The General Economy
The economic recovery in the second quarter was surprisingly spry, reflecting the reopening of businesses and spending by an increasingly vaccinated public. Gross Domestic Product (GDP) was forecasted by Fannie Mae to outperform its pre-pandemic peak, expanding at the annualized rate of 10.1 percent. Personal consumption led the rebound, likely matching the stimulus-check-fueled Q1 2021 pace of 11.3 percent. The areas hit hardest by the pandemic – restaurants, personal services and travel – bounced back the most. Total dollars spent in restaurants surpassed pre-pandemic levels in May. While business investment contributed somewhat to the economy this quarter, residential investment flagged, and both were held back by scarcity of materials and labor.
There was a slower-than-expected return to work and, due to the way employment is tracked, the true situation is murky. The unemployment rate stalled in June at 5.9 percent, although significant advances were made in leisure and food services. On the other hand, employment rolls expanded at the end of the quarter and new hire job postings hit a high, again led by an explosion of hotel and restaurant positions. Persistent fear of COVID-19, early retirements and supplemental unemployment benefits, as well as a lack of childcare and in-person school, reduced the ability or desire of workers to return. This employment gap drove up average hourly earnings by 0.3 percent in June, the third consecutive month of increases.
Concern over inflation emerged. The Consumer Price Index (CPI) rose, hitting a yearly rate of 5.0 percent, primarily from price increases for cars, home goods, air travel and restaurants. However, the importance of this news was uncertain. In mid-June, Federal Reserve Chairman Jerome Powell stated, “… it seems likely that these very specific things that are driving up inflation will be temporary.” He cited as an example the soaring and then recently moderating price of lumber. Some inflation is normal during an expansion, particularly one this rapid, all-encompassing, and marked by supply constraints and government spending. Furthermore, measures of economic activity for the quarter were heavily impacted by the “base effect,” which means that comparing the lockdown-depressed activity of Q2 2020 exaggerates the bounce back in Q2 2021.
The Real Estate Market
Residential real estate activity moderated slightly as expected, with limited supply continuing to propel home prices, according to the National Association of REALTORS®. Both existing and new home sales were off from Q1 2021's tempo, dropping in April and further declining in May, by 0.9 percent and 5.9 percent, respectively. The pace of single-family housing starts and permits was uneven but both remained at or above 1.1MM units, well above the same period in 2019. The constraints of land, labor and lumber on the construction industry kept it from further meeting market needs.
Despite increasing inflation apprehension, the Federal Reserve did not change its rate expectations stance until mid-June, and then only for 2023. The 30-year fixed-rate mortgage monthly average was 2.98 percent for the quarter, occasionally meandering above 3.0 percent. Mortgage originations overall were also lower than last quarter, as a smaller-than-expected increase in rates cooled off the refi market. However, originations for purchase transactions outpaced Q1 2021 and attested to relatively low interest rates and robust appetite for single-family housing.
Stores, restaurants and hotels benefitted from the outpouring of people wanting to eat out, see others and shop. Restaurant sales boomed and the business creation rate was in record territory. Real Capital Analytics (RCA) reported that pricing even improved slightly for retail properties. Although the rebound is spotty and slow, with smaller businesses still struggling to pay full rent, many are being supported by flexible landlords and lenders, and government small business programs.
This quarter was also marked by what did not happen: a bevy of distressed sales. While property investor funds grew, there were simply not that many properties yet in dire straits. This may change as winners and losers emerge. As RCA economist Jim Costello recently noted, it took years after the Financial Crisis of 2007 – 2008 for troubled properties to hit the markets. Adaptation is keeping some properties alive. Retail landlords attracted unconventional tenants like specialty medical providers, particularly in Class A suburban spaces. Those properties that were faltering, such as closed malls and unrented office buildings, are seeing creative conversions to new, more in-demand purposes like warehousing and apartments.
A Glance Forward
Forecasting has been a bit of a folly this past year. The pandemic is reshaping housing, employment, shopping and education. There are insufficient historical references, no precedents and no patterns to guide projections. Few could predict the surge in home demand and renovation coming last summer. Unexpected strength in consumer spending has caused upward revisions of GDP estimates, quarter after quarter. April’s disappointing unemployment figures were a surprise to many.
When looking to Q3 2021, much is still unpredictable. COVID-19 variants keep emerging, global and state vaccination rates are uneven, and supply chain disruptions continue. Meanwhile, there is some general agreement that the economy will grow, unemployment will decline and today, inflation is a reality. Reliable forecasters such as Fannie Mae and the MBA differ in their view on GDP growth for the next quarter by over a percentage point, at an annual rate of 6.4 percent and 7.5 percent, respectively. It is unclear when spending will return to “normal” levels, now that Americans have put their stimulus funds to use and blown off some spending steam. Businesses take longer to react to changing conditions, so they are lagging behind consumers in bounding back. A question remains as to how long shortages will impact business investment.
As more Americans continue to get vaccinated, unemployment benefits are reduced and children are occupied at camps or school, the availability of workers is expected to increase and unemployment to drop closer to 5 percent. Economists are a bit confounded by the contradictory data found in the June numbers, so a smooth decrease is unlikely. Inflationary expectations are divided. There are those who see inflation as likely temporary, typified by the Federal Reserve’s statements, and others who see bottlenecks, wage increases and strong consumer demand leading to persistent price pressure.
In the housing markets, there is agreement that construction and sales will continue to outperform 2020 levels and home values will continue to climb. However, originations projections vary based on disparate interest rate assumptions. Many believe that interest rates will be higher by the end of the year, but consensus for the pace – even for the short term – is lacking. Due to the impacts of economic uncertainty and wider world events, the 10-year Treasury note continues to be unpredictable. Mortgage lenders accepted lower margins this past quarter due to the significant decrease in demand for refinances.
Forecasters are also eyeing the eviction and foreclosure moratoria now due to end in July, again with no unanimity on the outcome. Unfavorable impacts may be mitigated by delinquent borrowers cashing in on all their equity created by soaring home prices. This outcome could give them money in their pockets and a paid off mortgage rather than a foreclosure. With forbearance program participation steadily shrinking – and under 4 percent for the first time since April 2020 – concerns about a wave of mass displacements are dwindling by the month. Approximately 1.9 million homeowners are currently in forbearance – less than half the number that peaked in May 2020. While this is good news for the economy, it negates previous predictions that the expiration would flood the market with foreclosed properties, thus improving the housing supply shortage.
Despite the uncertainty of these times, people are returning to work, paying their mortgages, traveling and looking forward to a school year in person. Like the last three months, the next three will reveal how a post-pandemic economy works, complete with growing gains and pains.