The key demographic shift that will boost housing
THE REAL ECONOMY |
Shifting demographics and an increased demand for shelter will boost residential real estate in the medium term.
Shifting demographics will support improving U.S. residential construction and home purchases during the medium term, pushing housing starts back toward their long-run equilibrium rate of 1.6 million on an annualized pace. While middle market firm managers can take solace in the reassertion of basic demand and younger homebuyers, that shift is unlikely to bloom until later in this business cycle before fully blossoming in the next. In the near term, homebuying preferences among the key 25- to 34-year-old cohort and the combination of lost wealth and tight lending conditions will continue to weigh on overall residential investment and purchases well below the full utilization of resources in the housing sector.
The housing sector experienced another weak first quarter this year. Housing starts slowed to an annualized pace of 968,700. While existing home sales saw a strong start to the traditional spring selling season, it wasn’t sufficient to offset the overall slowdown in sales during the past year. The median price of an existing home has seen a scant change in nearly two years, which has limited the inventory coming to market amid tight lending and difficult purchasing conditions for first-time buyers. In the market for new homes, the lack of inventory linked to a long 2013-2014 winter sent prices soaring and has kept buyers on the sidelines.
Even so, forward-looking building permits imply an increase in starts toward 1.1 million units on an annualized pace in coming months, which complements industry reports of an improvement in residential investment and sales this year. Given that buyer traffic is up, and the 30-year mortgage rate stands near historic lows, investors should see a modest improvement in home prices to near 4 percent this year.
Key missing ingredients in the soggy U.S. expansionary cycle have been residential investment and fixed business investment. Residential investment accounted for about 3.1 percent of growth in gross domestic product (GDP) through the end of the fourth quarter last year, compared with 6.2 percent at the peak of the bubble in 2005. New starts, home improvement and brokers’ commissions, which feed into the calculation of GDP, all steadily improved since the trough in 2008-2009 and climbed to cyclical highs of $177.9 billion, $246.9 billion and $137 billion, respectively, at the end of last year. While a combination of tighter lending, increased regulation and soft demand will make a return to prerecession levels unlikely, an improved labor market, the composition of hiring (i.e., high-wage versus low-wage job creation), rising household formation and historically low interest rates should all support a move back toward 4 percent in this business cycle.
The keys to an improved residential outlook are employment and wages for those aged 25- to 34-years-old. The employment-to-population ratio of this cohort has improved to a cyclical peak of 76.8 percent, while the share of the total labor force for this group has surpassed its pre-cyclical peak of 20.6 percent. Moreover, once one looks into the changing demographic profile of the economy and the workforce, there is added cause for medium-term optimism.
MIDDLE MARKET INSIGHT: With 61.2 percent of U.S. housing stock aged 30 years or older, middle market firms will prosper from new residential starts as millennial demand for shelter grows.
The millennials account for 27 percent of the population and 35 percent of the total working age population. Those aged 20 to 24 account for 7 percent while the 23-year-old cohort alone represents the single-largest age group of the population by a single year at 1.5 percent. This all points to an increase in demand for shelter and a demographically-driven return to long-run equilibrium in the housing market as pent-up demand for new homes is released.
The current risk, and one that will likely determine the shape of housing and the level of growth in the economy, will be the renting versus ownership preference of millennials. The recent resurgence in household formation is strongly correlated with the improvement in renter-occupied units, which fits nicely with the increase in multifamily dwelling starts. Multifamily dwellings currently have a three-year run rate of about 300,000 on an annualized pace, versus the 20-year average excluding the housing bubble of 253,000. This reflects a desire to rent rather than own. In fact, improved conditions in the labor market for that group is consistent with a move toward 1.3 million in total starts, with a decelerating asymmetric tilt toward multifamily dwellings in total housing starts and an increase in the construction of single-family residences.
From a policy perspective, this is not exactly what the Federal Reserve expected in the wake of expanding its balance sheet above 4.51 trillion at its peak and given its use of forward guidance to suppress rates at the long end of the curve. Such policy mix was designed to stimulate a resurgence in purchases of single-family residences and a boom in new residential construction. Thus, one key to the growth and residential investment picture during the next several years will be the return of a good portion of the working-age population to the real estate market and whether those at the upper-end income levels of that cohort shift demand to owning versus renting. As the baby boomers retire, it is essential that the millennials step forward to absorb the inventory that will be put on the market, which would facilitate the creation of conditions for the United States to move back toward the full utilization of capacity in the housing sector.
In 2015 to 2017, fiscal policy will likely make a difference on the margin. First, incentives that could provide up to 3 percent of the purchase price in closing assistance for qualified first-time buyers put forward by Fannie Mae (the Home Path Initiative) should support the absorption of existing homes that will come to market.
MIDDLE MARKET INSIGHT: Middle market commercial, speciality and residential contractors are poised to see solid growth from demographic-driven housing demand.
Second, the 800-pound gorilla in the room is what, if anything, the federal government will do to provide relief to millennials who carry $1.13 trillion in outstanding student loan debt. That, particularly, acts as a drag on home sales, especially among first-time buyers. While both political parties, and some presidential candidates, are talking openly about student loan relief, until something is done, residential investment is unlikely to rebound toward long-run equilibrium levels. As a result, housing will continue to act as a drag on overall economic growth.