The chart of residential construction since 1959 tells a sad story. While we are finally seeing a rebound from the historic lows of 2009 through 2011, housing starts are still lingering well below the 1.5 million or so averaged between 1959 and 2007.
Housing experts tell us that a key driver of housing demand is household formations. Historically people graduate from school, get a job, and move into a rental home or apartment. When financially able, they purchase a house. That path has been a cornerstone of the American Dream for years. For many, however, the severe downturn in 2008 and the agonizingly slow recovery have put that dream on hold.
The 25- to 34-year olds within the Millennial generation are currently those key first-time homebuyers. A 2014 survey by the National Association of Realtors found that 33 percent of all homebuyers were first timers, down from an historic norm of 40 percent. That’s the lowest rate since 1987. With only 63.4 percent of Americans owning a home, the lowest level since 1965, there is lots of room for improvement in the housing market. Unfortunately this group has been hammered by the confluence of four circumstances:
Soft job market – Well-paying jobs have been scarce except for young people with engineering, science, and technical educations. Many recent college graduates are waiting tables part time.
High student debt – About 71 percent of 2015 college graduates acquired personal debt while attending university. The average debt load was $35,000. A college degree remains a good investment, but the pay-off for Millennials is often many years in the future.
Rising home prices – The average sales price for houses at the end of last year was $369,000, up over 43 percent from the bottom of the market in early 2009. In many areas small starter homes are being demolished and replaced with million-dollar houses.
Tight mortgage loan criteria – Even with mortgage rates around 4 percent, a first-time buyer faces tight lending standards. Typically a lender is looking for a loan-to-value of 80 percent and a debt service-to-income ratio less than 36 percent.
With little ability to save money for a down payment, many Millennials have been forced to live with their parents or bunk in with friends. In spite of an expanding population, their situation has contributed to a significant drop in household formations as seen in the table below.
Key U.S. Housing Data
1959 - 2007
Average Annual Growth in Household Formations
Average Annual Housing Starts
Source: U.S. Census Bureau
It follows that housing starts would decline in parallel. From 1959 when data was first collected on starts through 2007, the average number of annual starts exceeded 1.5 million. In the seven years since then, this key indicator averaged less than 50 percent of that experienced over the previous 49 years. Obviously that decline translated into much lower sales of wood products like cabinetry, flooring, millwork, and furniture.
However, the unexpected jump of two million household formations in 2014 may be providing light at the end of the nearly eight year-long tunnel. Last year housing starts totaled one million, a rate significantly stronger than the 727,000 average of the prior six years. Add the 1.21 million annual rate reported for this July, and we finally have a positive sign that the housing sector may be on course to more normal levels. July’s performance is the best since October 2007 and is up 10 percent over July 2014. Builders are clearly responding to last year’s large jump in household formations especially among younger adults.
Today’s challenge is reaching sufficient macro-economic strength to enable those potential first-time homebuyers to step up from renting into ownership of single-family houses. To do that, builders must also construct more affordable, smaller homes. Thus far, signs of that happening are scarce.
The economic bottleneck keeping first-timers on the sidelines is adversely affecting the entire spectrum of single-family home sales. If owners of starter homes cannot sell to first-time buyers, they cannot move up in the housing market. When that situation prevails, the market for higher-end homes stagnates too. Only with stronger starter home sales will we see the housing economy begin to backfill the deficit in homes that has accrued since 2008. To do so, starts must substantially exceed the historic annual rate of 1.5 million.
That strength will only ensue when a solid supply of well-paying jobs develops. How is the job market performing?
Unemployment Rate: The headline unemployment rate in July remained at 5.3 percent, a solid 0.9 percentage point improvement in the last year. But remember that this metric, known as U3, does not account for people who are not seeking a job. Many of those not looking for work have simply given up their search. A less-publicized measure of unemployment, known as U6, considers those not looking for work or forced to work part time for lack of full-time jobs. Those latter groups are not potential homebuyers. U6 in July was 10.4 percent.
Employment Ratio: The employed share of the working-age population was unchanged at 62.6 percent and has yet to regain its pre-recession level. The other 37.4 percent are not potential homebuyers.
JOLTS Report: The monthly Job Openings and Labor Turnover Survey tracks the number of jobs that are unfilled. The 2 percent decline from May’s 5.357 million to 5.249 million in June is the wrong direction.
While many experts believe that the economy is now sustaining a strong job market, the numbers don’t show it.
Bottom Line: Simple math reveals that the housing deficit accumulated since 2007 totals about 5.8 million homes. That unfilled demand bodes well for the important homebuilding sector of our economy. How fast the shortfall is back filled depends on the Millennials’ ability to fulfill the American dream.
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