints, reflecting regional variations in housing dynamics.

• In the third quarter of 2024, U.S. house prices experienced a 5.1% year-over-year increase, marking the second consecutive quarter of decelerating growth amid elevated mortgage rates. Housing inventory has improved recently, but price appreciation varied across states and metropolitan areas. New Jersey and Connecticut led with 8.8% gains, followed by Rhode Island at 8.4%. Conversely, the District of Columbia had the lowest growth at 1.2%. Notably, 29 states surpassed the national average growth rate. At the metropolitan level, 21 areas experienced price declines, while 363 saw increases, ranging from -9.0% to +19.1%. Since the onset of the COVID-19 pandemic, national house prices have surged by 50.4%, with over half of metro areas exceeding this rate.

Freddie Mac’s latest analysis reveals a 3.7 million-unit housing shortage in the U.S., with the current housing stock at 147 million units, while 150.7 million units are needed.

• This gap has contributed to significant affordability issues, particularly for younger households. An estimated 1 million U.S. households have not formed due to high housing costs, with many young adults continuing to live with parents or friends. Freddie Mac attributes this to the affordability strain caused by the housing shortage. Additionally, the housing market has absorbed the shortage through rising home prices and rents, which occur when demand exceeds supply. Higher prices squeeze affordability, forcing many potential buyers or renters out of the market.
• Freddie Mac emphasizes that the root cause of decreased affordability is the failure to increase housing supply to meet demographic needs. Addressing the supply gap is critical for improving affordability and enabling more household formation.

• Inflation Adjusted House Prices 1.4% Below 2022 Peak:

• The price premium that buyers pay for new houses has been at about 3% this year through October, significantly below the historical average. The premium has declined in part because new homes are getting smaller, and builders have focused on less expensive materials.

• Pending US home sales rose last month, with a National Association of Realtors gauge tracking contract signings gaining 2%.

"Even with mortgage rates modestly rising despite the Federal Reserve's decision to cut the short-term interbank lending rate in September, continuous job additions and more housing inventory are bringing more consumers to the market."

- Lawrence Yun        

• New Home Sales: Sales of new single-family houses in October 2024 were at a seasonally adjusted annual rate of 610,000. This is 17.3 percent (+/- 12.8%) below the revised September 2024 estimate of 738,000.
• October 2024: -17.3 % Change
• September 2024 (r): +7.0* % Change

Office Conversions Find New Life After Property Values Plunge

• The decline in office property values has spurred a surge in office-to-residential conversions, addressing both rising office vacancies and housing shortages in urban centers. In 2024, over 70 such projects were completed, delivering more than 10,000 apartments, with an additional 94 projects underway and over 300 planned.

Total office conversions currently underway is about 71 million square feet, accounting for about 1.7% of U.S. office inventory, according to CBRE.        

• Developers are increasingly finding these conversions financially appealing, especially for outdated or poorly located buildings. Subsidies and tax incentives in cities like New York, Chicago, and Washington, D.C., are further encouraging these redevelopments to revitalize struggling downtown areas.

• However, not all office buildings are suitable for conversion due to structural and design limitations. Despite these challenges, the trend of repurposing office spaces into residential units is gaining momentum, offering a viable solution to urban housing shortages and underutilized commercial real estate.

• A study by the Cleveland Fed finds that rent inflation in the consumer price index may not decline toward prepandemic levels until mid-2026. Decreased mobility and fewer new lease signings may be keeping the rent component of the CPI elevated. This trend could complicate the Federal Reserve's thinking on interest-rate policy.

• Laws passed in San Francisco and Philadelphia limit the use of nonpublic data by rent-setting software, and other jurisdictions have similar laws under consideration. Meanwhile, the US Justice Department and eight state attorneys general are involved in a legal challenge of the rental software firm RealPage, Inc.
• Multifamily REITs have performed well in 2024, outpacing the broader REIT market. As of Nov. 13, multifamily REITs posted returns of 26.6% versus 10.3% for the FTSE Nareit All Equity REITs Index. Analysts from Baird , 瑞穗实业银行 Securities and 富国银行 say for 2025, fundamentals look solid based on expectations that supply has peaked, which should pave the way for improved pricing power going forward.
• Some mall owners are converting empty department stores or other vacant storefronts into housing projects. In some cases, these developments may include restaurants, outdoor spaces and other features.

"This is an opportunity to find land and have a built in customer base to get people into the mall."

- Jacob Knudsen of Macerich.        

• Private Equity Dry Powder Declining: The amount of dry powder in global private equity has started to decline from the peak in 2023, see chart below.

• Economists are pointing to positive signs for commercial real estate, citing expectations of lower interest rates and stabilizing asset values. Mariya Letdin of Florida State University, Abby Rosenbaum of Oxford Economics, Eva Steiner of The Penn State Smeal College of Business and Susan Wachter of the University of Pennsylvania discuss the trends they have observed this year as well as financing conditions and key developments going forward.
• The share of fully remote workers has fallen in 39 of the 40 largest markets over the past two years:

• A proposal to temporarily raise commercial property taxes in Boston has stalled in the Massachusetts Senate after revised data has indicated a less severe impact from declining office building values. State Sen. Nick Collins has delayed action on the plan from Boston Mayor Michelle Wu, citing the need to review tax assessment data.

Boston Rent Report:

• Rents in Boston fell 2.3% in November, compared to a 0.8% decrease nationwide. Month-over-month rent growth in Boston ranks #1 slowest among the nation's 100 largest cities.
• Year-over-year rent growth in Boston now stands at +0.6%, down from +2.8% one year ago.
• Today the median rent in Boston is $2,254 for a one-bedroom unit and $2,373 for a two-bedroom unit. And the citywide apartment vacancy rate stands at 5.8%, up 0.1 percentage points from this time last year.

• Watch CoreLogic Chief Data & Analytics Officer John Rogers at ResiDay discussing housing market's insurance shock.