The National Association of Realtors announced that the percentage of home sales to first time home buyers is now at 33%, down from a year ago’s 38%, and the lowest rate since Ronald Reagan was President. There will likely be a spate of commentary in the next 24 hours to try to explain this away, but traditional measurements and projecting the future based on past trends will generally miss the mark. The recent numbers in many ways support some of the theory and trends I identified a few weeks ago in the quarterly report and look at Case/Shiller data: RayMax2014- Case Shiller Analysis2.
While the recent first time home buyer number is shocking to many, particularly in light of what we are told is an improving economy and record low interest rates, let’s delve into many of the financial and social trends which have transformed the real estate market in ways few anticipated, and to which even fewer seem able to adjust. They go a long way in explaining the changing trends.
Lower Interest Rates Have Actually Been a Spur to the Rental Market Moreso Than the Purchase Market. When rates rise, the pressure will be on those investing in building and buying more rental stock – This is an issue which the RayMaxTeam has touched upon for quite some time, but the impact of available investor capital, especially the trillions emanating from hedge funds, large investors and investor pools, foreign buyers, and REITs, is rarely discussed in popular real estate journals nor by real estate practitioners. Perhaps because it is such a new and stealth phenomena, born from the dregs of a market collapse in 2007-2008, traditional measures of analysis and predictability have been blown to smithereens.
A brief recap: A “savior” from the real estate debacle caused in large part by aggressive sub-prime lending is largely recognized as the investor market. “Sharks” to many, but a needed source of capital when there simply were no buyers and no credit, these investors and investor pools stabilized declining markets everywhere, and set the stage for a major rally back in prices. Of course there are significant regional differences and factors, but it is safe to say that almost all markets were lifted by these trillions of dollars.
In subsequent years, as interest rates were driven lower, it became a “no brainer” for investors to plow into the market, whether it be the one-off individual investor looking to create his/her own real estate investment portfolio or the individual who saw opportunity in hooking up with a REIT or hedge fund which was buying distressed homes with the purpose of renting them out. With many previous home owners now forced into the rental market, and with tighter credit and a cautious mentality bordering on fear of a housing price relapse among potential new entrants, the new class of investor/buyers were often grabbing opportunities to buy homes and then rent them at significant positive cash flow from day one.
But it does not stop there. Builders build. Developers develop. After years of struggling to maintain cash flow and merely “stay alive”, this industry sought opportunities to rebound, and that source often became the development of rental housing. Absurdly low interest rates created historically-low “cap rates”, giving economic viability to projects which would never be approved in a more normalized interest rate environment. We are seeing the impact of this now, as many projects approved a few years ago are nearing completion or are recently-completed and the specter of additional supply hangs over once-tight markets. In January, 2014, the RayMax Team report warned of the potential of a coming market shift and an impending rental glut: https://nysr2.wordpress.com/2014/01/20/reston-town-center-housing-a-rental-glut-appears-inevitable/.
As this is being written, Election Day 2014, listings for both sales and rentals are languishing in the D.C, area, as sellers cling to visions of capitalizing on a rising market in both rentals and sales, yet the number of willing, qualified buyers and renters seems to be much more cautious as well. The result is a price gauge which reads flat, but a gauge which is on such low volume that it is difficult to identify the next trend.
Social/Life Style Changes are Dramatically Changing the Game – We have all played the game and heard the mantra so often, that it almost becomes an unquestioned biblical-like experience: young people get a job; they form families; they buy a “starter home”, probably financed by one of our stable Government entities; after several years, the family grows, as does the need for more space and prices rise with inflation; they “trade up”; the mortgage interest deduction makes it foolish to not participate in the game, and everyone plays. We all call it the “American Dream”, and it has become an unquestioned pillar of American society for decades now. I cringe as I hear the current debate revolve around whether the “American Dream’ is dead or not: it isn’t dead; it has merely shifted.
Much has been said and written about mortgage qualifying standards, and the recent tightening of credit. Yes, this has had an impact on the reduction in first time home buying, but this should be more than offset by the absurdly low interest rates. Past logic would say that the lower interest rates should be creating a buying frenzy, but perhaps that has already occurred, and occurred from a different source of buying this time around. And lower interest rates may be more important to the rental market, since so much of that investor base is playing the game as a fixed income alternative in an investment market which brings them no yield anywhere else. If that environment shifts, where will the buyers surface to soak up the trillions of dollars in currently-rented property which may become available for sale in, say, the next 5 or 10 years? This is of particular concern in a market in which wages lag behind housing price gains, and in which current low interest rates are needed to justify current prices. It is never wise to ignore affordability indices.
But let’s not blame the buying slowdown on first time home buyers alone. The older generations have in many cases had their equity ripped out by the 2008-2009 market, and millions of them no longer have the credit, nor the perceived need, to get back in the home ownership game. Renting is no longer seen as a negative for a variety of economic and social reasons, a factor which has helped prop up rents and spur new rental development. And with much new rental supply forthcoming, the fear of a “rental squeeze” is not shifting renters to feel the need to immediately buy en masse.
The bottom line is this: the American Dream of a single family home with two-car garage, a dog and 2.2 kids, with progressively increasing “trade ups” may not be dead. However, the changing demographics are real, and the traditional American Dream housing cycle will not be the sole driving force in decades to follow. The new urbanization trends the RayMaxTeam has been discussing for more than five years are gaining strength, and new builder/developer interest is in generating this kind of supply, some of it for rental. This is clearly the case in the D.C. and Metropolitan area, and I sense it is true in many other cities as well.
The RayMaxTeam has been following these trends for years now, and I welcome you to comb through past blogs on the subject. I also encourage you to examine the updated web site, http://www.RayMaxTeam.com, for a detailed look at the D.C, area markets and efficient, accurate, streamlined listings not found from other sources. I feel no need to harp on drinking “Realtor kool aid”, as a friend remarked to me recently, but to provide you with honest and detailed assessments of the markets and our specific market.
Given today’s remarkably low interest rates and incredible variety of choices in communities and home styles, this is in many ways a golden age to be looking for a dream residence. I look forward to discussing this at any time.
Ray Wedell, Realtor
Chartered Financial Analyst, CFA