Rent or buy? Rental demand holding strong as homeownership rises with a whimper
A decade after the housing bust, homeownership is rising slowly but remains well below prerecession highs. With a complex mix of cyclical, cultural and lifestyle forces influencing housing decisions over the past several years, a debate rages about where homeownership is headed and how U.S. households will consume housing in the years ahead.
The strong economy has driven unemployment to near 50-year lows and emboldened consumers, who have rarely been more optimistic about the economy than they have been in recent months (notwithstanding the recent stock market decline). Has this cyclical improvement been enough to reignite homeownership in the United States? The data so far indicate no and give little evidence to suggest a dramatic resurgence is afoot.
According to data from the U.S. Census Bureau, homeownership stood at 64.4 percent in third quarter 2018. This is up from a low of 62.9 percent in second quarter 2016, but it is far off the peak of more than 69 percent reached before the Great Recession (and lower than the roughly 66 percent average of the previous three decades). Also, these data are far from precise measurements. The U.S. Census Bureau notes the half percentage-point increase in homeownership over the past year is not statistically significant.
Increased home affordability following the recession, low mortgage rates and economic improvement encouraged some households to enter or re-enter the for-sale housing market. But headwinds are mounting, and the best opportunity for a sharp rise in homeownership may have passed. Mortgage applications and existing-home sales metrics have declined.
Rising rates and relatively low levels of construction, due in no small degree to the high cost of building, are affecting the affordability and availability of homes. Prices in many U.S. metros have risen beyond prior peak levels. Lending standards are loosening on the margin but certainly not reverting back to the freewheeling standards that helped cause the housing bust.
New tax legislation has reduced the benefits of ownership in higher-cost areas by placing a cap on the state and local tax deduction, and limiting the amount of mortgage debt that qualifies for an interest deduction at $750,000 on new purchases. In lower-cost areas and certain household situations, the ownership incentive is reduced by a higher standard deduction, which could nullify the benefits of itemizing tax deductions.
The effects of age
Many other forces have tempered the recovery in homeownership. Shifting demographics and lifestyle preferences, student debt, and even the high levels of foreign-born population living in the United States are keeping the share of households that rent elevated. Immigration has been a tailwind for U.S. population growth and apartment demand, so tightening immigration policy presents a downside risk for multifamily investment.
Within the data, we do see a measurable uptick in the homeownership rate among younger households but not a wave that would cause concern for apartment investors. For households under age 35, the rate has risen from a low of slightly more than 34 percent to nearly 37 percent in third quarter 2018. Smoothing for seasonal effects would indicate less of a change (see “Homeownership rate, by age,” left). Compared with the levels of greater than 43 percent reached prior to the recession, this is far from a rebound.
Millennials and their lifestyle choices have long been at the crux of the homeownership discussion in the United States. Peak birth years for millennials currently sit in the 25- to 29-year-old age group, with about 2 million more in that age group today than there were five years ago, making them the dominant cohort within the population less than 35 years old. Their homeownership rate is 33 percent, slightly less than half the national average and about a percentage point lower than the rate of homeownership for this age group five years ago.
Apartment investors are rightfully interested in the decisions made by 25- to 29-year-olds, given their sheer number and high propensity to rent. Will their homeownership rate rise 15 percentage points to the 48 percent level now measured among the slightly older millennials in the 30- to 34-year-old age cohort? Given they already own at a modestly lower rate than their predecessors, and the tailwinds for homeownership are waning — the economic cycle is maturing and affordability is low — it seems unlikely this jump will fully materialize.
Similarly for 30- to 34-year-olds, will they make the 10 percentage point jump to the nearly 58 percent homeownership rate of today’s 35- to 39-year-olds? There undoubtedly will be a significant shift to ownership among this group, as we saw over the past five years, but they are unlikely to own at higher rates than their slightly older peers are today.
For these younger age groups, a variety of factors are at play beyond cyclical conditions related to the economy, pricing and insufficient housing supply. Marriage and childbearing are delayed versus past generations, and these life events have historically been triggers for ownership. An October 2018 report from the National Center for Health Statistics noted a significant decline in U.S. fertility rates over the past decade, particularly in large urban areas.
High rates of job-hopping also may be playing a role and, although population mobility across the United States is historically low, ownership is viewed as a clear block on mobility in the event an individual decides to make a job change that requires a geographic move. Having observed the housing bust, millennials also likely perceive more risk in homeownership than the generation that preceded them.
Lifestyle preferences are a significant obstacle to rising homeownership, as well. All generations identify price as a key consideration in their housing decisions, but a Freddie Mac study found millennials placed a higher emphasis on proximity to work than prior generations. Interestingly, another Freddie Mac study showed a jump in the number of millennials renting for financial reasons versus other generations, and there is likely some correlation here.
Millennials, particularly more affluent ones, have shown a tendency to reside in live-work-play locations, and ownership in these types of locations tends to be prohibitive in terms of both the cost and availability of for-sale housing. Employers have taken notice, which is one reason so many firms have endeavored to relocate to the places where the young talent is living.
We also must acknowledge a factor that has tempered both for-sale and rental housing demand — low rates of household formation among young adults in the United States. Some of this could be related to decisions to rent in multiple roommate situations, but other drivers are at work. Recently released census data show both the number and share of young adults ages 25 to 34 living at home with their parents rose to record highs in 2018.
These “failure to launch” situations have worsened even as the economic prospects for young adults have improved significantly since the early stages of the recovery. Student debt, high housing costs and employment opportunities that do not offer sufficient wages are all contributing to keeping young adults at home. Census data reveal, while the population ages 25 to 34 rose by more than 14 percent from 2007 to 2017, there was virtually no change in the number of households in this age group. Some of this population group may be staying at home to save money for their first home, but it is reasonable to expect that as most transition to forming a new household, they do so as renters, not owners.
This brings up a crucial point we have observed for some time now. A significant portion of new rental demand has come from older households even as the economy has improved. This has been, and should continue to be, an influential driver of keeping the homeownership rate low. We observe in the data for those ages 50 and over that homeownership is not picking up. For those 65 and over, it actually seems to be declining.
Apartment investors are too often caught up in thinking about what young adults may want in their units. With life expectancy continuing to rise and signs older households view renting as an attractive option, property owners would do well to consider how they can effectively cater to these older age cohorts as well.
There is good reason to expect that, on the margin, U.S. households will rent at higher rates than they have in the past. Numerous factors are at work to keep ownership low, and young adults are growing up in an era where it is not uncommon to rent and share almost anything, from clothes to cars. Further, the peak birth years of the millennial generation still sit firmly in age cohorts that have historically demonstrated a below-average propensity to own. Meanwhile, the desire to own may be waning among their parents.
Apartment investors stand to benefit from these trends as vacancy remains low, rents continue to rise modestly, and data suggest multifamily construction has likely peaked for the cycle. Single-family home construction continues to run well below the levels of the previous two decades, exacerbating affordability issues.
To maximize investment performance, landlords have to be conscious of the expectations of their renters and work hard to foster the sense of community many desire. But they also must strive for flexibility in their operations and look to control assets that appropriately cater to the demographics of their location. In an era where renting is likely to remain elevated, landlords need product offerings that can meet the changing needs of their residents as they age.
Paul Briggs is head of research at Bentall Kennedy (U.S.) Limited Partnership.