Many residents that are capable of purchasing a house are making the transition into ownership, though the headwinds on the housing market are unlikely to sustain the current trend. In the first quarter, the homeownership rate was 64.2 percent, unchanged from the end of last year, but 130 basis point higher than the most recent trough. Homeownership has been trending higher in recent quarters as buyers take advantage of low interest rates and a booming job market. However, that trend is expected to run out of steam in the near future.
How high can homeownership go?
Peak homeownership occurred at the end of 2004 at 69.2 percent. The housing market was much different during that housing boom, driven by high construction and lax lending standards. A return to that rate is unlikely. The long-term average is 65.3 percent, and outside of the last boom, homeownership has been consistent. Furthermore, nearly every pressure on the housing market is a headwind to higher homeownership. Pricing, interest rates, wages and the maturity of the current economic expansion suggest a ceiling on the number of future buyers.
Prices have soared to new highs, with both Case-Shiller and the National Association of Realtors reporting a new high watermark. High prices, combined with relatively lackluster wage growth, particularly for millennials, is making affordability challenging. A deeper dive into the most recent data from the Census shows a decline in the homeownership rate for millennials. In the first quarter, the rate dipped to 35.3 percent, from 36 percent in the fourth quarter. This group serves as bellwether for the for-sale housing market since they’re most susceptible to pressure from outside forces.
Developers are not bringing enough homes out of the ground to move homeownership. Low housing starts and a lack of entry-level homes on the market will keep millennials from transitioning out of rentals. Although housing starts are up from recessionary lows, they are significantly less than the long-term average of 1.4 million units annually. That figure is amplified when compared to starts per person. Since 1959, builders have averaged one new home for every 200 people annually. Currently, the average is one home for every 270 people and since the end of the recession, the average has been one home for every 375 people.
Additionally, builders are not constructing the right kind of homes for millennials. In March of this year, existing homes sold for $250,400, while new homes sold for $337,200. At peak homeownership, the spread was less than $10,000 between new and existing homes. High development costs and a dearth of construction workers have builders staying very selective when it comes to which projects to pursue. As a result, millennials are unable to take advantage of new for-sale construction. When existing entry-level homes do come to market, the competition from investors hinders millennials from making the move into ownership. First-time buyers are often deliberate in their search, and hesitation in a hot housing market can mean moving back to the drawing board.
Interest rates are also a significant and strengthening headwind for homeownership in the current market. According to Freddie Mac, the average 30-year fixed interest rate is 4.5 percent, up from 3.4 percent in the third quarter of 2016. As the Fed continues to move the funds rate higher, mortgage rates will also climb through the end of the current economic expansion. A recent study by HomeUnion Research Services showed that some metros could see more than 100,000 households priced out the market as rates climb to 5.5 percent.
Should rising homeownership concern investors?
Real estate is a long-term investment and long-term trends need to be the focus for potential buyers. Homeownership is unlikely to rise much higher as fewer buyers can afford to purchase a property. Additionally, the buyer pool is evaporating with each passing quarter, and millennials are the most likely to be impacted. They’re also one of the largest groups of renters. Older millennials are now entering the age to start families, and suburban rental properties are in high demand. Rental vacancy in suburbs was 6.5 percent in the first quarter, lower than both urban and rural vacancy. While investors need to do their due diligence and partner with an experienced investment platform like HomeUnion, the long-term outlook for rental housing remains bright.
U.S. Census, Freddie Mac, National Association of Realtors, Case-Shiller