HOUSING MARKET ANALYSIS - Supply and Demand Pacey Economics, Inc. January 6, 2015
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HOUSING MARKET ANALYSIS
Supply and Demand
Pacey Economics, Inc.
January 6, 2015EXECUTIVE SUMMARY
Concerns over the lack of condominium construction in the Denver area have led some to
allege fault in the existing construction defect laws, and to argue that further limiting a
homeowners’ avenue for remedies will reduce costs to builders, who will then choose to
construct more condominiums in the Denver area urban centers. However, a careful analysis
reveals that the reasons for the lack of condominium construction are the current low
demand for such housing and stricter financing qualifications for builders and owners, both
of which are primarily consequences of the recent recession and the credit market scandal
and upheaval, and not construction defect costs. As will be demonstrated in this report, the
lack of demand resulted in low condominium sales prices, making apartment construction
more profitable in the Denver urban centers.
Denver Area Apartment Value The market value of apartments relative to
Relative to Detached Home Value detached homes has grown steadily since 2006,
creating a clear market incentive to build
100.0 apartments. Further, our observations on
historical condominium prices from various
95.0 data sources (i.e., housing market data
websites) indicate the growth in apartment
90.0
values relative to condominium values has been
85.0
even greater than to detached housing. (We are
seeking permission to reprint this information.)
80.0
2000 2005 2010
Sources: U.S. Federal Reserve; Colorado Department of Local
Affairs, Division of Housing
These market conditions are not unique to Denver, but have been a nationwide phenomenon in
cities where rapid apartment building and rising rents have become the norm over the past several
years.
The following chart shows there was a surplus of condominiums constructed in 2009 (reflected in
the increase in the number of unsold units). In response to the slow sale of condominiums during
that period is the supply response of reduced construction, reflected locally in the dramatically
reduced number of permits (which may or may not result in actual buildings) issued for
condominium construction in the Denver area between 2006 and 2013. The chart also shows that
condominium building activity in Denver parallels that of the Western region of the U.S. Also,
(although not shown on the chart) the behavior of condominium completions for the U.S. is nearly
iidentical to that of the Western region trend (just larger volume). Of note, the shift between the
Denver permits and Western completions likely reflects the time it takes, from one to two years,
for a building to be completed after a permit is issued.
Condominium Completions & Sales
30,000 3,000
Condos Completed - West Region
25,000 2,500
Condo Permits - Denver
20,000 2,000
15,000 1,500
10,000 1,000
5,000 500
0 0
1995 2000 2005 2010
Condos Completed - West Region
Condos Not Sold in 6 Months - West Region
Denver Condo Permits
Sources: U.S. Census Bureau (Western Region includes CO, NM, WY, MT, AZ, UT, ID,
WA, OR, NV, CA and AK); Denver Metro Area Housing Diversity Study
It is an economic reality that the 2008 financial crisis and the residual effects from the Great
Recession resulted in low demand for many goods and services, including housing products.
Stringent lending requirements, typically manifested in higher down payments and higher
credit scores, plus increased origination fees and mortgage insurance premiums that were
put in place following the housing bubble served to correct some of the lending issues BUT
also led to increased difficulty in qualifying for home ownership (i.e., reduced demand). The
charts below illustrate the negative impact of the lending requirements on changes on
housing ownership.
Higher Down Payments
$25,000
$20,000 If a buyer could have purchased a
$15,000 $200,000 home with a 3% down payment,
$10,000 but now must put 10% down, this will
$5,000 result in additional closing costs of
$0 $14,000.
3% Down 10% Down
payment payment
iiInitial Fees and Charges on Conventional 30
Year Fixed Rate Non-Jumbo Single Family Loans
Initial fees and charges for conventional
2.00
loans have increased from 0.45% in 2005 to
Percent
1.60 1.30% (nearly three-fold) in 2014. Although
seemingly small on a $200,000 mortgage,
1.20
this increase will amount to an additional
0.80 $1,700 up-front charge to the homebuyer.
0.40
0.00
1990 1994 1998 2002 2006 2010 2014
Initial fees and Charges (%)
Source: Federal Housing Finance Agency
Mortgage Insurance Premiums for FHA Loans
with Terms Greater than 15 Years Annual premiums for FHA loans increased
1.6% from a low of 0.50% circa 2008 to current
1.30%
annual rates of 1.30% (more than double).
1.2% Also, the time required to pay the mortgage
insurance premium was dramatically
0.8% increased resulting in further long term costs
0.50%
to the buyer. Because many FHA loans are
0.4%
for buyers who cannot afford a large down
payment, these costs substantially increase
the cost of owning a home. In our example,
0.0%
2008 2013 a .80% increase on a $200,000 purchase will
add another $1,600 annually.
Source: U.S. Department of Housing and Urban Development;
Rates represent the minimum.
Average Weighted Credit Scores for Freddie
Mac 30-Year Fixed Rate Loans Further, mortgage companies Freddie Mac
and Fannie Mae now require higher credit
780 766 scores to be eligible for a conventional loan.
763 762
(The same is true for FHA loans which are
750 741 typically more applicable to first-time
homebuyers). The higher credit score
725
712
requirements remove a subset of the
720
population that would otherwise be willing
to buy a home.
690
660
1999 2002 2005 2008 2011
Source: Freddie Mac
iiiIn addition to the more stringent lending requirements, depressed wages and high
unemployment over the past several years, consequences of the 2008 recession, made
homeownership of any kind less affordable across all ages, and to first-time homebuyers in
particular.
Current Real Income as a Percent of Real
Income from Approximately a Decade Ago
Every age group has experienced some loss
of purchasing power, but the greatest
reduction is for the younger generation
100%
(generally first-time homebuyers) whose
90% real income is only 82.7% of what they
earned approximately a decade ago. These
80% lower real incomes result in a downward
“shift” in the demand for housing, as well as
70%
other goods and services.
60%
50%
26-30 31-40 41-50 51-60 61-70
Age
Source: Bureau of Labor Statistics: Current Population Survey
Unemployment Rates for the Denver
Metropolitan Area In addition to falling real income, the
recession resulted in high unemployment
10
rates in the Denver metropolitan area (as
9
Percent
well as nationally).
8
7
6
5
4
3
2
1
0
2000 2003 2006 2009 2012
Source: Bureau of Labor Statistics
ivColorado Unemployment Rates by Age
40% When sorted by age, younger workers
(again, the most likely to be first time
30%
buyers) have experienced and continue to
20% experience higher rates of unemployment.
10%
0%
Age
Source: Bureau of Labor Statistics
Further aggravating these factors are the natural demographic changes that are taking place
in our society. The Millennials are coming to the age where home buying traditionally begins
to take place. However, due to a myriad of factors including increased student debt,
decreased marriage rates and p o s t p o n e d c h i l d b e a r i n g , younger generations are
delaying forming households of their own, further dampening the demand for
homeownership.
Average Debt of Colorado Four-Year Graduates
$25,000 The average debt of Colorado four-year
college graduates increased from
approximately $15,000 in 2004 ($18,200 in
$20,000 2012 dollars) to nearly $25,000 in 2012 (the
most recent year of available data), over a
one-third increase in real dollars. Such debt
$15,000 decreases the demand for housing, given the
debt-to-income requirements of lenders, as
well as the common sense of consumers.
$10,000
2003-04
2004-05
2005-06
2006-07
2007-08
2008-09
2009-10
2010-11
2011-12
Academic Year
Source: College Insights
vLikelihood of a 26-30 year old Owning a Home by
Marital Status
Married Never Married Marriage is highly correlated to
homeownership and married individuals
60% ages 26 to 30 are more than twice as likely to
50% purchase a home as those who have not
40% married.
30%
20%
10%
0%
National Colorado
Source: Current Population Survey
Likelihood of a 26-30 year old Being Married
National Colorado
However, the percentage of those aged 26
100%
to 30 and married has fallen in Colorado
80% from approximately 75% in the 2000s to 50%
today. The reduced number of young,
60% married individuals is yet another reason for
the decrease in the demand for home
40%
ownership in the Denver metro area.
20%
0%
1970 1980 1990 2000 2010
Source: Current Population Survey
Likelihood of an Urban 26-30 Year Old Living in their
Parent’s Home
Also, the percent of 26-30 year olds living at
Colorado National
home has increased by some 30% in the last
18% decade in Colorado, consistent with the
15% trends in national data.
12%
9%
6%
3%
0%
1977 1987 1997 2007
Source: Current Population Survey
viIt is another economic reality that when construction costs rise, supply will decrease. Labor
costs, materials costs, and construction insurance premiums (as well as the costs of remedy
or the costs of potential lawsuits), all affect the costs of building and ultimately, the
profitability to the builder.
Annual Payroll per Employee in the Construction
Industry
The average pay of an employee in the
National Denver construction industry steadily increased from
2005 to 2012. Construction labor costs for the
55,000 Denver Metro area have been substantially
more (15 to 20%) than the national average for
50,000
this class of worker, increasing Denver area
builders’ overall costs relative to the national
45,000
market.
40,000
35,000
30,000
2005 2007 2009 2011
Source: County Business Patterns, US Census
Producer Price Index of New Construction
220 The Producer Price Index is a more general
210
measure of new construction costs. This
index includes all of the costs of building
200 (e.g., labor, materials) weighted by their
190 respective usage. The Producer Price Index
shows that the costs of new construction
180
increased by more than 20% from 2006 to
170 2013, putting downward pressure on the
overall supply of housing.
160
150
2006 2008 2010 2012
Source: Bureau of Labor Statistics
The data illustrated in the previous charts show that costs have increased for builders in
recent years, which will negatively impact both the supply of housing products as well as
the profits to developers and builders.
viiConstruction insurance premiums and costs of construction defects and/or associated
litigation are factors that impact the supply of housing, with increased (decreased) costs
having a negative (positive) impact on the supply of housing.
However, we were unable to obtain relevant empirical data to ascertain the trend
of insurance premium costs (and associated coverage) or litigation costs.
These data exist but are only available from the developers/builders who claim
the current construction defect laws make building condominiums exorbitantly
expensive (apparently because litigation or the threat of litigation).
While this data could be voluntarily produced by the industry or gathered
through legislative action, neither has occurred to date.
Importantly, a careful analysis (the details of which are provided in the body of this study) of
construction defect statutes across the nation shows that Colorado laws are quite similar to
(and less onerous to the Colorado developer/builders) than those in many other states. In
addition, we observe that:
If, in fact, lawsuits or the threat of lawsuits or high insurance rates are the reason
for reduced condominium construction, then the proper solution is to
preemptively prevent construction defects from occurring.
Preventing construction defects can be accomplished with quality control
processes that have been developed over the last several decades and utilized by
apartment owners and other industries that require quality assurance to their
customers. Providing quality control is a normal cost of business.
The solution to construction defect issues is not to make it easier to allow poor
workmanship or construction defects and then shift the subsequent costs to
unsuspecting consumers.
The earlier report by Environmental Planning Systems (EPS) found the Colorado construction
defect statute(s) are likely to increase the cost of a condominium construction per $15,000
per unit and such a cost increase would deter the construction of condominiums in Denver
urban centers. We found NO empirical evidence to support such a claim and we must
STRONGLY DISAGREE.
Even if one is willing, for the sake of the argument, to assume a $15,000 per condominium
unit cost increase (remember we do not believe this can be supported) due to increased
construction insurance premiums because of potential construction defect litigation, the EPS
claim cannot be supported for reasons outlined below:
viiiConsider a potential homeowner who is willing and able to purchase a $200,000
condominium unit but, because of the increased costs (from increased insurance premiums
due to construction defect litigation), the price is now $215,000 (i.e., the full cost is passed
on to the home buyer).
This new homeowner will have to amortize the $15,000 into a 30 year mortgage which
will amount to approximately $750 more in annual payments for the homeowner. EPS
seems to claim this will deter all construction by builders of condominiums.
Now consider this new homeowner faces a 10% down payment rather than a 3.0%
down payment, requiring $21,500 cash upfront rather than $6,450 or $15,050 more
cash needed for a down payment. This is a more dramatic barrier to purchase than
the additional $750 per year if the full cost of the builder’s insurance premium is
passed on to the new homeowner.
Now further consider, as noted above, that there is also an increase in the origination
fee which increased approximately 75 basis points in recent years (since 2007/2008)
adding $1,600 more in upfront costs and a mortgage insurance premium with an 80
basis point increase over the same time frame adding an additional $1,720 in annual
costs to the homeowner. Both are clearly more limiting for a potential homeowner
than the amortized annual cost of the fully passed on cost of the claimed cost of
construction defect litigation.
Finally, consider the earnings of likely first time buyers (26-30 year olds ) today is
only 83% of the earnings (real) of their counterparts a decade ago BUT housing prices
have increased, obviously making home ownership even more difficult.
Clearly, the increased down payment, origination fees, mortgage insurance premiums,
reduced real earnings are all more significant financial deterrents to home ownership than
any barrier from construction defect laws.
ixThe good news for the housing market is that economic activity is finally on the upswing in
Colorado and across the nation, allowing demand to rekindle and market forces to provide
both the demand and supply incentives necessary to induce condominium construction.
Also good news, markets are continuing to correct, unemployment rates
are reaching more normal levels, the economy is sustaining its recovery, and
incomes are starting to rise.
Further good news, banks are beginning to loosen their lending requirements
and interest rates still remain at low levels allowing the market to feed an
increase in the demand for housing products.
Also, if the Millennials’ delay in home buying is “pent-up” demand, there will
be a natural increase in the demand for housing products once they begin to
marry and have children.
Ultimately, when the price is right, which is determined by demand and supply in a market
economy, developers/homebuilders will focus on constructing condominiums again.
(Moreover, if there really was an unmet demand for condominiums, apartments can be
converted to condominiums.)
The demand for condominiums appears to be gaining momentum as prices of
condominiums are on the rise, which will result in more condominiums being built
as a part of the normal market process.
In fact, there are a half-dozen or more condominium projects either currently
being developed or in the planning and processing stages.
Limiting or restricting a homeowner’s avenue to remedy a construction problem by changing
the Colorado construction defect statute will not make the costs of repair go away.
Modifying the statutes will only shift the remedy costs to the individual
homeowner and/or future homeowner (via increased cost and/or reduced
property value), who had no way of knowing of this defect prior to purchase of
the housing unit.
In addition to shifting costs to the individual homeowner, the property value of
the entire complex will be reduced if the other owners have similar issues.
There is a further negative ripple effect from an individual homeowner to a
complex or neighborhood of homeowners to the overall community as property
values fall, lowering property tax values, and ultimately lowering city revenues and
services.
xThe Colorado construction defect statute serves two public policy purposes:
It assures homeowners or potential homeowners that there is an avenue to seek
remedies for poor quality construction issues; and
It signals to developers/builders that they are responsible for the production of
their product.
The construction defect statute serves the same purpose as the quality control requirements
in every industry, whether it is in the manufacturing of automobiles, aircraft, toys, agriculture,
etc. That is, as a consumer has no way to assess the product quality (or safety) of a product,
be it a home, a toy, an airline flight, procedures are in place through our regulatory or legal
system to insure that the consumer receives the product as advertised. Without quality
controls and avenues to remedy a problem, markets will not work efficiently.
xiTABLE OF CONTENTS
SECTION I: INTRODUCTION
SECTION II: THE MARKET FOR HOUSING
SECTION III: BASIC ECONOMICS OVERVIEW
SECTION IV: FACTORS AFFECTING DEMAND FOR AND SUPPLY OF HOUSING
TABLE I: FACTORS AFFECTING THE DEMAND FOR HOME OWNERSHIP
TABLE 2: FACTORS AFFECTING THE SUPPLY OF HOMES
FIGURE 1: CONDOMINIUM COMPLETIONS AND SALES
FIGURE 2: TOTAL HOME MORTGAGE APPLICATIONS FOR 1-4 UNIT FAMILY DWELLINGS
FIGURE 3: DENVER AREA APARTMENT VALUE RELATIVE TO DETACHED HOME VALUE
SECTION V: THE KEY DETERMINANTS IN THE DEMAND FOR HOUSING
FIGURE 4: CURRENT REAL INCOME AS A PERCENT OF REAL INCOME FROM APPROXIMATELY A DECADE AGO
FIGURE 5A: UNEMPLOYMENT RATES FOR THE DENVER METROPOLITAN AREA
FIGURE 5B: COLORADO UNEMPLOYMENT RATES BY AGE
FIGURE 6: PERSONAL SAVINGS AS A PERCENT OF DISPOSABLE INCOME
FIGURE 7: AVERAGE DEBT OF COLORADO FOUR-YEAR GRADUATES
FIGURE 8: TOTAL HOME MORTGAGE LOAN APPLICATIONS FOR 1-4 UNIT FAMILY DWELLINGS
FIGURE 9: FANNIE MAE SINGLE FAMILY LOANS
FIGURE 10: AVERAGE WEIGHTED CREDIT SCORES FOR FREDDIE MAC 30-YEAR FIXED RATE LOANS
FIGURE 11: AVERAGE WEIGHTED CREDIT SCORES FOR FANNIE MAE SINGLE FAMILY MORTGAGES AND PERCENT
OF LOANS WITH A CREDIT SCORE BELOW 620
FIGURE 12: INITIAL FEES AND CHARGES ON CONVENTIONAL 30 YEAR FIXED RATE NON-JUMBO SINGLE FAMILY
LOANS
FIGURE 13: MORTGAGE INSURANCE PREMIUMS FOR FHA LOANS WITH TERMS GREATER THAN 15 YEARS
FIGURE 14: INTEREST RATES ON CONVENTIONAL 30 YEAR FIXED RATE NON-JUMBO SINGLE FAMILY LOANS
FIGURE 15: LIKELIHOOD OF A 26-30 YEAR OLD OWNING A HOME BY MARITAL STATUS
FIGURE 16: LIKELIHOOD OF A 26-30 YEAR OLD BEING MARRIED
FIGURE 17: LIKELIHOOD OF AN URBAN 26-30 YEAR OLD LIVING IN THEIR PARENT’S HOME
FIGURE 18: PERCENT OF URBAN COLORADO POPULATION IN THEIR TWENTIES (20-29)
FIGURE 19: LIKELIHOOD OF HOME OWNERSHIP BY ETHNICITY – 2014
FIGURE 20: PERCENT OF THE URBAN POPULATION THAT IS A MINORITY (NON-WHITE AND/OR HISPANIC) IN
URBAN COLORADO
xiiSECTION VI: THE KEY DETERMINANTS IN THE SUPPLY OF HOUSING
FIGURE 21: LAND VALUES (HOME VALUE MINUS STRUCTURE COST) BY YEAR
FIGURE 22: ANNUAL PAYROLL PER EMPLOYEE IN THE CONSTRUCTION INDUSTRY
FIGURE 23: PRODUCER PRICE INDEX OF NEW CONSTRUCTION
SECTION VII: CRITIQUE OF EPS FINDINGS
SECTION VIII: CONSTRUCTION DEFECTS STATUTES
SECTION IX: THE DEMAND FOR CONDOMINIUMS IN PEER CITIES
FIGURE 24: PERCENT OF PAYROLL THAT IS PROFESSIONAL, FINANCE, MANAGEMENT, OR INFORMATION, IN 2012
FIGURE 25: LAND VALUES IN 2014 (HOME VALUE MINUS STRUCTURE COST)
SECTION X: CONCLUSIONS/FINDINGS
SECTION XI: AVENUES TO REACH GOALS OF METRO VISION 2035
APPENDIX A: CITES AND SOURCES
APPENDIX B: FIRM OVERVIEW AND AUTHOR BIOGRAPHIES
APPENDIX C: SUMMARY CHARTS
xiiiI. INTRODUCTION MetroVision 2035 sets an overall goal
to accommodate fifty percent (50%) of
As the country focuses on building for the region’s new housing and seventy-
the future, many cities, including five percent (75%) of new employment
Denver, are working to accommodate in urban centers by 2035. This goal is
population increases in a sustainable intended to include a mix of housing
manner so that the generations to that matches the ages, incomes, and
come can prosper economically with a preferences of our diverse population.
high quality of life while conserving Such a mix includes single-family
natural resources. The Denver homes, townhouses, condominiums,
Regional Council of Governments and apartments planned around
(DRCOG) brings together counties and transit oriented developments (TODs)
municipalities from Denver and the to increase housing/urban density.
surrounding areas to address regional Importantly, attracting these housing
issues with a focus on avenues to products will require new and quality
improve economic prosperity and employment opportunities within the
enhance the quality of life for its region as well as amenities such as
citizens. DRCOG’s current MetroVision parks, shopping, etc.
2035 seeks sustainable development
through collaboration that provides DRCOG recognized the need to
housing, employment opportunities, understand the characteristics of the
improved transportation and personal high density housing market in order
mobility, and diverse shopping and to accomplish the goal of creating a
community activities for residents of concentration of jobs, housing,
all ages and incomes. shopping, and community activities
oriented around TODs. To gain a better
A major topic of agreement within understanding of high density housing,
MetroVision 2035 is the need to curb DRCOG commissioned Environmental
urban sprawl by increasing urban Planning Systems (EPS) to research and
density, particularly around transit identify the factors and economic
oriented developments (TODs), in conditions that contribute to housing
order to provide the amenities and development generally and specifically
lifestyle opportunities associated with within the Denver metro area. The EPS
mixed-use pedestrian development study reached two major conclusions.
(supported by transit services). Such
development will not only reduce The first is that while there has been
vehicle congestion and miles driven, a resurgence of multi-family
thereby improving air quality, but will construction in the Denver metro
also improve many other aspects of life area (obvious to anyone who has
for our citizens. traveled in the area), most of this
construction in recent years has
been for apartments and little is for
condominiums.
1 The second EPS conclusion is that, how to move the Denver area toward
while numerous factors impact the the goals set forth in MetroVision
market for apartments and 2035.
condominiums, the root cause of
the decrease in condominium We explain the basic economic
construction is the cost associated principles involved in the housing
with construction defects liability. market and identify the key factors
underlying the demand for and supply
Various constituencies have taken of housing products. We then
issue with the EPS study in general and collected more detailed and more
the conclusion regarding construction specific empirical data to evaluate the
defects specifically. Professor Emeriti, impact of these factors on the Denver
Larry Singell, Sr. and Jane Lillydahl of metro housing market. In the end, we
the University of Colorado, Boulder concur with professors Singell and
economics department were retained Lillydahl, and must strongly disagree
to evaluate the EPS analysis. The with the EPS findings that construction
professors were very critical of the EPS defect liability issues stemming from
study, noting that it relied upon little the statute is the root cause for the
or no data, biased information, and ad lack of condominium construction in
hoc analyses resulting in narrow and the Denver area urban centers and,
misleading findings. rather, we find that:
Further, the Singell and Lillydahl report The reason for limited
urged that the EPS report not be the condominium construction over
basis for any new legislation without the past few years in the Denver
more rigorous analysis, as the Metro area is due to a simple
unintended market consequences of economic principle—a decrease in
providing additional protection to the demand for condominiums
developers against construction (i.e., there are fewer buyers
defects litigation are to increase the willing and able to purchase
likelihood of construction defects and condominiums at market price).
to shift the costs of construction The decreased demand for
defects to buyers. condominiums includes factors
such as lower real incomes, stricter
The Pacey Economics, Inc. study was lending requirements and greater
commissioned to perform a more costs for mortgage fees and
rigorous and more empirically based insurance, greater amounts of
analysis of the market for housing student debt, and lower household
products in the Denver Metro area and formations, among others.
also to provide recommendations on
2 Apartment construction has been The remainder of this report
on the upswing in recent years as documents the analyses supporting
the demand for apartments has our conclusions that it is the decrease
increased relative to the demand in condominium demand from
for condominiums for reasons decreased real income, increased
listed above as well as others lending requirements and home
detailed in Section V, resulting in mortgage costs, later household
more profitable rental markets. formations, among other key factors,
that has driven the lack of
Peer cities (i.e., cities comparable condominium construction, and not
to Denver in terms of population, construction defects per se.
age and income distribution,
industry mix, land area, etc.) The good news, also to be discussed in
experienced similar decreases in this report, is twofold: the 2014 data is
condominium construction which showing a healthy increase in
affirms market forces other than condominium permits as the economic
construction defect liability are at recovery is buttressing the demand for
play. Notably, San Francisco is not condominiums and there are more
and should not be considered a effective public policy decisions
“peer city” given the substantial available to advance the goals
differences in income and industry expressed in MetroVision 2035.
mix as well as land values and
housing density (which will be
addressed later in this report).
Colorado statutes related to
construction defects do not create
more risk for construction
companies than those in other
states. Our findings, discussed in
Section VIII, show no substantial
differences in the statutes relating
to construction defects and its
remedies that would have a
meaningful impact on
development trends. Indeed,
Colorado appears to have a healthy
balance falling within the mid-
range criteria, when compared to
other states
3II. THE MARKET FOR HOUSING conditions such as financing
options while the stock of housing
Unlike the movie Field of Dreams is relatively fixed in the short run as
where a voice whispers to Kevin it takes time for new housing to be
Costner “if you build it, he will come;” constructed.
in the real world construction does not
guarantee a buyer. Rather, people That is, the supply of housing is
come to markets only if the interaction slow to change, but changes in
of supply and demand leads them demand are almost instantly
there. The basics of the market for reflected in market price. In times
housing are described below. of decreased demand, prices will
fall quite quickly, and construction
The supply of housing is dependent will slow or cease (as has occurred
on the cost of land, labor, and since the 2008 Great Recession).
materials as well as overhead costs However, once demand recovers
(which include, among others, (which it ultimately will do since
costs associated with construction the demand for housing is directly
defects). Most single family homes linked to population growth), sales
can be built in a few months, but prices will rise and developers will
several years can pass between the resume construction.
conception and completion of a
However, it is important to
multi-family structure. Because of
recognize the time lags required
the time required, the decision to
for new housing construction.
build housing depends on the price
Prices must rise long enough for
developers expect to receive in the
developers to be convinced that
future. Of course, expected future
the increase will continue into the
prices are more uncertain but
future, and then time is required
highly related to current market
to actually build the structures.
prices.
Therefore, modest increases in
Housing demand is dependent on a demand (e.g., a few consumers
multitude of factors including here and there desiring a
income, age, marital status, credit condominium) are not sufficient
availability, etc. Contrary to supply, to provide the financial incentives
the decision to buy (or rent) a necessary to induce new
home is largely based on the condominium construction.
prevailing market price.
There is no argument in the economic
Housing demand tends to be more profession about these basic principles
sensitive to current market associated with the interaction of
4supply and demand. Thus, the reduced both willing and able to purchase a
demand for housing ownership will, as housing product of their choice, i.e.,
described above, reduce the price of there is a demand for such housing.
the product, NOT the cost of the
product, making it less profitable for That said, the overall demand for
suppliers (developers) to build for ownership has been weak over the
ownership vis-à-vis rental. past several years. However, as the
population requires some kind of
Since 2008, the demand for housing housing, the alternative product is
products has been impacted by more renting and, not surprising, the
strict lending requirements, tougher demand for rental units over this same
credit scoring, increased household time frame has been strong. And
and student loan debt, slow or no strong demand for rental properties
growth in wages, etc., all reducing the will increase its prices and increased
able component of the demand for prices will generate the opportunity
housing, which, in turn, negatively for increased profits to the suppliers
affects the price a buyer is willing to (developers)—inducing them to
pay for housing. construct apartments.
The increased uncertainty in This is a major reason for developers
employment stability, the desire or and builders constructing apartments
need for mobility, later age for as opposed to ownership units; profits
marriage rates, changes in the ethnic are better for apartment construction
composition with an older age for because the basic economic
home ownership, the reduced determinants that generate increased
(perceived or real) opportunity to demand for housing ownership have
“flip” a property, etc. also play a role as been extraordinarily weak over the
these factors impact the willing past several years.
component embedded in the demand
for housing. The trend of these
demographic attributes all serve to
dampen the demand for housing
ownership, which, in turn, negatively
affects the price a buyer is willing to
pay for housing. Notably, there
appears to be no lack of housing
products available (detached or
attached) at high end prices (which are
down but still active in the market) as
in this sector of the market buyers are
5III. BASIC ECONOMICS: AN OVERVIEW Step 1: Demand
The downward sloping line is the demand
The following discussion is a bit (D) for a housing unit. The demand line
academic but is designed to offer a tells us how many units will be
visual illustration of the impact of a “demanded” at specific prices.
factor that affects the demand for or
supply of housing products. The graphs As an example, at $400K there is a
demand to buy 100 housing units; while at
below offer a simple economic primer
$100K there are some 250 housing units
on how, given other things remaining to be purchased.
unchanged, impacts on demand and
supply affect the price and quantity of
a good sold. Following these graphs, in $600
Price (Thousands)
Section IV, are Tables I and II which
$500
identify the key determinants (factors)
in the makeup of the demand for and $400
supply of housing and the direction
$300
these factors will have on price and
quantity (again, without changing $200
other factors).
$100
First let us review the market demand $0
for housing. This example considers 0 50 100 150 200 250 300
Quantity Demanded
housing generically but this
phenomenon applies to any housing
product. (This example does not go
into the machinations of how the Step 2: Shift in Demand
market demand is actually calculated
or explain the concept, it doesn’t need Let us now assume the lending
to; suffice to say it is common sense requirements are tightened such that
instead of a 3% down payment being
that there are fewer high income required it became (almost overnight) a
households relative to middle and 10% down payment required.
lower income households and hence
there would naturally be fewer high An increase in the required down
priced housing units.)1 payment (nothing else in the economy
changing) will mean, most, if not all
consumers will be able to purchase less,
1
For more explanation of the machinations of the Demographic Shift From Single-Family to Multi-
housing market please reference “The Family Housing” by Jordan Rappaport, Federal
Reserve Bank of Kansas City.
6generally, across all levels of income and demanded for housing units at all
all prices. housing price levels (although less so
at the higher income and housing
This is illustrated in the graph below
where the original demand has now prices). Table I to follow in Section IV
shifted down at every housing price – as shows (by use of up/down arrows) the
demonstrated by D '. positive and negative impact on price
and quantity for each of the factors
Now there are only 50 consumers
considered key in the demand for
demanding a housing unit at $400K and
only 175 at the $100K housing unit price. housing.
Having explained the basic premise of
$600 the market demand for housing, let us
Price (Thousands)
now turn to the factors that explain
$500 the supply of housing, i.e., what
builders are willing and able to supply
$400 at certain selling prices of the housing
unit. (Again, as with demand, the detail
$300
of how housing market supply is
specifically determined is not
$200
discussed here, nor will it change the
$100
phenomenon.)
$0 Step 3: Supply
0 50 100 150 200 250 300
Quantity Demanded
The upward sloping line is the supply of
housing units (S) developers are willing to
build at the specified prices they are
Consumers, especially lower and willing to sell.
middle income earners are less likely
to have additional monies needed for To construct a housing unit, the supplier
incurs costs – costs of land, labor,
a higher down payment or the higher materials, etc. as well as costs for interest
mortgage transaction fees, etc., (while on construction loans, insurance, etc. in
high income earners may still be addition to the profits that need to be
“able”), such that it is increasingly included. All of these costs will impact
more difficult for those consumers how many housing units will be built and
at what price; naturally the higher the
seeking lower priced housing. costs, the higher the housing price.
Thus, an increase in lending In this example, at $100K a house there
requirements with no other changes to would be 50 housing units offered by
the market will reduce the quantity suppliers while at $400K the number of
housing units that would be built is 200.
7Price (Thousands) $600 thus the “market for housing” can be
depicted on the graph below.
$500
$400 Step 5: Supply and Demand
$300
Integrating supply and demand gives the
$200 average market price such that markets
will clear, i.e., so that the quantity
$100 demanded equals the quantity supplied.
$0
Of course, there will be housing units
0 50 100 150 200 250 300
sold at lower prices but fewer housing
Quantity Supplied
units will be built at the lower price than
consumers would desire - but it is
because suppliers are not willing and/or
Step 4: Shift in Supply are not able to offer more at the lower
price. Conversely, suppliers would desire
to build more high priced housing units
Now for similar reasons as discussed but have no consumers to sell them to.
regarding demand, if the cost of materials
(e.g., lumber, cement, labor) increases Hence, with more strict lending
(again considering no other changes) it requirements for consumers to purchase
will affect the cost to build a housing unit a housing unit and increased costs for
and the new quantity supplied, S', shows suppliers to build there will be fewer
fewer units will be offered at the various units at lower average prices in the
prices. market.
$700 $700
Price(Thousands)
Price (Thousands)
$600 $600 S'
$500 $500 S
$400 $400
$300 $300
$200 $200 D
$100 $100 D'
$0 $0
0 50 100 150 200 250 300
0 50 100 150 200 250 300
Quantity Supplied
Quantity
Now, as in any market, supply and
demand do not work in isolation of
each other, but rather are interrelated;
8If you then sort this general housing IV: FACTORS AFFECTING DEMAND FOR
market into various price points and AND SUPPLY OF HOUSING
sectors, it is easy to recognize that
most of the major market factors that Tables I and II summarize the multiple
impact demand such as real income, factors that play an important role in
unemployment, tight lending determining the demand for and
requirements, student debt, etc., have supply of home ownership, noting the
weighed more heavily in the past trends in these factors over the last
several years towards the reduction in several years, the subsequent impact
the demand for housing units (and on the demand or supply, and the
concomitantly the supply of housing), concomitant impact on prices and
especially for middle and lower income quantity (which ultimately affects
households. profitability). Importantly, the factors
identified in our analysis are consistent
It comes as no surprise to economists with the factors considered relevant in
and hopefully this primer now makes it the EPS study; however, our view, like
clear to policy makers why there are that of Drs. Singell and Lillydahl, is EPS
little to no condominiums being built failed to fully understand the
in the low/middle price points. It is interaction of these market variables
because there has been little or no and made findings that were either
demand for such. inconsistent with the limited data they
presented or inappropriate given the
The following section describes the key data cited in their report or the data
determinants (factors) in the makeup reviewed by our firm. The supporting
of the demand for and supply of data for each of these factors, plus
housing and the positive or negative additional factors Pacey Economics
impact these factors will have on price identified as relevant, are described in
and quantity (and implicitly on profits more detail in Sections V and VI.
to builders).
9Table 1: Factors Affecting the Demand for Home Ownership
Effect on Effect on Effect on
Factor Trend
Demand Price Quantity
Income/Assets
(Able)
Real Income Real incomes (i.e., inflation adjusted
income) as measured by the Current
Population Survey have fallen for all age
↓ ↓ ↓
groups since a decade ago, particularly for
younger individuals (26-40 years old)
leaving traditional first-time homebuyers
less able to purchase a home.
Unemployment Not only have real incomes decreased, but
employment opportunities have not
returned to pre-recession levels for the
↓ ↓ ↓
Denver Metro area per Bureau of Labor
Statistics data.
Personal Savings Bureau of Economic Analysis data report
personal savings as a percent of disposable
income has declined drastically since its
↓ ↓ ↓
peak in the 1970s; while savings increased
during the Great Recession due to lack of
consumer confidence, rates have
nonetheless remained low indicating
generally less money available for down
payments.
Student Debt College Insights reports that average
student debt of four year college graduates
has risen nearly 67% over the past decade,
↓ ↓ ↓
placing more of a burden on disposable
income and the ability for younger
generations to acquire a home mortgage.
10Table 1: Factors Affecting the Demand for Home Ownership (Continued)
Effect on Effect on Effect on
Factor Trend
Demand Price Quantity
Lending
(Able)
Requirements Mortgage lending/credit availability
tightened as a result of the housing bust
when delinquencies and foreclosures
↓ ↓ ↓
skyrocketed from unsustainable
mortgages; as a result, debt-to-income
ratios were capped, stringent
documentation and verification was
required, among other restrictions.
Credit Scores After the subprime fallout/mortgage crisis
in 2008, lenders began and continue to
require higher credit scores (i.e., higher
↓ ↓ ↓
quality borrowers) to be eligible for a loan
with no expectation to relax this
requirement to pre-recession levels,
hindering borrowers’ ability to obtain
financing.
Fees/Insurance Higher upfront origination fees and costs
for mortgage insurance has resulted in
increased costs and payments for
↓ ↓ ↓
mortgagees again, dampening the ability
to afford a mortgage loan.
Interest Rates The Federal Reserve Bank has chosen to
keep interest rates near all-time lows
which has helped to boost the housing
↑ ↑ ↑
industry by increasing a borrower’s ability
to obtain financing; however, if interest
rates begin rising there will be a reverse
impact on demand, price and quantity.
11Table 1: Factors Affecting the Demand for Home Ownership (Continued)
Effect on Effect on Effect on
Factor Trend
Demand Price Quantity
Demographics
(Willing)
Marriage Rates The Current Population Survey shows if
someone is married they are more than
twice as likely to own a home; but, the
↓ ↓ ↓
proportion of younger generations not
married or delayed in marriage is
increasing.
Delayed Likely due to other factors mentioned, the
Household
Formation
percent of younger people still living with
their parents is trending upwards.
↓ ↓ ↓
Age The younger generations are making up
less of the Colorado urban population
whom are typically first-time homebuyers.
↓ ↓ ↓
Ethnicity The State of the Nation’s Housing study
indicates first-time homebuyers among
minorities are generally older; and with an
↓ ↓ ↓
increasing younger minority urban
population, willing homebuyers has been
decreased.
12Table 2: Factors Affecting the Supply of Homes
Effect on Effect on Effect on
Factor Trend
Supply Price Quantity
Costs
(Willing/Able)
Land Costs Land values sharply decreased following the Great
Recession allowing for more home construction
given other things constant; however, given the
↑ ↓ ↑
increased supply, i.e. higher quantity, puts
downward pressure on the price which makes it less
profitable for developers to build.
Labor Despite the recession, construction labor costs have
continued to rise affecting the ability of developers
to supply housing.
↓ ↑ ↓
Producer Price The Producer Price Index for new construction
Index (New
Construction)
published by the Bureau of Labor Statistics indicates
costs for new construction continues to increase.
↓ ↑ ↓
Lending Credit availability in commercial lending for
Requirements multifamily construction tightened as a result of the
housing bust, for example, requiring higher pre-
↓ ↑ ↓
sales, a majority of units owner-occupied, lower loan-
to-value ratios, sufficient budget coverage, etc.
Interest Rates Interest rates have been low, decreasing the costs for
construction and hence, supporting an increase in
supply.
↑ ↓ ↑
Insurance Increased insurance premiums, whether arising from construction defect litigation (litigation
Premiums/ costs, costs to repair, costs to mitigate, i.e. third-party quality assurance, etc.) or other factors,
Construction will increase costs to the builders/developers. However, we have been unable to obtain reliable
Defect empirical data due to the highly guarded information from both builders and insurance
Legislation 2 companies. Therefore, the trends in these costs cannot be ascertained and cannot be analyzed
until such information is forthcoming.
2
We encourage builders/developers to submit information regarding insurance premiums, costs of
litigation/lawsuits, etc. so a proper analysis of these factors may be performed. Further, a legislative oversight
and review of insurance rates could allow appropriate insight into construction insurance rate trends.
13Table I simply provides the reasons for Figure 1: Condominium Completions & Sales
what is known by the most casual 30,000 3,000
observer, that the demand for housing
Condos Completed - West Region
25,000 2,500
fell following the 2008 recession while
Condo Permits - Denver
Table II delineates the major costs 20,000 2,000
incurred over the most recent years by 15,000 1,500
developers/builders. 10,000 1,000
5,000 500
Further evidence of the decreased
demand for condominiums is 0 0
1995 2005
illustrated in Figure 1 which shows a
Condos Completed - West Region
surplus of condominiums constructed
Condos Not Sold in 6 Months - West Region
in 2009 (reflected in the increase in
Denver Condo Permits
number of unsold units). Likely in
response to the slow sale of Sources: U.S. Census Bureau (Western Region includes CO,
condominiums during that period is NM, WY, MT, AZ, UT, ID, WA, OR, NV, CA and AK); Denver
Metro Area Housing Diversity Study
the supply response to slow sales, i.e.,
the number of permits issued for
condominium construction in the
The decreased demand for any type of
Denver area (which may or may not
housing ownership is likely directly
result in actual buildings) between
linked to home mortgage loan
2006 and 2013 has also fallen
applications (i.e., the more
dramatically. Figure 1 also shows that
applications, the more home loans
the number of the condominium
being sought). Figure 2 visually and
completions for the Western region of
simply demonstrates that the total
the U.S. parallels the Denver
applications (for mortgage loans for
experience for decreased
one to four family dwellings excluding
condominium activity. Of note, the
manufactured homes) decreased by
shift between the Denver permits and
more than sixty percent (60%) from its
Western completions likely reflects the
peak in 2005 to its recent bottom in
time it takes, from one to two years,
2011.
for a building to be completed after a
permit is issued.
14Figure 2: Total Home Mortgage Loan Figure 3: Denver Area Apartment Value
Applications for 1-4 Unit family Dwellings Relative to Detached Home Value
10 100.0
Millions
8
95.0
6
90.0
4
2 85.0
0
80.0
2004 2008 2012 2000 2005 2010
Total Applications (in millions)
Sources: U.S. Federal Reserve; Colorado Department of
Local Affairs, Division of Housing
Source: Home Mortgage Disclosure Act, Federal Financial
Institutions Examination Council
Figure 3 shows that the market value
The consequences of the extensive of apartments relative to detached
changes in demand that have been homes has grown steadily since 2006,
experienced in recent years are creating a clear market incentive to
changes in the market values of build apartments. Further, 0ur
rented-homes versus owned-homes. observations on historical
The market value of apartments condominium prices from various data
relative to the market value of sources (i.e., housing market data
detached homes is indexed and websites) indicates the growth in
illustrated in Figure 3.3 apartment values relative to
condominium values has been even
greater than to detached housing. (We
are seeking permission to reprint this
information.)
Given the market conditions of falling
value in the face of decreased supply and
longer holding times to sell, it would take
a special set of circumstances for a
rational developer to construct
condominiums rather than apartments.
3 rents which, assuming a fairly constant
Figure 3 plots the ratio of the rental rate of 2-
bedroom, 2-bathroom apartments to the Case- capitalization rate and expected future rents
Shiller home price index, normalized to 100 in the proportional to actual rents, is proportional to
year 2000. Of note, the value of an apartment is the current rent.
present value of the expected future stream of
15V: THE KEY DETERMINANTS IN THE Figure 4: Current Real Income as a Percent of
Real Income from Approximately a Decade
DEMAND FOR HOUSING Ago
The data underlying the trends in
housing demand, supply, and prices 100%
summarized in Table I are discussed in
90%
more detail in this section. The sources
and cites for this data are oftentimes 80%
noted on the chart but also in the text
or appendix of this report. 70%
60%
Income/Assets (Able) 50%
26-30 31-40 41-50 51-60 61-70
Real Income Age
Figure 4 below identifies current Source: Bureau of Labor Statistics: Current Population
(2014) income as a percent of real Survey
income (i.e., inflation adjusted income
to reflect actual purchasing power) by Unemployment
age group as compared to a decade
In addition to falling real income, the
ago (from the 2001-2003 time frame).
effects of the recession on the job
It is well known (and reflected below)
market resulted in high
that the recession had the largest
unemployment rates in the Denver
effect on the income of the younger
metropolitan area (as well as
generation (generally the first-time
nationally), especially among the
homebuyers), although every age
younger workers (as shown in Figure
group experienced some loss of
5b) who have not returned to pre-
purchasing power. These lower real
recession earnings levels. Those
incomes result in a downward “shift”
experiencing a spell of unemployment
in the demand for nearly all goods and
will not be able to obtain mortgages
services (or savings), including
(given tenure in job, debt-to-income
housing. Household income among the
requirements, credit, etc., i.e. able)
young population (26-30 year olds) is
and they are less likely willing to
only 82.7% of the income earned
purchase a home for lack of stability,
approximately a decade ago.
income and loss of potential for
mobility. Figure 5a demonstrates that
the unemployment rate for all ages
was a record low in 2000 (some 2.5%),
and was still below 5.0% in 2008 but
increased to a high of 9.0% in 2010
before gradually falling to the current
16unemployment rate of 5.5%. When Personal Savings
sorted by age for the Denver metro
Another well known (and intuitive)
area, the younger aged workers have
factor affecting the demand for
experienced and continue to
housing is personal savings, especially
experience higher rates of
in the wake of mortgagers requiring
unemployment. (Importantly, these
larger down payments and higher
statistics do not include those who
transaction costs (e.g., origination
have left the labor force or are
fees, mortgage insurance, etc.).
underemployed which would be a
Savings as a percent of disposable
further dampening on the demand for
income fell to a bleak 3% in 2007 as
housing.)
people spent a significant portion of
their money on goods and services
Figure 5a: Unemployment Rates for the including housing; but, as consumer
Denver Metropolitan Area
confidence plummeted during the
recession, savings rates have
10
recovered to pre-recession levels, as
9
Percent
8 presented in Figure 6. Nonetheless,
7 the low savings rates relative to history
6 reduces the ability to make down
5 payments and pay higher fees on
4
mortgage loans.
3
2
1
0 Figure 6: Personal Savings as a Percent of
2000 2003 2006 2009 2012 Disposable Income
Figure 5b: Colorado Unemployment Rates by 14
Percent
Age
12
35%
30%
10
25%
20%
15% 8
10%
5% 6
0%
4
2
Age 0
1950 1960 1970 1980 1990 2000 2010
Source: Bureau of Labor Statistics Source: Bureau of Economic Analysis
17Student Debt Lending (Able)
Perhaps one result of suppressed Requirements
savings rates is the increase in debt
Following the bust of the housing
students have faced over the past
bubble which served as a catalyst for
decade. Figure 7 below shows that the
the Great Recession, mortgage lending
average debt of Colorado four-year
tightened and government agencies
college graduates increased from
had to step in to provide stability to the
approximately $15,000 in 2004
housing market. Subsequent
($18,200 in 2012 dollars) to nearly
restrictions on lending and/or
$25,000 in 2012 (the most recent year
tightening credit conditions required
of available data), over a one-third
higher quality borrowers, i.e. higher
increase in real dollars. Such debt
credit scores, higher down payments
decreases the demand for housing,
(lower Loan-to-Value ratios (LTV)),
given debt-to-income requirements
lower debt-to-income ratios (DTI), as
(as well as the common sense of
well as strict verification of
consumers). Additionally, to the extent
documentation and the ability to repay
students default on their debt
in underwriting. (In fact, it was
resulting in lower credit scores, the
mandated in 2013 that no loans were
demand for future homeownership is
to have debt-to-income ratios
further reduced.
exceeding 43%, slowing the demand
for housing in early 2014.) The
increased restrictions have further
Figure 7: Average Debt of Colorado Four-
Year Graduates hindered demand for homeownership
over the recent past as it has made
$30,000
buyers less able to obtain lending,
particularly when compounded with
$25,000
the various factors mentioned
$20,000 previously, including increasing debt,
lower real incomes, etc.
$15,000
$10,000 Figure 8 shows not only the decrease
in total applications as mentioned in
$5,000
Section II, but also highlights the
$0 increased rate of denials of those
2003-04
2004-05
2005-06
2006-07
2007-08
2008-09
2009-10
2010-11
2011-12
home applications, suggesting the
more strict lending requirements
Academic Year
empirical impact on housing demand.
Source: College Insights
18Figure 8: Total Home Mortgage Loan Credit Scores
Applications for 1-4 Unit family Dwellings
Figures 10 and 11 indicate mortgage
10.0 16%
companies Freddie Mac and Fannie
Mae are now requiring higher credit
8.0
scores to be eligible for a loan
6.0
12% (conventional loans). (The same has
4.0
been true for the Federal Housing
2.0
Administration (FHA) loans which are
0.0 8%
typically more applicable to first-time
2004 2007 2010 2013
homebuyers as they require as little as
Total Applications (in millions) 3.5% for a down payment.) The higher
% denied credit scores inherently remove a
subset of the population that would
Source: Home Mortgage Disclosure Act, Federal Financial even be willing to buy a home but due
Institutions Examination Council
to higher credit standing are now not
able to meet the requirements.
Figure 9 represents the decrease in
Figure 10: Average Weighted Credit Scores
Fannie Mae loans with loan-to-value for Freddie Mac 30-Year Fixed Rate Loans
(LTV) ratios greater than 90% (i.e.,
requiring higher down payments) as
well as the number of loans with credit 780 763 766 762
scores below 620 over the 750 741
recessionary period. 725
720 712
Figure 9: Fannie Mae Single Family Loans
690
20.0%
660
1999 2002 2005 2008 2011
15.0%
Source: Freddie Mac
10.0%
5.0% Figure 11 also shows conventional
loans not only have higher weighted
0.0% average credit scores, but also have
2004 2008 2012 essentially stopped lending to
Origination LTV 90%-100% borrowers with scores less than 620
% with CreditYou can also read
