Embarking on a ground-up development project may seem like a monumental task, but the opportunity to build something entirely new makes it one of the most exhilarating ventures in real estate. But, at the heart of any successful development analysis lies a thorough understanding of zoning.
This guide will dissect the key facets, from general zoning classifications to intricate parameters such as height restrictions, setbacks, unit density, and the critical interplay of community incentives and neighborhood ordinances.
General Zoning: Decoding Designations
Zoning designations are slightly different in each city, but they share some common ground. In the code, like R3, the R means residential use—usually no offices or retail. The number 3 signals more density and height are allowed compared to, say, R2. Similarly, C means it’s for commercial, and M is for manufacturing.
These simple designations help us understand the basic rules of land use in any city.
Zoning Parameters
Here’s a look at some specific zoning parameters.
Height restrictions and FAR
In most cities, there are designated areas for single-family homes (SFH), typically zoned as R1 or R2, where only single- or two-story structures are permitted. Multifamily buildings and taller structures are usually allowed in areas zoned as R3 or higher. For instance, in densely populated cities like New York, residential zones can go up to R10.
Some zoning allows for unlimited stories, but in these cases, your building’s height is constrained by the floor area ratio (FAR). FAR sets the limit on the total gross building area permitted. For example, if the zoning permits a 10,000-square-foot (sf) building based on the FAR and each floor covers about 2,000 sf, you’re restricted to constructing around five stories without surpassing the FAR limit.
Setbacks
Zoning regulations use building setbacks—side, front, and rear distances—to shape urban structures. By defining these setbacks, zoning codes balance land use efficiency with preserving the surrounding environment’s character.
Side setbacks maintain space between buildings, preventing congestion. Front setbacks enhance streetscapes, creating visual buffers and allowing space for trees and bike parking. Rear setbacks ensure privacy and outdoor space separation.
Some urbanized cities in San Francisco and New York have no building setbacks, and you can build directly against the neighbor’s property. On the other hand, Los Angeles requires at least 5 feet on the sides and 10 feet in the front and rear.
Unit Density
Unit density dictates the maximum number of residential units allowed in a given area. This restriction is a crucial aspect of urban planning, influencing the overall population density and character of a neighborhood. By setting specific limits on unit density, zoning aims to balance the need for housing with considerations such as infrastructure capacity, traffic flow, and the preservation of community aesthetics. These restrictions play a vital role in shaping the social and physical fabric of a locality, ensuring sustainable, harmonious development.
Figure A. Part of the Los Angeles zoning summary
Incentivizing Urban Development Through Affordable Housing
In transit-oriented neighborhoods, capitalizing on affordable housing initiatives strategically amplifies unit density, building height, FAR, and other zoning parameters, thereby expanding the scope of your project. If your development lies within a half-mile radius of a metro station, it’s probable that established policies facilitate augmenting zoning parameters by allocating a specific percentage of units to affordable housing.
For instance, dedicating 10% of your units to low-income housing may translate to a 40% increase in unit counts and a 50% rise in FAR, effectively allowing your project to grow by up to 50%. Even in the absence of preexisting policies, proactive engagement with the city could result in negotiations for incentives.
While not a by-right entitlement, such negotiations are often successful due to the general municipal inclination toward fostering affordable housing. Moreover, state-level incentives may also be accessible to bolster your project’s viability.
Neighborhood Ordinances: Harmonizing Community Values and Development Objectives
In each neighborhood, the presence or absence of a neighborhood ordinance plays a pivotal role, serving as the regulatory backbone for urban development. Understand how these ordinances strike a balance between community interests and the imperative for progress, ensuring the evolution of neighborhoods aligns with their distinct character.
Locating these ordinances isn’t always straightforward. While some are conveniently accessible online, from sources like the zoning map or the city’s website, others necessitate direct contact with the city’s planning staff.
The content of these ordinances varies widely; some may span just a few pages, delineating specifics like building height limitations or transitional requirements from single-family home lots. In contrast, others may extend up to a hundred pages, imposing detailed criteria encompassing design colors, historical features, shapes, and materials.
Remember: The lengthier the ordinance, the more time-consuming the approval process, necessitating careful consideration.
By-Right vs. Discretionary Review
In general, adhering to specified zoning parameters categorizes your project as by-right, alleviating the need for discretionary reviews and neighborhood hearings by the planning department. However, exceptions exist, and legal challenges may arise, stemming from concerns like environmental, traffic, or historical impacts.
Interestingly, even if your project aligns with zoning parameters, larger developments may necessitate discretionary reviews imposed by the city. Notably, certain cities uniformly mandate discretionary reviews, even for a single-family home, a practice more prevalent in smaller cities.
Meanwhile, discretionary review allows local authorities to scrutinize projects more closely. This in-depth examination considers various factors, including community input, aesthetics, and potential impacts on the neighborhood. While this process ensures a tailored approach to each project, it also introduces complexity, as decisions may involve negotiations and public hearings. Discretionary review serves as a mechanism for municipalities to balance the need for development with the preservation of community interests and character.
Final Thoughts
While this article doesn’t encompass the entirety of the intricate, ever-evolving subject of zoning, we’ll discuss that in a coming article. In the meantime, I encourage you to share your questions or additional insights in the comments section.
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Do You Know the Fundamentals of Zoning Rules? Here’s What You Need to Know
Embarking on a ground-up development project may seem like a monumental task, but the opportunity to build something entirely new makes it one of the most exhilarating ventures in real estate. But, at the heart of any successful development analysis lies a thorough understanding of zoning.
This guide will dissect the key facets, from general zoning classifications to intricate parameters such as height restrictions, setbacks, unit density, and the critical interplay of community incentives and neighborhood ordinances.
General Zoning: Decoding Designations
Zoning designations are slightly different in each city, but they share some common ground. In the code, like R3, the R means residential use—usually no offices or retail. The number 3 signals more density and height are allowed compared to, say, R2. Similarly, C means it’s for commercial, and M is for manufacturing.
These simple designations help us understand the basic rules of land use in any city.
Zoning Parameters
Here’s a look at some specific zoning parameters.
Height restrictions and FAR
In most cities, there are designated areas for single-family homes (SFH), typically zoned as R1 or R2, where only single- or two-story structures are permitted. Multifamily buildings and taller structures are usually allowed in areas zoned as R3 or higher. For instance, in densely populated cities like New York, residential zones can go up to R10.
Some zoning allows for unlimited stories, but in these cases, your building’s height is constrained by the floor area ratio (FAR). FAR sets the limit on the total gross building area permitted. For example, if the zoning permits a 10,000-square-foot (sf) building based on the FAR and each floor covers about 2,000 sf, you’re restricted to constructing around five stories without surpassing the FAR limit.
Setbacks
Zoning regulations use building setbacks—side, front, and rear distances—to shape urban structures. By defining these setbacks, zoning codes balance land use efficiency with preserving the surrounding environment’s character.
Side setbacks maintain space between buildings, preventing congestion. Front setbacks enhance streetscapes, creating visual buffers and allowing space for trees and bike parking. Rear setbacks ensure privacy and outdoor space separation.
Some urbanized cities in San Francisco and New York have no building setbacks, and you can build directly against the neighbor’s property. On the other hand, Los Angeles requires at least 5 feet on the sides and 10 feet in the front and rear.
Unit Density
Unit density dictates the maximum number of residential units allowed in a given area. This restriction is a crucial aspect of urban planning, influencing the overall population density and character of a neighborhood. By setting specific limits on unit density, zoning aims to balance the need for housing with considerations such as infrastructure capacity, traffic flow, and the preservation of community aesthetics. These restrictions play a vital role in shaping the social and physical fabric of a locality, ensuring sustainable, harmonious development.
Figure A. Part of the Los Angeles zoning summary
Incentivizing Urban Development Through Affordable Housing
In transit-oriented neighborhoods, capitalizing on affordable housing initiatives strategically amplifies unit density, building height, FAR, and other zoning parameters, thereby expanding the scope of your project. If your development lies within a half-mile radius of a metro station, it’s probable that established policies facilitate augmenting zoning parameters by allocating a specific percentage of units to affordable housing.
For instance, dedicating 10% of your units to low-income housing may translate to a 40% increase in unit counts and a 50% rise in FAR, effectively allowing your project to grow by up to 50%. Even in the absence of preexisting policies, proactive engagement with the city could result in negotiations for incentives.
While not a by-right entitlement, such negotiations are often successful due to the general municipal inclination toward fostering affordable housing. Moreover, state-level incentives may also be accessible to bolster your project’s viability.
Neighborhood Ordinances: Harmonizing Community Values and Development Objectives
In each neighborhood, the presence or absence of a neighborhood ordinance plays a pivotal role, serving as the regulatory backbone for urban development. Understand how these ordinances strike a balance between community interests and the imperative for progress, ensuring the evolution of neighborhoods aligns with their distinct character.
Locating these ordinances isn’t always straightforward. While some are conveniently accessible online, from sources like the zoning map or the city’s website, others necessitate direct contact with the city’s planning staff.
The content of these ordinances varies widely; some may span just a few pages, delineating specifics like building height limitations or transitional requirements from single-family home lots. In contrast, others may extend up to a hundred pages, imposing detailed criteria encompassing design colors, historical features, shapes, and materials.
Remember: The lengthier the ordinance, the more time-consuming the approval process, necessitating careful consideration.
By-Right vs. Discretionary Review
In general, adhering to specified zoning parameters categorizes your project as by-right, alleviating the need for discretionary reviews and neighborhood hearings by the planning department. However, exceptions exist, and legal challenges may arise, stemming from concerns like environmental, traffic, or historical impacts.
Interestingly, even if your project aligns with zoning parameters, larger developments may necessitate discretionary reviews imposed by the city. Notably, certain cities uniformly mandate discretionary reviews, even for a single-family home, a practice more prevalent in smaller cities.
Meanwhile, discretionary review allows local authorities to scrutinize projects more closely. This in-depth examination considers various factors, including community input, aesthetics, and potential impacts on the neighborhood. While this process ensures a tailored approach to each project, it also introduces complexity, as decisions may involve negotiations and public hearings. Discretionary review serves as a mechanism for municipalities to balance the need for development with the preservation of community interests and character.
Final Thoughts
While this article doesn’t encompass the entirety of the intricate, ever-evolving subject of zoning, we’ll discuss that in a coming article. In the meantime, I encourage you to share your questions or additional insights in the comments section.
Get the Best Funding
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Ready to succeed in real estate investing? Create a free BiggerPockets account to learn about investment strategies; ask questions and get answers from our community of +2 million members; connect with investor-friendly agents; and so much more.
Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.
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Downes named president of Enterprise Housing Credit Investments
Enterprise Community Partners announced on Wednesday the appointment of Kari Downes to the position of president at its housing credit investments business, effective April 1.
Downes, who currently serves as Enterprise Housing Credit Investments EVP, will succeed current president Scott Hoekman who has spent the past 30 years at Enterprise.
In addition to serving as president, Downes “will also serve as a member of the leadership team of Enterprise’s Capital division, which collectively oversees a $16.6 billion affordable housing and community development investment platform,” according to an announcement from the company.
“It has been a great privilege to be a part of Enterprise over for the past 30 years, and I am making the decision to step down with the utmost confidence in our extraordinary team, all of whom are committed to creating and preserving affordable homes by providing best-in-class service to our investor and developer partners,” Hoekman said in a statement. “With Kari as Enterprise Housing Credit Investments’ next leader, I know that the organization is in the best possible hands.”
Downes will assume the leadership position at the organization as it marks a milestone of $20 billion in cumulative investments. These “have financed 2,800 developments, creating or preserving 200,000 affordable homes nationwide,” The company said. $7.1 billion of that total investment figure occurred during Hoekman’s tenure as president, which began in 2018.
Last year marked “a fifth consecutive year of record investment,” as Enterprise Housing Credit Investments deployed $1.729 billion, the company added.
Downes is looking forward to serving in the new position.
“The Low-Income Housing Tax Credit is the most powerful and impactful way to increase the supply of affordable homes. With the help of our incredible team here, we will continue to grow our impact so that everyone can have a safe and affordable place to call home,” she said.
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Pennymac pulls back on 2021 plan to hire 300+ workers in North Carolina
Nonbank mortgage lender and servicer Pennymac Financial Services scrapped its plans to hire more than 300 staff in North Carolina due to prolonged periods of elevated interest rates.
In 2021, Pennymac vowed to create 322 jobs in Wake County, North Carolina and invest $4.3 million into Pennymac Loan Services, its mortgage lending subsidiary, to establish a mortgage fulfillment production center in Cary, North Carolina.
“Currently, however, mortgage rates have climbed to a 20-year-high, which impacts housing, hiring and further expansion efforts. Due to the cyclical nature of the mortgage industry, we were hopeful that the duration of elevated interest rates would not be long lasting,” Janis Allen, executive vice president of corporate real estate at Pennymac, wrote in a Dec. 19 letter to the North Carolina Economic Investment Committee and the North Carolina Department of Commerce.
“Unfortunately, we do not see this change taking place within the base period or extended base period of the Community Economic Development Agreement (CEDA),” Allen noted.
Pennymac’s expansion was set to be facilitated in part by a Job Development Investment Grant (JDIG) approved by North Carolina’s Economic Investment Committee in 2021.
The JDIG agreement authorized the potential reimbursement to Pennymac of up to $1.9 million over the course of 12 years. Over the 12-year term of the grant, the project was projected to grow North Carolina’s economy by more than $813 million.
The current project location is still operational and occupied by key information technology teams and senior leaders.
Since Pennymac opened doors in Cary, North Carolina three years ago, a total of 68 full time employees worked at the facility as of December.
Pennymac invested more than $1.5 million in tenant improvements in North Carolina since 2021, the letter added.
Pennymac referred to the letter sent to the North Carolina Economic Investment Committee and declined to comment.
As with many other lenders across the country, Pennymac has been feeling the full brunt of elevated interest rates.
The lender’s U.S. workforce declined to only “over 4,000” at the end of fiscal year 2022 from 6,900 employees, according to its annual report filings with the Securities and Exchange Commission (SEC).
Most recently, Pennymac issued pink slips to more than 80 employees in November in its California offices impacting loan officers, senior app developers and vice presidents of app development, talent sourcing and sales manager.
In Q3, the California-based lender delivered a $92.87 million net income, up from the second quarter’s $58.2 million but down from $135 million in Q3 2022. Pennymac’s servicing earnings propped up its latest third-quarter performance.
On the strength of its correspondent mortgage business, Pennymac ranked as the second-largest mortgage lender in the first nine months of 2023, trailing just United Wholesale Mortgage (UWM), according to data from Inside Mortgage Finance.
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DataDigest: Study shows agents are aplenty, most with few or no sales
Most agents seldom sell homes, according to a new study published by the Consumer Federation of America last week.
The study, CFA’s third of three on this topic, suggests that a significant portion of agents in the U.S. sell at most five homes in a year. It relies on examinations of agents’ sales for five major real estate firms in each of four geographic areas; out of a sample of 2,000 agents, 100 were selected randomly from each firm in each area.
On average for all areas studied, 70% of agents sold five or fewer homes in the past year, and 49% sold only one or no homes.
The study’s findings are far below the 12 sales per year for the median agent suggested by the National Association of Realtors’ annual member survey, which the study attributes to sample bias for the survey – successful and full-time agents are more likely to respond to the survey than unsuccessful or part-time agents.
The median agent in the study’s result, by contrast, had two sales per year, leading the study’s author, CFA senior fellow Stephen Brobeck, to conclude, “the residential real estate industry is clearly a part-time industry.”
Many of the individual agents in the study had other full-time jobs as “teachers, government workers, restaurant servers, commercial employees, and a large number in associated industries – mortgage lending, real estate appraisal, commercial and residential investment, and the practice of real estate law.”
Other analysts have similarly concluded that the top 20% of agents are responsible for 80-90% of transactions.
To Brobeck, the fact that so many agents rely on residential sales for occasional, marginal or supplemental income is a problem. These “sporadic sales… drain income from those struggling agents, most of whom are women, who work full-time or nearly full-time but sell only a half-dozen to a dozen properties each year.”
Barriers to entry (or lack thereof)
In the second part of his three-part study, published last October, Brobeck argues it is too easy to become a licensed agent.
On this, NAR has previously reached the same conclusion. A 2015 NAR study noted that becoming a licensed agent takes on average 70 hours, which is 302 hours less than it takes to become a cosmetologist.
“The knowledge and competency gap from the most to the least is very large, due to the low barriers to entry, low continuing education requirements, and the lure of quickly making big dollars,” the NAR study reads. “… The delta between great real estate service and poor real estate service has simply become too large, due to the unacceptably low entry requirements to become a real estate agent.”
To become an agent, most states require an applicant be at least 18 years old, have no criminal conviction that affects ability to practice as an agent, pass an educational course, pass a state licensing exam, receive sponsorship from a broker and receive a state license, according to Brobeck’s CFA study.
He notes there is significant variance in requirements from state to state. Required course hours range from 40 in several states to 180 in Texas, while expenses range from $338 in Michigan to $1,225 in South Dakota.
Recruiting agents
Despite the abundance of agents, many companies still actively recruit new ones, according to the CFA study. Companies do this due to high turnover rates and to bring in new clients who come with new agents, the study argues.
Additionally, new agents generate fee revenue, the study notes.
Given these factors, companies often have low hiring standards and underinvest time and resources into the continuing education or professionalization of their existing workforce, Brobeck contends.
“Yet despite this agent glut, many large companies keep recruiting new agents, often regardless of agent qualifications,” he wrote. “They do so largely because of four factors – high agent turnover rate, new agent sales to friends and family members, fees paid by these agents, and limited liability for these agents since they are independent contractors.
“For these same reasons, many companies continue an association with agents even when the agents routinely sell only one or no properties a year. The surfeit of agents ensures that many will not be able to receive adequate personal training and mentorship.”
What to do about the glut of agents
Brobeck offers a few potential solutions:
Although unmentioned in the CFA study, the outcomes of various lawsuits over commission structures could also dampen the appeal of entering the residential real estate space, depending on how compensation changes.
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Opinion: More financing options for ADUs are needed
In the ongoing struggle for attainable housing, one positive development has been the increased availability of funding options for homeowners seeking to incorporate Accessory Dwelling Units (ADUs) into their properties. A recent survey by Villa noted that some ~60% of rental tenants said that living in an ADU has allowed them to live in a neighborhood they would not otherwise be able to afford — that’s a big deal.
For homeowners, ADUs can generate substantial rental income that assists homeowners in covering escalating property taxes and mortgage payments. Additionally, ADUs present an excellent solution for housing family members in need including aging parents by adding infill housing in the most desirable neighborhoods.
Heading into 2024, there are continuing and emerging financing options, grant programs and legislation all designed to help homeowners and builders create much-needed infill housing. These will help on the margin, but we still need smart lenders to help create even more robust financing options for ADUs. Here are a few trends in financing that will continue to catalyze the construction of more ADUs:
Expanded access to mortgage financing
The Federal Housing Authority announced a new policy in October 2023 that has made it easier to finance construction of new ADUs, as well as making it more achievable to buy or refinance a house with an existing ADU. Under this policy, lenders can include income earned from ADUs when underwriting their mortgage. Importantly, homeowners can also include 50% of their estimated rental income when applying for an FHA renovation loan to construct an ADU, which helps with DTI constraints.
However, despite these well-intentioned programs, ADUs remain a somewhat tricky thing for many consumers to finance – and many lenders are still figuring out how to best serve this growing category. Fannie Mae and Freddie Mac already have some guidelines for ADU financing, but they have yet to have a major impact on the overall supply in the market. Consumers often get “lost” in the myriad financing alternatives that span from cash-out refinances, HELOCs, renovation or construction loans, personal loans and some emerging “alternative financing” products such as HEIs. Most of these products are substantially more expensive to consumers than the cost of a typical first-lien mortgage, which makes ADU financing far less efficient than it should be — we really need more efficient second-lien products to really make ADU financing work well.
One of the challenges is that appraisals for ADUs are often unrefined and idiosyncratic, as appraisers are still getting used to this asset type and good comps can be hard to assemble. Draw structures for loans supporting new construction of ADUs, especially for prefab, are still “clunky.” This is unfortunate — and somewhat irrational — because homeowners who have or want to build an ADU are typically quite well-qualified with strong credit scores, income and solid home equity coverage.
The good news is that we are making progress at solving these problems. Some smart lenders, especially among credit unions, have developed some great products for ADU financing. The bad news is that overall progress has been slower than it could be.
Grant funding for ADUs
While grant funding is still primarily at the local or state level, many programs are starting to fund 2024 opportunities for homeowners. That includes the second round of funding for California’s CalHFA ADU Grant Program, which offers low-income homeowners up to $40,000 towards ADU construction. The program helps lower income individuals access funding, though these grants can feel complicated and cumbersome for homeowners to navigate.
Another initiative spearheaded by the Orange County Housing Finance Trust will finance construction loans up to $100,000. The program requires homeowners to rent their funded ADUs to very low-income tenants for the first 10 years and forgives 48% of your debt if you are able to find renters who make less than 50% of the area median income.
While these programs are still a bit more limited to specific zip codes, I am optimistic that 2024 will see more funding opportunities to encourage the build of attainable infill housing in areas where ADUs are becoming commonplace.
Private sale
In late 2023, one of the most significant shifts for California residents occurred as Governor Gavin Newsom signed AB-1033 into law. This legislation permits the separate sale of ADUs from the homes they are connected to, effectively creating condominiums in regions where affordable condo construction is severely limited or non-existent.
For individuals with more constrained budgets, this law effectively introduces a new category of starter homes at more accessible price points and with potential to be created in great infill locations. Additionally, it provides an avenue for elderly homeowners to downsize and remain in their communities. In some instances, they can build their dream ADU and sell their larger primary residence without the need to change their address.
Looking ahead
Historically, most policies addressing ADUs have been crafted at the local or state level. Through the policy actions taken by the GSEs, we’re seeing that national policy can streamline the financing process and also signifies a broader acceptance of ADUs as a viable and essential component of the overall housing market. This federal recognition suggests a commitment to fostering the growth of ADUs nationwide, potentially unlocking new avenues for attainable housing solutions and contributing to the diversification and expansion of housing options for individuals and families across the country.
These represent just a few of the financing trends poised to supercharge ADU construction. The market opportunity for lenders to better serve ADUs is large, growing and a rare greenfield opportunity in the mortgage landscape for creative lenders to develop better products that meet the market needs.
In my view, these changes, with many introduced in the latter part of 2023, will continue to highlight the value of incorporating ADUs into our communities and contribute to the ongoing growth in ADU permit applications. I think we can say that the continued growth of ADUs is one major housing trend to anticipate in 2024, both in California but increasingly in other places across the country too.
Sean Roberts is the CEO of Villa Homes.
This column does not necessarily reflect the opinion of HousingWire’s editorial department and its owners.
To contact the author of this story:
Sean Roberts at sroberts@villahomes.com
To contact the editor responsible for this story:
Sarah Wheeler at sarah@hwmedia.com.
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ICE Mortgage Technology’s Encompass to offer investment advisory advice for clients
ICE Mortgage Technology — part of Intercontinental Exchange (ICE) – will be offering lenders access to investment advisory advice in its Encompass loan origination system (LOS) through a partnership with Halcyon, a tech firm specializing in advanced data integration.
“In the current market where the refi boom has dried up and interest rates are sky high, most home purchases are being driven by life events that come with other financial considerations. Halcyon is helping diversify revenue and strengthen borrower-lender relationships with their new registered investment advisor (RIA) Offering,” Halcyon said in a news release.
Through the partnership, loan officers can introduce their clients to an RIA within Encompass.
Borrowers will receive financial advice including – college savings plans if their household is expanding, additional life insurance and 401k at no cost. Halcyon’s proprietary technology will be responsible for the tracking and compliance for the lender.
Halcyon is the first to provide the service through Encompass and lenders will immediately see the value, said Kirk Donaldson, CEO of Halcyon.
“The lender has comfort that the borrower is making sound decisions that can help protect future default and it provides a way to diversify income,” Halcyon noted.
The software partnership comes amid strong sales in Encompass in Q3 2023.
In its latest quarterly earnings, ICE Mortgage Technology reported an adjusted operating income of $131 million despite the headwinds in the mortgage industry.
In Q3, about 60% of existing Encompass customers that were due for a renewal increased their base subscriptions.
Following ICE’s acquisition of Black Knight in September, ICE had been focusing on cross-selling opportunities across the platform and ICE’s expanded customer base.
ICE identified north of $300 million worth of opportunities for the company to go after which includes cross-selling data and document automation platform to the entire Black Knight’s mortgage servicing system.
Executives expect net revenue synergies of up to $125 million by 2028 largely through cross-sell opportunities.
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Don’t expect a significantly better mortgage market in 2024: Piper Sandler
The mortgage market should improve in 2024 due to a combination of competitive pressures easing and mortgage demand picking up from historical lows last year, according to a note from Piper Sandler, a leading investment bank.
But don’t expect profitability to be significant compared to long-term historical averages as home prices still remain high.
Mortgage rates have softened in the past couple of months, leading to a slight decline in the median mortgage payment and a pickup in mortgage demand.
But even if mortgage rates dropped to 4%, the median monthly payment would still be 44% above pre-pandemic levels, noted Kevin Barker, managing director of Piper Sandler.
“We need to see a more meaningful decline in home prices or affordability will continue to be a headwind to home sales even if we see further softening in rates,” said Barker.
Median home prices trended lower for the fifth consecutive month on an absolute basis in November, down 5% from near-term highs in June.
However, on a year-over-year basis in November, median home prices increased 5% in the Northeast, the West, the Midwest, respectively, and 3% in the South.
A variable that could lead to a softening in home prices is unemployment.
“We continue to expect home prices to come under pressure despite the near-term resilience and supply shortage. Home prices and rates remain too high for new home buyers, particularly with income growth slowing. If we were to see the labor market soften, we expect a more pronounced decline in home prices.” said Barker.
Mortgage prepayment speeds continuing its lower trend will prop up servicing fee revenue streams.
Prepay speeds on 30-year fixed rate pools of agency mortgages in the month of November dropped by 40-55 basis points (bps) month over month to 4.3% for Fannie Mae and Freddie Mac pools. Ginnie Mae pools remained relatively steady at 5.7%. The low prepay speeds indicate mortgage servicing rights (MSR) amortization expense should continue to decline.
“We expect these tailwinds to continue despite the near-term drop in mortgage rates given very few borrowers have a mortgage rate above the current market rate. We would need to see a more persistent decline in 30-year fixed rates to up to 6% for a more meaningful pickup in prepay speeds,” said Piper Sandler.
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New Flood Zones Could Skyrocket Housing Costs in the Midwest—Here’s What You Need To Know
If you’ve been reading the BiggerPockets Blog for any length of time now, you’ll have noticed that the Midwest has often been named as one of the best places to invest in real estate right now. It offers reasonable home and rental prices and stable job markets in major cities. The result is a buoyant housing market that has so far avoided the post-pandemic slump seen in other areas.
But what if we told you that, while all this is true, the Midwest is also the most at-risk area for flood damage over the next 20 years—with all the related consequences: abandoned communities, dropping house prices, and rising insurance costs that will make homes less attractive for both buyers and investors?
The Midwest: An Upcoming Flood Zone
Unfortunately, according to the latest cutting-edge research from the climate risk-focused nonprofit First Street Foundation, it’s all true. The Midwest has the highest projected share of what the foundation is calling Future Climate Abandonment Areas—areas that will see population declines over the period between 2023 and 2053 because of increasing damage from floods.
How can we trust this new research? It’s highly detailed, and it’s based on real data from flood risk assessments performed on real homes. Instead of making sweeping statements about the most at-risk states (Florida and Texas are well known to be at huge risk of regular flooding), the researchers adopted what they’re calling a ‘‘granular’’ approach, assessing communities county by county and even block by block. ‘‘Climate risk is a house-by-house issue, not a state-by-state issue,’’ the report says.
This method of projecting where Climate Abandonment Areas will be clustered offers a great advantage because flood risk can vary significantly within small areas. Quite simply, even within a single city, there will be areas that are far more prone to flooding than others. It can even come down to one block of houses being at a greater risk than another.
Looking at the map First Street provides as part of its report, high-risk areas are dotted throughout the country rather than covering whole states uniformly. However, it’s clear that the Midwest will experience climate-related relocations and property abandonment disproportionately over the next 20 years.
The areas most at risk for these changes are located in Illinois, Michigan, Indiana, and Ohio. The cities projected to have the highest rate of growth of climate abandonment areas are Minneapolis (Hennepin and Ramsay counties), Indianapolis (Marion County), and Milwaukee.
What the research doesn’t mean is that these areas will suffer some kind of disaster movie-style exodus. As the report explains, ‘‘While many areas in these states are projected to decline in population with high flood risk, other areas of the state may see growth as populations redistribute to avoid risk.’’
As the researchers emphasize, most research into migration patterns tends to focus on dramatic interstate migrations, e.g., from New York City to Florida. In reality, that’s not how the majority of Americans move. Most people move very locally, not just within their state but within their local county. These localized moves are driven by ‘‘individual preferences to remain close to their families, support networks, local labor market, and familiarity with the local housing market.’’
In other words, people may be pushed to leave their homes if they keep flooding, but they will tend to go to the next town over rather than across the country.
Make Sure to Do Your Due Diligence
The First Street report drives home the importance of real estate investors doing thorough local research. Investing in low-flood risk areas should become best practice for anyone serious about investing in the Midwest. It could make a difference between investing in a community that will have a healthy housing market in a decade or two and one with an ailing housing market with low property values and unattractively high flood insurance premiums.
In fact, a recent study has shown a direct correlation between increased flood risk and declining property values. Add to that the already existing problems with population declines in some areas of the Midwest, and the flood risk becomes a tipping point.
The fact is that many people don’t want to move away from their homes—until they feel that there is no alternative. Communities that are already on the brink because of other issues (e.g., a lack of jobs) are more likely to empty out when the climate change risk is added to the equation.
Philip Mulder, a professor at the risk and insurance department of the University of Wisconsin-Madison, explained the difference between the Midwest and somewhere like, say, Miami, in an interview with Fortune. Mulder points out that Miami is also at high risk of flooding, but it’s still a place with a vibrant economy, with many people still wanting to move there despite the flood risk, ‘‘whereas in the Midwest, you may see there’s not the same reason for people to be there. So flood risks become sort of a tipping point that pushes people out of communities.’’
Real estate investors who are looking at the Midwest should assess multiple risk factors when selecting a location to invest in. While flood risk on its own may not automatically make a place unsuitable for real estate investing, this factor, plus an existing population decline and a stagnant or declining local economy, almost certainly does.
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Fewer homes will take a price cut in spring 2024
Will the number of homes that take a price cut this year drop below 2023 levels? Yes! If the current trends continue into the strong seasonal pricing period, we will see fewer homes that are discounted before selling. I believe this was the most overlooked housing story of the last year because even as mortgage rates rose all the way to 8%, the home price cut percentage data was always about 4% lower year over year.
Traditionally, one third of all homes get a price cut before they sell and when demand gets weaker, this percentage increases, which we saw in 2022 when prices were falling in the second half of the year. However, as home sales stabilized in 2023, so did this data line. While the percentage of price cuts is still much higher than 2021 levels, this explains why prices were stable in the second half of 2023 versus the second half of 2022.
Now that mortgage rates have fallen and as we start the brand new year, we need to focus on this data line more. I believe we should get more sellers in 2024 than in 2023, but that doesn’t necessarily mean home prices will fall.
Price cut percentages
As you can see in the chart below, if we continue the current seasonal trend, we are going to surpass the price-cut percentage lows of 2023 by this spring. This is why following the housing market tracker tied to the 10-year yield, mortgage rates, and purchase application data will be as critical as last year to tell you what’s going on in the housing market. That way you don’t need to wait for stale sales data. If mortgage rates increase or supply grows faster than expected, this data line is critical to telling the truth.
Here are the year-over-year price-cut percentages from the first week of the year:
It’s 2024! Time to get this party started!
Of course, my main wish during the crazy COVID-19 period was to try to get total active listings back to pre-COVID-19 levels, which was a functioning marketplace with more choices. It’s been challenging as only a few parts of the U.S. have returned to pre-COVID-19 levels. However, one key for 2024 is finding the seasonal bottom in housing inventory sooner rather than later. We want to see active inventory bottom out in January and February — not March and April.
Weekly housing inventory data
Here is a look at the first week of the year:
New listings data
This is the year we should all be rooting for new listings data to grow. Last year, It was great to see that new listing data didn’t take a new dive lower no matter how high mortgage rates got. While working from the lowest levels, 2024 should show year-over-year growth: I’d like to see new listings data get back to 2021 and 2022 levels. Both these years were the lowest new listing levels before rates rose, so it’s not asking for much. I talked about this on CNBC a few months ago.
The year-over-year data is meaningless late in the year or very early: we need to get back to 2021 and 2022 levels during the spring period entering the summer. Hopefully, this will occur in 2024.
Mortgage rates and the 10-year yield
In my 2024 forecast, the 10-year yield range is between 4.25%-3.21%, with a critical line in the sand at 3.37%. If the economic data stays firm, we shouldn’t break below 3.21%, but if the labor data gets weaker, that line in the sand — which I call the Gandalf line, as in “you shall not pass,” will be tested. This 10-year yield range means mortgage rates between 7.25%-5.75%. If the spreads get better, mortgage rates can be lower than this.
Last week was jobs week, and some of the data was good, while some showed softness. Starting from Tuesday, mortgage rates starting didn’t move too much even though the bond market had some wild swings.
However, from the previous week, we went from mortgage rates of 6.61% to a high of 6.76%. Right now, I am watching for 3.80% on the 10-year yield, and if the economic data gets better and the Federal Reserve makes another mistake by getting too hawkish, 4.40% on the upside. However, one big positive now is that the spreads are improving. We have the CPI inflation report coming up this week, so that should be a market mover. Always remember, the Fed presidents can say something hawkish and mess things up daily.
Purchase application data
I will keep this very short and sweet: we never care about the last two weeks of the year with purchase applications because nothing happens during Christmas and New Year’s Eve. Traditionally don’t track the first week of the year either, but for the tracker purposes, starting next week, I will.
The truth is that mortgage demand has collapsed, and it has a tough time growing with rates above 6%. With that said, last year, we had 23 positive and 24 negative prints, and two flat prints for the year. Before Christmas came, we had an excellent six-week positive growth trend as mortgage rates fell almost 1.5% from 8%.
Purchase apps are seasonal; we focus on the second week of January to the first week of May. Traditionally, volumes always fall after May, so we will get a good idea of how the year will look soon. Remember, context is vital we are working from the lowest levels ever, so it doesn’t take much to move the needle higher, but we want to see real growth, not a low-level bounce. A sub-6% mortgage rate with duration should do the trick, but we aren’t there yet. So, for now, we will be very mindful of the weekly data.
The week ahead
We have two inflation reports coming out this week: The all-important CPI report on Thursday and the PPI report on Friday. The growth rate of inflation has cooled down enough to stop the rate hike cycle and now we want to see rate cuts. The one good thing about the CPI report is that the most significant component of CPI, shelter inflation, hasn’t had its big move lower yet. Also, it’s impossible to have core CPI accelerate higher without shelter inflation taking off again since it’s 44.4% of the index.
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Older Americans could become their children’s ‘biggest expense’ in coming years, says aging advocate
The seniors who are often the parents of Generation X and Generation Y (millennials) could become a pronounced expense for their kids in the coming years, but adult children also want to see their parents successfully age in place.
This is according to a commentary from Sarita Mohanty, president and CEO of elder financial advocacy organization The SCAN Foundation in a commentary published by Fortune.
There will be 16 million “middle-income” seniors in the U.S. by 2033, Mohanty said, citing a 2022 study from the National Opinion Research Center (NORC) at the University of Chicago.
“As NORC’s research summary explains: ‘Many will struggle to pay for the health, personal care, and housing services they need. […] Even with home equity, nearly 40% will not be able to afford assisted living,’” she cited.
These kinds of expenses have only become more burdensome over time, Mohanty said.
“In 2002, adults over 65 spent $48,000 (adjusted for inflation) a year on average, according to data from the Bureau of Labor Statistics,” she wrote. “Today, the average is $58,000, a more than 20% increase. The average rent and medical costs for those in assisted living currently stand at $65,000 a year.”
The far and away preference for both U.S. seniors and their children is for the seniors to age in place in their own homes, Mohanty said. Citing a survey from Today’s Homeowner, 89% of Americans at or over the age of 55 want to remain in their homes.
But a late 2023 survey by CNBC found that nearly 60% of Americans feel they are not on track to retire comfortably, Mohanty pointed out, and that lack of assurance in their own retirement security means the younger generations are often unprepared to assume any support position for their parents.
“Something has to give,” she said. “If you’re in the sandwich generation – Gen X and older millennials – and want to share in the responsibility for their parents’ retirement, you should begin by thinking of your parents’ retirement plans in the context of your own.”
In December, the U.S. Department of Housing and Urban Development (HUD) announced a $40 million notice of funding opportunity to connect seniors in affordable housing with resources that could help them age in place.
The reverse mortgage industry often describes its product as a vehicle that can help older Americans remain in their homes since a core requirement of any reverse mortgage is for the borrower to remain in the property as their primary residence.
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