The young and the mortgage-less: Millennials drive housing demand
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When the U.S. housing bubble deflated a little over a decade ago, it felt for years like the sector would remain depressed forever. Home ownership rates plunged, as an entire generation of young adults, who came of age during the bust, disavowed buying a home in favor of renting. 

The notion of owning a home as a good long-term investment seemed foreign given the massive price drops and foreclosure wave seen during the financial crisis.  Amazingly, in much the same way that the unemployment rate has returned to pre-crisis lows, housing demand has heated up again. However, the post-housing-bust landscape looks far different than the go-go 2000s boom times.

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On the demand side, there are two key developments shaping the housing market. First, for years after the bust, the bid from first-time buyers was unusually weak. As noted above, young adults rejected the suburban home with the white picket fence for apartments in more exciting and convenient urban locations (or for their parents’ basements). 

  

As the "20-somethings" are moving into their 30s, getting married and starting families, the lure of the suburbs has strengthened — as it inevitably has for every successive generation —  as they begin to have children. Thus, first-time home buyers have flocked back into the single-family housing market over the last year or two, creating torrid demand for entry-level homes.

At the same time, the high-end of the housing market has softened, reflecting the aging of the Baby Boomers, many of whom are now looking to downsize their homes as they get older, and perhaps changing attitudes toward conspicuous consumption. In the Northeast, for example, the sharp declines in income in the upper echelons of Wall Street are also weighing on the demand for luxury homes. 

In fact, in many large metropolitan areas, realtors describe a bifurcated market, where the luxury end is awash in overpriced homes for sale, while inventories of homes for sale in modest price ranges are extremely low, often leading to bidding wars when an attractive house comes on the market.

Meanwhile, the dynamic has been reinforced by developments on the supply side. In the years just after the bust, an overhang of existing home inventories existed, including the “shadow inventory” represented by homes that were in the foreclosure process or in danger of moving in that direction.

At the same time, even when builders may have wanted to aggressively build, banks were unusually conservative in doling out construction loans, having taken major losses during the bust. With time, those issues have faded. Though, to be sure, credit is nowhere near as easy as it was during the boom, for either builders or homebuyers (undoubtedly a good thing given where the 2000s borrowing binge eventually took us).

The constraints on the supply side now look more like traditional bottlenecks that are trademarks of a strong ( perhaps overheated) economic performance. Builders’ primary complaint in most areas of the country is now a shortage of skilled labor. The tradespeople who were laid off during the housing crisis shifted to other industries (e.g., oil and gas drilling).

When builders sought to ramp back up, the massive pool of idle workers that they might have expected to be available was nowhere to be found. Now, despite offering all sorts of aggressive compensation, such as signing bonuses, home builders are generally having trouble building as many units as they would like to due to manpower shortages, preventing a quick solution to the problem of tight inventories that plagues many metropolitan areas.

Another frequently-heard story is that zoning restrictions and rising regulatory costs have added a considerable chunk to the expense of building a home. Since most of these issues add a fixed amount to a new home’s cost, the economics have favored builders focusing on more expensive homes, where it is easier to recover these costs without sacrificing their margins. 

Indeed, builders have spent the bulk of the expansion concentrating on the upper-half of the price scale, reflecting the new cost structure that they face, as well as a dearth of entry-level buyers, as laid out above. Now, however, as the composition of demand shifts, builders’ high-end focus has exacerbated the bifurcated markets (hot at the bottom, cold at the top). Of course, builders will refine their approaches, but it will take time and some creativity to meet the developing demand from first-time buyers.

So, where does this leave the housing sector? For the time being, demand is generally strong, reflecting favorable finances for households as well as a normalization of preferences after an overreaction to the housing bust, though there are sizable pockets of weakness in the luxury price range.

Supply has been constrained, which actually constitutes good news in the sense that it means, even eight years into the economic expansion, there is ample room for housing to continue to grow, which contrasts historical experience. As you would expect when demand is outstripping supply, prices are generally rising at a pace well in excess of general inflation. 

In fact, most home price indices have exceeded the 2000s peaks. Hopefully, builders will figure out how to meet robust demand, but for now, it’s a seller’s market.

 

Stephen Stanley is the chief economist at Amherst Pierpont Securities, a broker-dealer providing institutional and middle-market clients with access to fixed-income products.


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