by Gary H. London
There is considerable pundit buzz lately about the fact that the much heralded home ownership rate will permanently drop as a result of the recession.
It has lately been on a down slide. At the peak of the market in 2005, the national home ownership rate was 69.1 percent. It is now 66.9 percent. The San Diego index shows that home ownership, which at its 2005 peak was 63.3 percent, has now dropped to 55.3 percent.
These numbers — both nationally and locally — are undoubtedly “functionally” even lower given the amount of households that are behind on their mortgage payments.
They are, in effect, renters.
The reduced numbers of home ownership are clearly attributable to the recession and the current disenchantment with home ownership. The drop in home values causes a concern that this is permanent. Why purchase and lose money when you can rent? There are even perfectly legitimate studies demonstrating that at this moment in time it is cheaper to rent than to own.
Demographic, Behavioral Influences
A permanent drop in home ownership would be caused by either (or both) demographic changes, or behavioral changes that will cause the next wave of prospective homeowners to not actually turn into homeowners at all.
Let me dissect both of these ideas.
It is true that there has been a decline throughout the nation in the “value” of a home. The Case-Shiller Home Price Indices demonstrates this by analyzing housing values from 2005 to the present, which have dropped 16 percent nationally. San Diego has experienced a 30 percent decline, according to the Case-Shiller index.
This is a big number, and is undoubtedly correct, although I have often also argued that these numbers are based on mostly distressed sales, so you would expect a steep decline in values to show up in this or any index.
Yet, periods of home value decline — most recently in the early 1990s as well as the early 1980s — have been followed by increases in home values. The peak of the next cycle has always exceeded the peak of the previous cycle.
Perhaps the key difference this time is that the statistical drop in home values is much higher than in these previous cycles. It is possible that past trends can no longer predict the future. Many argue that the market will take many years to recover, if at all.
Government Wants You to Own
There is a powerful argument which bodes well for the recovery of the housing market: The government wants you to own a home. There are strong subsidies available to homeowners, including:
• The interest you pay on your home mortgage is mostly deductible as long as itemized deductions exceed the standard deduction;
• $250,000 ($500,000 for a married couple filing jointly) of capital gains on the sale of a house can be excluded following certain conditions;
• When you are over 55 you can reduce or carry-over your assessed property value.
Absent some outlier legislation to yank the incentives, these subsidies are unlikely to change.
The better argument against eventual increases in home values is an overall drop in demand, coupled with a large oversupply. This may very well be the fate of some of this nation’s most oversupplied regions such as Las Vegas, Phoenix and Florida where the overhang in homes and lots are likely to impact pricing for an extended period.
This is unlikely to be the case in coastal California, including San Diego, because inevitably demand should outpace supply. Over the past three years only 5,490 housing permits have been issued in San Diego County. These are historic lows. At some point, this market should begin playing “catch-up” with demand. The result should be a rise in home values.
If demand does not outpace supply it will be owed to a failure of these coastal economies to bounce back. But as I have argued in previous columns, it is the coastal regions that ought to see the most dynamic recovery because they house the diverse economic drivers, including technology companies, which are most likely to grow. If this is correct, then jobs will be added. If jobs are added, demand for home ownership will increase.
Generation Y’s Won’t Buy
The other part of the homeowner reduction argument is rooted in demographics. There is the suggestion that the biggest demographic cohort, Generation Y or Millennials born between 1980 and 1990 and who now make up some 76.4 million people (or about 25 percent of the total U.S. population), while aging into their traditional prime homebuying years, may actually not buy.
Instead, they are too busy moving around the nation, taking advantage of the very same new technologically based economy to not tether themselves to any one community. Therefore, it is better to rent.
I have no doubt that some of this is actually going on. Part of this is simply that young people are, well, young. They are not ready to be tethered. They are in career or life exploration mode.
But I have also no doubt that these behavioral patterns will eventually change, and that they will settle down, particularly when they are ready to have and raise children. There is a certain innate need to cocoon that comes with raising a family. Owning a home is a commitment to life, a community, a family and a sign of your prosperity.
They may need to take a few extra years to save for the down payment, or they might purchase a smaller home or condominium because that is what they can afford.
But home ownership delayed is not home ownership denied.
In time, values will rise again unless there is a dramatic change in buying habits or incentives.
Rental Properties to Prosper
I think the most that can be said about this agnosticism toward purchasing a home is that in the short term rental properties will prosper. There will be a renewed demand for rental units, almost everywhere. In the coastal markets this should mean that rental rates will increase because these same Gen Y’ers will be able to pay more for rent as they grow in their careers.
There is likely to be a shortage of rental properties as well. In a restrictive entitlement region, no segment of the housing delivery system is immune from building restrictions. When the economy begins to prosper anew, we simply won’t be able to build any type of housing quick enough.
Yet, the rental craze should give way to a demand to own a home. As home values rise, people will want in. People will eventually regain their faith in a home as a great life investment. On this last point, I only suggest that you put a blindfold on and pin the tail on virtually any location on the globe. Most of those locations don’t have governments that want us to own, or a mortgage delivery system that makes it affordable. Yet people buy anyway.
That should tell us something.