The following is an excerpt from an Economic Letter by UCLA Anderson Forecast Senior Economist David Shulman. The UCLA Economic Letter is published by the UCLA Ziman Center for Real Estate and offers compelling observations related to the nationwide housing rebound.
After a long, hard slog, housing starts (both single- and multifamily) are poised to approach the long-term average (1959–2014) of just under 1.5 million units in 2016. We forecast housing starts of 1.14 million units for 2015 and 1.42 million units and 1.44 million units in 2016 and 2017, respectively. This level of activity is well above 1 million units recorded in 2014 and the 2009 low of 550,000 units.
This activity is far from the mid-2000s’ boom level of above 2 million units a year, but it will yield some compelling new trends in the coming year.
1. Higher mortgage rates are coming, but they will not meaningfully cut into housing activity until 2017.
Low mortgage rates have been with us for years, credit standards have eased with respect to FICO scores, and downpayment requirements have been reduced. To be sure, we are not going back to the “wild west” lending standards of 2005, but compared with 2010 and, yes, early 2014, mortgage credit conditions have decidedly eased. Thus, we do not believe that higher mortgage rates will slow housing activity until 2017, because a rise in rates will initially hasten buyers into the market out of fear that rates will go much higher. Time will tell whether or not this assumption is too heroic.
2. Millennials will start buying homes again.
Today’s housing recovery is occurring during an unprecedented decline in homeownership. The rate has dropped from 69 percent in 2005 to the current 63.5 percent, which is roughly where it was in 1989. This decline is attributable to the following: the after-effects of the housing crash, which scared off would-be homeowners; tighter mortgage requirements; sluggish income growth; a preference for urban versus suburban lifestyles; and the rapid growth in student loans. The biggest drop in homeownership is among the 25- to 34-year-old cohort—the much-watched millennial generation—falling 5 full percentage points from 1993 to 2014. But this declining trend has about run its course and will soon begin reversing. In support of this notion, we note that the recent decline in life events associated with homeownership such as marriage and childbirth have ebbed and are now in the process of reversal.
3. The multifamily market still has room to boom.
The flipside of the decline in homeownership is the rise in renting. Multifamily starts, which bottomed out in 2009 at 112,000 units, will exceed 400,000 units this year and average 460,000 units over the next two years. The boom is underpinned by rents increasing at a rate of 3.5 percent a year in the official data, but according to the publicly traded apartment real estate investment trusts, rents are increasing on the order of 4.5 to 5.0 percent. The official data tend to lag the actual marketplace because of the prevalence of rent-controlled jurisdictions in the official sample.
4. Traditional homebuilders will develop single-family, for-rent residences.
The current cycle has given rise to nationally oriented single-family rental businesses funded by institutional investors. This business is the creature of the huge amount of bank-foreclosed property that came on the market following the financial crisis, enabling the bulk buying of single-family homes. Single-family rentals have captured an unprecedented half of the total rental market over the past few years, and the public companies have been reporting rental growth on the order of 4 percent a year. In fact, we are now witnessing the purchase of new single-family homes for the rental market by investment institutions and the development of homes for rent by traditional homebuilders. The American dream of living in a single-family home is far from dead. For many, that dream will start with renting, before turning into owner-occupied housing.
5. Affordability will, finally, start to constrain rents.
The decline in the homeownership rate will level off and then increase. Likewise, new-construction levels will rise and negatively affect apartment vacancy rates. So, ultimately, the apartment boom is likely to show real signs of strain by late next year. Of greater importance, with rents rising faster than incomes, affordability will soon become a binding constraint on rents. For example, from 2004 to 2014, the amount of households paying more than 30 percent of their income on rent increased from 40 percent to 46 percent. With developers building for the top of the market (high-income renters), they may not yet be cognizant of this trend, but they will soon find out that the high-end apartment market might not be as deep as they think.
