Jun222016

Housing market full recovery delayed while Millennials find spouses and jobs

Eventually Millennials will buy houses, bubble-era buyers won’t be underwater, and the housing market will finally recover.

I_want_to_believeSince early 2012 when housing prices stopped going down, I characterized the price rally as a reflation of the old housing bubble rather than a price recovery. IMO, the crash was the price recovery because the prices that preceded the crash were a bubble with no tether to fundamental values. The price crash restored market prices to values supportable by income and rent.

However, most people refuse to accept this reality, particularly deeply underwater homeowners who dismiss the idea that they erred when buying during the bubble. Due to psychological anchoring, most homeowners cling to the illusion that peak housing bubble prices were fair value. To them the crash represents a deeply undervalued condition that needs to recover to restore fair value prices. This tenuous viewpoint requires people to believe that record low interest rates and a bevy of market manipulations restored fair value rather than reimposed artificially high bubble-era prices.

A durable housing recovery based on improving fundamentals would be hard to deny, and it wouldn’t need so many artificial boosts. A real recovery would be characterized by surging new home construction and steady gains in sales and prices commensurate with strong job growth and rising incomes. Although these conditions are improving, by most historical measures the economy and the housing market are still relatively weak.

In the end it boils down to how each individual wants to view the rally. Is the market improving (glass half full) or is it still historically weak (glass half empty).

Unfortunately, seeing the glass as half full with regards to investments a path to ruin. Historically, taking a glib and Pollyanna view toward major investments is characteristic of herd behavior in a financial mania. People need to make important decisions about housing with their eyes open to the potential disasters, not just to the potential rewards.

This is a basic philosophical difference I have with most financial writers who view their work as investor therapy, a source of reassurance for previous decisions. People who bought houses want to read the housing market is going up and prices will head to the moon, so that’s what financial reporters tell them.

Why the Housing Market Will Boom Again

By Akin Oyedele, Business Insider, June 8, 2016

The next housing boom will be triggered by millennials.

Like older demographic groups, the lumped-together cohort of 20- and 30-somethings is interested in getting married, starting families, buying homes, and living the aspirational suburban life.

In the 60 years between World War II and the housing bust, each generation obtained an education, secured a job, got married, and bought a home in the suburbs, enshrining our nostalgic notions of the American Dream. Unfortunately, lenders destroyed all that.

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The problem is that they are delaying all this, in part to build careers in large metros.

Irresponsible lending inflated a massive housing bubble, saddled a generation with onerous student loan debts, and poisoned the economy so many can’t find a job, which caused many Millennials to postpone marriage, family, and buying a house. Most housing market analysts blithely assume Millennials will follow the same path as preceding generations once they have opportunity, but what if Millennials decide not to buy homes?

In a note Tuesday, William Smead, CEO of Smead Capital Management, discussed why this lag among millennials could be responsible for the next housing boom.

He wrote that their move into “exile” — away from home and college towns — is only delaying what will eventually be a boost for new home construction.

This is another variation of the pent-up demand argument. (See: Is pent-up housing demand real or a realtor fantasy?)green building

Here’s Smead (our emphasis):

We would argue that many Millennials have removed themselves from their hometown and their college town via their employment and the lateness of marriage. This contributes directly to Ivy’s “elongation.” We find it easy to estimate that the current new homebuilding pace of 629,000 units in 2016 will grow to a 1.5 million unit run-rate within five years. This would truly be a boom and could carry the U.S. economy along with it.

I hope he’s right. The last decade has been brutal for land development professionals.

Numerous studies show that folks under thirty years of age change jobs much more often than prior generations. The average age to marry has risen above 28 years old, with men at 29 in the mix. BCA Research has taught us that American women who have three children are likely to bear more of them in their thirties than in their twenties. The Census Bureau just reported a drop-off in teenage pregnancies and a lower rate of birth for women in their twenties. This was offset by sizable growth in pregnancies between 30 and 45 (Janet Jackson not withstanding).

In other words, the housing recovery is waiting on Millennials to find a job, get married, and have children.OC

Smead referenced a recent Barron’s interview with veteran housing-market analyst Ivy Zelman, in which she noted the dire shortage of affordable housing on the market. She said this housing cycle is likely to be longer and flatter than past cycles.

I believe this is true. We had no burst of building that anyone could characterize as overbuilding. Without an excess, there is no need for a correction. (See: When will homebuilding really recover?)

And Smead argues that millennials are the reason for this elongation — as they choose to settle and buy houses, that demand should propel the market if homebuilders are able to keep up.

“We believe that the current fears of a slower economy are the last gasp of a post-financial meltdown era and are about to be replaced by exiles in the US building homes and having families,” Smead wrote.

“This will produce much higher economic growth, spawn higher interest rates and benefit companies with a direct and/or indirect connection to an America, which will be much different in ten years.”

The typical sources of housing demand are largely absent; in particular, first-time homebuyer participation is at near-record low levels. First-time homebuyers only make up 32% of the market today, compared to 40% in normal times, and without first-time homebuyers, long-term homeowners are unable to execute move-up trades.supposed_to_be

Like the author of today’s featured article, some point to the lack of first-time homebuyers as a significant source of pent-up demand; for example, more Millennials are living at home than any generation in recent history. And Millennials probably will step forward and begin buying houses, but they face some significant headwinds which may keep them out of the market for many years: high unemployment, stagnant wages, large student loan debts, excessive consumer debts (credit cards and car loans).

Assuming Millennials find jobs, to become prospective homebuyers, they must save enough money to provide a down payment. I wrote the Renter’s guide to preparing for home ownership to address this issue. A disciplined saver willing to sacrifice current consumption can save for a 3.5% down payment in just under two years — two years at a minimum, and that’s only for the most disciplined and least indebted. Unfortunately, most people upon getting a new job go lease a new car and max out their credit cards. That behavior takes them out of the housing market for many more years.

Another difficult and time consuming task for the younger generation is to pay down debts to fit within the 43% back-end DTI cap. Even if they have the qualifying income and the down payment, if they have too much debt, they won’t get a house. As I mentioned above, many take on car leases and consumer debt, but the larger problem is with student loans.

Most potential homebuyers with the income to afford a house went to college to get a high-paying job; in the process, the likely acquired a huge student loan debt. It may take five, ten or twenty years to pay down this debt enough to qualify for a house.

On the bright side, I agree with Ivy Zellman that the demand from Millennials will be a slow but steady increase that should contribute to long-term growth in the homebuilding industry.

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