The coronavirus has been the toughest force behind the recent volatility in real estate markets, which has been running uninterrupted since October 2019. We should be aware that real estate markets could react ahead of the peak of the epidemic, as they tend to overreact at the beginning of a crisis and then stabilize and rebound, despite the continuation of negative news. Unless this doubt is able to disrupt our economy into a shock wave – which not happened so far – excessive downward setbacks could provide an opportunity for investors to acquire real estate with attractive valuations and good fundamentals.
Brexit and the US/China trade impasse were the headline stories of 2019, but the probability of a worst-case scenario on both issues has meanwhile clearly diminished. We see sufficient goodwill in the most recent US/China rhetoric to suggest that some of the previously announced tariffs could be cancelled rather than just postponed. Such an outcome might provide much needed confidence. However, the US economic growth is expected to slow down in the near term, as the effects of weak growth, uncertainty and slower hiring continue to weigh on real estate investment. Nevertheless, policy actions by the government and the central bank to ease and maintain supportive financial conditions, lower rates, coupled with sound economic activity in the US service sector and robust job creation should result in sustainable growth of disposable income, strong domestic demand and private consumption, and thus drive US GDP higher in 2020. The US housing market could become a further source for an acceleration of economic growth in the US. Moreover, credit score requirements for new mortgages have eased compared to the level in 2018.
The decline in mortgage rates in 2019 has substantially improved the buy-to-rent and payment-to-income affordability ratios. According to the US Census Bureau, the median price-to-rent ratio (median home value divided by the median annual rent equals the median price-to-rent ratio) has fallen to 17.91, a level which compares to the ratios seen in 2015/2016 and is only slightly higher than the median ratio of 16 from 2004 to 2006. In 2007/2008, during the period when the US real estate market heated up, this ratio moved to 24.5, and then declined in the aftermath of the financial crisis back to below 20 in 2011. A very similar picture emerges by looking at the payment-to-income affordability ratio, which also stands at levels comparable with those of 2015/2016.
Another phenomenon is now clearer. The excess homes built prior to the crisis have finally been digested, and the US housing market is now entering a period of overall scarcity, in which potential housing demand exceeds housing starts and housing inventories. US household formation is now growing faster than housing starts, which indicates that investments to grow the housing stock are needed to fill this gap. `Average annual household formations have risen since the period between 2013 and 2016, when they stood at around 1 million per year, and in 2019 now stand at approximately 1.45 million, an acceleration of about 45%, according the US Census Bureau. For the period 2017 to 2019, housing starts dropped behind household formations when they increased by only 18%. Against the backdrop of low funding costs and robust income projections for the next couple of years, this might result in excess demand for new apartments, and given an income multiplier greater than one, residential investment spending could spur GDP growth in the US.
Benefits of the partial solution for the US/China trade tension and the definitive Brexit decision will, however, outweigh the increasing concerns with respect to the outbreak of the novel coronavirus in China. We believe these corrections in real estate prices are only temporary in nature. We therefore currently do not intend to change our projections or our recommendations to purchase real estate in “pockets of opportunity” as pointed out in our quarterly research report MARKET CYCLES.
