At the end of 2010, the American homeownership rate was at 66.5 percent according to the Census Bureau, down from its peak of 69.2 percent in 2004; this is the lowest rate since 1998. At the same time, the census reported that the rental vacancy rate dropped to 9.4 percent nationally, the lowest it has been since the first quarter of 2003, and, according to data from Reis Inc., a national real estate research firm based in New York, rents increased 2.3 percent year over year.

The six-year trend of households moving from owning a home to renting one is continuing unabated. Two-thirds of all households in the United States are still homeowners, but the drop in the homeownership rate since 2004 means that 3 million households are now renters that were once, or once would have been, homeowners, resulting in an average loss of 400,000 homeowners a year.

Whether this trend will continue, however, is hotly debated. Is it simply a function of demographics and the recession—one that, in time, will reverse itself? Will the homeownership level return to its pre-recession highs? Or is this a reversal of a trend that lasted for a little over a decade, from the early 1990s until 2004, and once again homeownership will settle in the 62 to 64 percent range as it was from the 1960s until the early 1990s? This would mean that 5.5 million to 8 million households would no longer be in the market to buy a home.

Homeownership has been a dream of most American families since the days following World War II, when production line housing construction first developed by the Levitt Brothers made it possible to sell homes for $7,900 ($73,200 in 2010 dollars), a third of today’s median home price of $221,900. (The median size of a new home today, however, is also three times the size of those early Levitt ranch homes). Along with a combination of federal government programs like FHA, VA, and Fannie Mae, the cost of owning a home became no more than the cost of renting one.

This made housing affordable for the average working man who was, more likely than not, a returning serviceman. As the homeownership rate climbed from 55 percent in 1950 to 69.2 percent, in 2004, it was strongly supported by federal policies and programs. This allowed young families to acquire their first home and then trade up, climbing the “housing ladder” until they finally bought a large suburban home and large SUVs to tote their family and goods around the American suburbs.

In 2004, this upward march came to a halt. Pulling down the homeownership rate is a combination of factors, including the following: demographic trends; ongoing high levels of foreclosures (2.9 million U.S. homes received foreclosure filing in 2010, according to USA Today); continuing high unemployment and underemployment; and tightened standards for mortgage financing.

Is the fall in the homeownership rate temporary? Once jobs come back, will Americans once again buy homes and push the rate back up?

There is plenty to be said for both sides of this issue. Home ownership retains its appeal among young families; the freedom to paint the living room purple if one wishes is not to be underestimated. Nor is the satisfaction of “owning” a home, despite the fact that most homeowners have less of a financial interest in their homes than the banks and investors who hold their mortgages.

There is also the fact that the largest group of potential new homeowners in American history is waiting in the wings. Generation Y—those 18 to 32 years of age, a group larger than their parents, the baby boomers—is in their prime household formation years, and they are full of aspirations. With the guidance of Leanne Lachman and Deborah L. Brett, a recent ULI survey found the dream of homeownership alive and well among the young. As Lachman and Brett reported in a recent UrbanLand online article,

Gen Y’s homeownership dreams are incredibly strong. Within five years, two-thirds of all respondents expect to own their residences, including over half of those who will still be in their 20s in 2015. Almost 80 percent of those who will be in their mid-30s anticipate owning. . . . Among respondents saying they are unlikely to own by 2015, seven out of ten anticipate doing so at some point in the future. So, bottom line, 90 percent of gen-Yers plan on owning a home. Clearly, members of this generation are extremely optimistic about their residential futures.

This would be good news for the housing industry but for the fact that Gen Y’s optimism may be more aspirational than realistic. Already the homeownership rate of Gen Y has fallen from 43 percent before the recession to 37 percent. It is possible that young people starting out in their careers are reevaluating their interest in homeownership—a reasonable thing to do when they can see so many people all around them losing their homes to foreclosure while others are trapped in “underwater homes” that they are unable to sell.

Then there are financial issues. By some estimates, over 25 percent of the members of the Gen Y cohort are unemployed, which is one reason why the rate of household formation in the United States—under 400,000—is now less than one-fourth of what it was before the recession. A generation living through years of high unemployment while carrying historically high rates of debt from college and graduate school will take time to be able to afford a home.

Nor, once jobs come back, are their incomes likely to rise much. Incomes for all but the richest 5 percent in the United States have been flat or even falling for more than a decade, Gen Y included. The census reports that the median income for younger men fell roughly 10 percent from 2000 to 2008, while that of younger women—already lower than men’s—fell approximately 3 percent. No one is predicting that wages or incomes for the middle class are likely to rise anytime soon.

Compounding the constrained finances of the young is the mortgage market’s return to conservatism. Even FHA, which now insures over 50 percent of all new mortgages, has raised the credit scores it requires for low-downpayment mortgages, while Fannie Mae and Freddie Mac are back to requiring 20 percent or more down and even higher credit scores. The “good old days” of option adjustable-rate mortgages and the like are long gone, limiting those who can qualify for financing to those financially stable (not necessarily a bad result for a nation in need of deleveraging).

In the past, periods of conservatism and caution in financial markets have lasted only as long as the notoriously short memories of those in the industry. Thanks to the Dodd Frank financial reform legislation passed last year, however, caution is being embedded in laws and regulations that will last longer than memories. This includes new rules to be published soon by the administration on “qualified residential mortgages” and the outcome of the arm-wrestling over the future of Fannie Mae and Freddie Mac and what, if anything, will replace them. Note that all proposals for the future of the government-sponsored enterprises (GSEs) will create a more costly mortgage market for consumers. The most expensive proposal from the perspective of the consumer is that which some in Congress are calling for—namely, a fully privatized mortgage market with no federal backing.

Finally, it is important to keep in mind that it is inevitable that interest rates are going to rise—if not this year, then the next. The long-term average for 30-year fixed-rate mortgages is between 7 and 8 percent, and adding 200 to 300 basis points to the cost of a mortgage will only delay or prevent homeownership for large numbers of would-be homebuyers.

On the other hand, smart people are saying that the cost of housing has fallen so far, and is likely to keep on falling for another year or so. This has made housing more affordable than it has been for a decade. And the cost of land, building materials, and labor is elastic: the price of homes, goes this argument, will settle at what the market can afford.

The size of new residences may also be elastic, and the recent decline in the median size of new homes may be the start of a trend as builders work to bring affordable new products to market. New consideration is also being given to rent-to-own and shared-equity programs as ways to help bridge the financial gap for first-time homebuyers.

When all factors are added together, what seems certain is that if the homeownership rate is to climb again, it will be because there are new products and new ways to finance their purchase. Already, the more successful builders are finding new products for niche markets.

A lot more change and creativity will be needed, however, to increase the number of new homes sold from 321,000 in 2010 to 1 million, considered by some to be the level needed to stabilize the housing industry, a level that is still half the pace of the go-go years of the last decade. Without such major changes in the homes and financing offered, the homeownership rate can be expected to continue its decline for some years to come.