Is the American Dream of homeownership dying with Millennials, and do they even care? Will the proposed tax reform be the death knell?
Let’s start with a quick review of current housing market conditions:
- Homeownership rates are hovering around a five decades low.
- Low inventory rates are making it hard to find a house to buy; compounding this issue, rental inventory has become an increasingly appealing option for would-be buyers. It’s no longer hard to find a rental unit with the bells and whistles of a million dollar house… this makes it easier for would-be buyers to “park” in a rental and shop longer for that perfect house.
- Interest rates, by historic standards, are currently favorable for borrowing. Rates will almost certainly go up from here. Likely in 2018. This will make borrowing harder and will add to the debt burden of student loans (and credit card debt, car loans, etc.). This will hit Millennials particularly hard.
- At approximately 85 million people, Millennials are now the largest generation; they will have an increasingly large impact on the housing market as they reach prime buying age and Boomers begin to age out.
- Millennials have already started to take their position as the drivers of the housing market: 34% of all homebuyers today – by far the largest group of buyers – are Millennials. And, this number is expected to grow significantly in the next 3-5 years. Millennials already represent 66% of first time homebuyers, according NAR.
- The tax reform bill working its way through Congress will potentially eliminate the appeal of the mortgage deduction.
So, what does it all mean?
There does not seem to be any major change on the horizon that will improve homeownership rates in a meaningful way. This is doubly true given the increasing importance of Millennials in the housing market and the reality that most home ownership headwinds will hit Millennials particularly hard.
Expect a continuation of low homeownership rates. Sure, most of us still want to own a plot of land to call “home.” But, the decision to own versus rent has become increasingly blurry; there are attractive rental options to ride out the low inventory environment and buying is unlikely to get easier or more attractive from a purely financial perspective.
For real estate agents, they must understand and adjust. The message is simple: there is only one “housing” market. Increasingly, your clients will debate rent versus purchase. You need to be able to service both options. Many real estate agents seem to understand this. They are starting to service the large and growing renting population in order to build long-term relationships with future home buyers; agents are also using rentals to diversifying their commission revenue during a softer sales cycle, especially agents who are new to the business.
Let me leave agents with this: as part of its 2017 housing trends report, Zillow found that 57% of first time buyers considered renting and 50% of all eventual renters considered buying.
What do you see when you read the tea leaves?
The following is some additional information for readers intended to help assess whether home ownership rates may rebound in a meaningful way:
In 2017, national housing inventory hit some of its lowest levels on record. According to Trulia, the number of homes on the market dropped for eight consecutive quarters leading up to Q1 2017, falling 5.1% over the past year. Across different housing segments, starter and trade-up home inventory fell 8.7% and 7.9% year-over-year nationally. Meanwhile, the stock of premium homes remained relatively unchanged since last year, having fallen just 1.7%.
The disproportional drop in inventory of starter homes is driving home prices higher, which in turn makes homeownership less affordable.
Interest rates have been hovering at or near historic lows for the past few years. Buyers – especially first-time homebuyers – should be very motivated to borrow at today’s rates. However, credit has tightened and borrowing a mortgage requires much higher credit scores and larger down payments.
Interest rates seem to be on an upward trajectory, likely impacting buyers in two meaningful ways:
- Mortgage rates will increase, which makes any purchase and carrying cost, more expensive. This will compound an already high price environment caused by tight inventory constraints (more on this later).
- Student loans are paralyzing millennials. More than two-in-five (42%) millennials between 18-29 years old report that they, or someone in their household has student loan debt. 58% of college graduates report having student debt according to a recent Harvard IOP study. The more expensive it is to service that student loan debt, the longer it might postpone the home buying decision.
The tax reform currently being proposed by congress will cap – and all but eliminate – the mortgage interest deduction. Given the increased standard deduction ($12,000 for single and $24,000 for married taxpayers), many more taxpayers will forgo itemizing and take the standard deduction. The mortgage interest deduction is perhaps the single largest tax deduction folks make on their personal income tax return each year. Losing that benefit could present a serious disincentive to becoming a homeowner.
Residential rental properties, like owner-occupied housing, currently receive tax subsidies under existing tax rules, but the newly proposed tax plan significantly shifts the tax system to favor rentals over owner-occupied homes. This could result in increased cost of home ownership and lead to more people deciding to rent. The dramatic increase in the relative tax advantage for residential rental real estate could lead to increased home rentals in your neighborhood. Maybe it will be cost-advantageous to sell your home to a residential real estate firm and lease it back?
Finally, if the mortgage tax deduction is eliminated, Moody’s Analytics estimates that it could cause home prices nationwide to drop between 3-5%. This would likely further tighten inventory as sellers will likely balk at accepting losses in the near term.
According to the census bureau, the muted housing recovery in recent years can be traced, in part, to slower household formation among young adults; analysis suggests that the boom and bust in housing has been a key factor. Recent weakness in household formation relative to population growth among young adults represents a reversal of the unusual strength during the boom years. The net effect has left shares of current young adults heading households at levels similar to those in the mid-1990s before the housing boom.
Source: U.S. Census Bureau, Housing Vacancy Survey and Annual Population Estimates; annual rates reflect July year-over-year percent changes.
Headship and Homeownership as share of age group population
Source: U.S. Census Bureau CPS Annual Social and Economic Supplement, Annual Population Estimates, and Housing Vacancies. Author’s calculations.