We sat down with Ali Wolf, chief economist at Zonda, to discuss housing supply, economic uncertainty, inflation, recessions and how builders can gain market share during changing times.
Paul Hanson, President of Epcon Franchising: Ali, I’ve heard a lot of different opinions on the level of housing supply across the country. What’s your take on that? Are we undersupplied, oversupplied or perfectly supplied as an industry?
Ali Wolf, Chief Economist at Zonda: When we look at the undersupplied environment, there are two ways to answer this question. Way one is acknowledging that as the market goes through peaks and troughs, we are a cyclical industry. We always have been. There will be periods that were undersupplied and periods that were over supplied.
If the market slows notably this year, you could have a very temporary point of time where the market does become oversupplied. Now, that’s only cyclical. That does not account for structural and more long‑term trends.
If you remove the cyclicality of the market, and you look at how the market has performed, in terms of how many new starts? How many new permits? What have we seen with vacancy? What have we seen with obsolescence? What have we seen with population?
If you roll a lot of those factors together, we are of the belief that the undersupply is between one and two million, two million being higher than our actual number. There are many reputable firms that also estimate one to two million. There are a handful of companies that are on the higher end saying three to four million. I think the latter estimates are high, but it all depends on the methodology.
Paul: With what we’ve seen, especially with specs being overbuilt in a lot of cases, in a lot of markets, then what you’re saying makes a lot of sense. That, yes, for six months or so, we might be a little oversaturated, but long‑term, fundamentally, we’re still at this number that indicates a healthy runway ahead for housing.
Ali: Exactly. There’s this number that comes up nationally, whether it’s zero to six million, that people say we’re undersupplied. Then there are a lot of organizations on the for-sale side, on the for-rent side, on the build-to-rent side, that are saying, “Oh, we’re six million undersupplied, we need to build whatever, wherever to match the demand.”
It felt like throwing caution to the wind over the past couple of years given that backdrop. The next important question from my opinion is– at what price points are we undersupplied? In what locations are we undersupplied? What kind of product is undersupplied?
There’s a next layer that becomes more complicated, more local, and more granular, almost to the street level. It’s a very important question.
I agree with you, though, that the fundamental undersupply supports some runway for homebuilding.
Paul: You mentioned build-to-rent. Where do you see that heading in the next year or two? I hear about massive amounts of money pouring into that. Is that getting overheated or is it already overheated? What’s your take?
Ali: It will depend on the market that you’re in. Let’s step back. Phoenix was the breeding ground for build-to-rent. There were a lot of companies that were going there. There were intersections, where on two sides of the intersection, there were build-to-rent communities competing with each other.
In the instances where capital was deployed at all costs, we will find that the rent growth softens, and maybe occupancy levels are not as high as originally projected.
In other markets, build-to-rent is still a very, very small share of the overall market, and does provide an opportunity to have a single-family home with a backyard, typically in a good school district, without having consumers bring money towards the down payment.
There may be a reckoning day for some. We ultimately believe that this is an asset class that serves a purpose and is here to stay, as long as we don’t see too much of an oversaturation in a given market.
Paul: If you’re seeing it everywhere in your market, then it’s probably oversaturated. If you’re not seeing a lot of it and you feel people are talking about needing it, then it’s not.
Ali: Yes. That’s a nice, simple way to say it.
Paul: There’s a lot of economic uncertainty out there. What advice would you give to builders that want to gain market share during uncertain times?
Ali: It all goes back to the fundamentals of location, location, location. What we have found is even as the market has shifted, A locations and B locations are holding up way better than some of the riskier land deals/locations.
Builders need to stay focused on consumer research and thinking through what the long-standing desires of consumers are.
You should ask yourself: When there are two or more competing products, why would a consumer choose you over your competitor? A great sales team can help. Proper training, proper education, acknowledging how the market is shifting, and thinking through what matters to the consumer become imperative for your customer-facing team.
Paul: You mentioned sales teams. It’s been tough to know who your good sales performers are and who isn’t because anything moved in the last couple of years.
Ali: A lot of people in the industry are saying, from a consultant side, from a supplier side, from a builder supply side, all of us were just taking orders.
We were just so busy and that clients were coming from everywhere. What we’re finding now is it’s going back to sales. It’s going back to one‑on‑one. How do you communicate with the client? How can you offer them what they want? How can you identify their pain points and address them? Back to the fundamentals.
Paul: A lot of people anytime, there’s an economic change, they start to tie it to the last time that there was an economic change. A lot of people are wondering if we’re on the precipice of something like what we experienced 15 years ago. Could you give me your thoughts on the differences in fundamentals for housing now versus what they were in 2007, 2008?
Ali: The most notable would be the policy changes that came in response from the Dodd‑Frank rules. The regulation was put in place to say, “We know how catastrophic a housing bust is, and we do not want to see another one of those.”
What that’s done is resulted in really solid buyers. During the last cycle, 26 percent of all loans originated had a credit score under 660. Today, it’s 6 percent. Last cycle, 24 percent of all borrowers had a credit score of 760‑plus. Today, it’s 70 percent.
You can see it from overall credit score fundamentals. You can see it from debt‑to‑income ratios. We can see it in down payment funds. All of those factors are different, plus supply. For example, we talked about how there may be some cyclical overbuilding, but nowhere near the prolonged year after year of overbuilding that we saw last cycle.
If there is any kind of home price correction (we forecast there will be), the expectation is it becomes more concentrated and less of a catastrophic spiral, like we saw last cycle. Last cycle, we had more years of home price appreciation that caused a cascade effect when home prices started to come down. We saw more people get locked in, more foreclosures, more job losses.
The main thing I will say linked back to last cycle is we did see exuberance come into the market over the past two years.
Paul: A lot of apples and oranges, and those credit score numbers are just incredible. The differences in how that has flipped over the last decade or so is very encouraging. I read an interview with you recently, where you talked about how housing tends to slow faster than the rest of the economy, but then also rebounds quicker than the rest of the economy. Could you expand upon that a little bit, why do you think that happens?
Ali: What I think is the core piece to understand is as we go through an economic expansion, we start to get into an environment where the market feels overheated. That matches up with today’s economy. We have inflation that’s running hot at the same time that we have unemployment back at 3.5 percent.
When that happens, the Federal Reserve’s tool to control that is to start raising short‑term interest rates. Now, as we know, short‑term interest rates are not mortgage rates. Generally speaking, when the Fed starts raising those short‑term interest rates, you would expect to see mortgage rates rise as well.
Now you have the most interest‑rate‑sensitive industry that is starting to run into higher interest rates. That’s one of the tools that our policymakers can do to control the economy, is to raise borrowing costs to slow growth. Because we’re so interest‑rate‑sensitive, we slow a lot quicker than other parts of the economy.
On the other side, though, you then go through this period where the housing market slows, and then the broader economy slows. Think about the housing industry. For every home we build, we create three jobs.
For every home that is purchased, people spend money at so many other places in the economy. They work with a realtor. They work with an escrow company at the point of sale. They work with a mortgage broker. Then after they move in, maybe they go to Home Depot or Wayfair or Target more.
If you have housing contracting, you’re not contributing to the job growth anymore, and you’re not contributing to consumer spending, which is 70 percent of the economy. You can see the broader economy come down as a result of slowing housing.
Once we get to a point where it feels that the market has slowed enough, the Federal Reserve starts to cut rates. As the Federal Reserve cuts rates, we’re one of the industries that’s obviously going to feel it the most.
It’s been interesting to watch, at least this cycle, as the rest of the economy seems like it’s humming along. At the same time, housing has cooled. If you ask me, that’s really following a textbook example of how a market progresses.
Paul: Great explanation. Inflation is obviously a big question on everyone’s mind right now in the summer of 2022. Do you feel that we’ve peaked, or do we still have work to do on that front?
Ali: I think the two numbers that you can pretty easily get wrong in this market is forecasting mortgage rates or inflation. I will give you my take, but I want to set that as the backdrop.
When we look at inflation, one month does not make a trend. Though the most recent data that came out does support that, maybe there’s a little bit of a rollover in terms of overall inflation. There’s a lot of ways that you can cut it. Shipping container costs have come down. Gas price costs have come down. Major retailers have found a little bit more inventory available. They’re offering sales maybe at a time when they normally wouldn’t. In the for-sale housing market, some sellers are dropping their list price.
From housing’s perspective, we don’t directly contribute to or pull back from the overall inflation level because of how inflation is calculated. It’s calculated by what is known as owner’s equivalent rent.
If we start to see that homeowners believe they can’t rent their home a lot more than what they were renting it for last month, and what they were renting it for last year, and that number starts to come down, you could see inflation come down a bit in response to that as well.
There are signs that inflation has already started to roll over, and could continue to, with the biggest risk being what we’re seeing out of the Port of Los Angeles. They have a lot of demand still at the ports but they don’t have enough workers. They’re concerned that we’re going to start to run into some of the supply chain problems again.
If that happens to be true, then I think we may see a little bit of a break in inflation with it turning back around. I would say our best case is that we believe we’ve hit peak inflation.
Paul: When it comes to indicators that you’re looking for as you analyze inflation and where it’s headed, are you more concerned or equally concerned with what the Fed does with rates, what you expect the Fed to do with rates or with the monetary supply?
Ali: The answer is both. What still feels like a risk to the market is quantitative tightening and the Fed trying to offload some of their balance sheets. Especially how they played into the mortgage‑backed security market.
I am not an expert on how that plays out. My understanding is that could have an impact on where rates go and how that plays into consumer demand. I think when we look at Fed policy, they’re continuing to raise rates to slow inflation. They’re starting to see that it’s working.
I think they’re going to need to continue to be aggressive. Moving from 9 percent inflation to 8.5 is going in the right direction. 8.5 is still way above 2. I’m anxious about both of those factors. A problem is that the Federal Reserve is making decisions off of data, which of course makes sense.
As we all know though, data lags, is sometimes confusing and sometimes gives you mixed messages. Fed officials run the risk of having a policy mistake, just because there are so many unprecedented moments this cycle, a lot of unknowns and a lot of contradictory data in the overall economy right now.
Paul: Last question. You’re one of the first economists that I’ve ever heard preach that a recession is not technically two negative quarters of a contraction or two consecutive quarters of economic contraction. Based on that, that there’s a number of things to look at, and it’s sometimes even decided in hindsight, do you feel that we’re in a recession right now or not?
Ali: This is a really interesting and important question. The first thing you need to know is that we were doing presentations on this back in 2017. We were saying, “I know everyone thinks a recession is two consecutive quarters of negative GDP growth, but there’s a group called the National Bureau of Economic Research that has an actual definition, which is a general decline in economic activity, spread across multiple sectors, lasting more than a few months.”
There are a few reasons why that’s important. The first thing is, like you said, Paul, we will find out about a recession in hindsight. You will be in one and you won’t technically know that you’re in one, because the group hasn’t called it. They usually wait 6 to 12 months to officially call it.
With that being said, typically, what the group does is wait until the economy has hit peak, and then starts to contract. Oftentimes, the way they measure peak is the last month that employment growth is positive is the official start of the recession, and then you go negative.
It’s a complicated way that they define it. I think we’ve seen certain sectors in the US economy that are past peak. Housing is a clear example. We’re past peak where we were. In the broader economy, we continue to add jobs.
Based on what I know today, I don’t believe we’re in a recession, though I don’t think we’re far off from one.
The last thing I’ll say is whether or not we’re in a recession, the talk, and talk, and talk of a recession plays into consumer confidence and spending. We could talk ourselves into a recession. You can’t open the news without hearing about a recession. Consumers will react accordingly in some cases.
If they pull back spending, we know how much consumers contribute to the economy, so they can slow the market. Our belief is it’s more of a run‑of‑the‑mill recession. We don’t think it’s a mid‑2000s recession. We think it looks shallower and that we’ll get back to growth in a quicker timeline.
Paul: Thanks so much, Ali. Really enjoyed talking to you.
Ali: Thank you, Paul.
To hear more from Ali Wolf, check out Epcon Experts Podcast With Ali Wolf on the State of the Economy.