Much has been written since the Great Recession about secular changes in homeownership versus rental housing in the US; lagging household formation, student debt, enduring consumer credit issues, changing views of property investment and ownership, and more interest in urban living are all mentioned as reasons for this trend. The evidence seems to support this trend, with home-ownership hitting a 40 year low at 62.9% in the third quarter of 2016. However, is this a long-term trend or a temporary regression from the mean?
As evidenced by the above chart, the long term mean for home-ownership is around 64%- about a point higher than the current homeownership percentage of the entire home inventory. Although it is too early to know if we have bottomed out, there are reasons to think that we at or near the bottom.
Time heals all wounds: The credit damage from bankruptcies, judgments, short sales, and foreclosures is healing. Most people who were negatively affected are now at least two years post these credit events and are eligible to apply for mortgages.
People do not really change: It turns out that Millennials do want to leave mom and dad, get married and form a household and even build some equity over the long run. (Anecdotally, my wife and I went to five weddings in 2016 and turned down two…) It is safe to assume that Millennials, once they become parents themselves, will focus on the quality of their children’s lives too, their schools, and so the burbs will beckon.
Unemployment: Unemployment reached 4.9% in November 2016 which should now start to push up income growth- but note that there is a shadow workforce out there of “voluntarily” unemployed, so we need to see how that plays into an increase in wages.
Rental Prices: According to Trulia, property investment is still 37.7% cheaper than renting on a national basis*. Nationally Rents are up 1.7% from 2015, although rent rate growth is slowing down slightly from 2015.
*assumes a 20% down payment, a 3.66% mortgage, a 25% tax deduction on interest, and a seven-year stay (trulia.com/rentvsbuy).
Affordability: In most regions of the US, housing is still very affordable from a historical point-of-view as well as from the rent versus ownership point-of-view. The inflation adjusts Case-Shiller Index is still 17% off its peak. However, as of the end of the 3rd quarter 2016, the Wells Fargo Affordability Index (HOI) was at 61.4%, and home ownership was at 63% which means houses are getting slightly less affordable on average. Unless wages start to grow following their historic long stagnation, that will remain an issue.
Supply: Housing supply is still constrained relative to demand, which keeps prices relatively high. Some of that is due to small builders lack access to credit. (Pre-recession, over 75% of all housing starts were done by small home builders, so any constraints on their credit will constrain housing inventory). Housing stock is now relying more on super-regional or national builders who on larger parcels and require longer lead-time.
Urbanization: If the young continue to flock to the large urban centers, renting will probably be their preferred choice. There is also a less social stigma to renting in a city and certain neighborhoods.
In summary, we believe that:
Home-ownership and property investment has reached the bottom and will settle in the 63% to 64% range. The biggest constraint to owning versus renting is house prices, not mortgage rates (see Rent vs. Buy: Haunted by Prices, Not Rates). Income continues to put a cap on both rental rates and home prices. Builders need to build to their market and not overpay for land, or assume that a larger house will compensate for excessive land costs (Land developers will also do well to keep that in mind when pricing lots).