Many investors argue the recent surge in rental construction is the salvation of the U.S. housing market. Some basic economics, however, suggests otherwise.
In the United States, history indicates a rental property is an "inferior good" – meaning the demand for rental property increases as income declines. This fact is easily seen by the 80-per-cent correlation between real income and the home-ownership rate. So if shifting to renting from home ownership is such a good signal, as many investors claim, why has the home-ownership rate been declining in lock-step with median real income since 2007?
For a truly sustained housing recovery, the pool of first-time home buyers needs to increase. Currently that pool is at drought levels. While savvy investors and policy-makers rejoice in rising home values, the jump in rental construction and hiring of construction workers, they also scan the horizon for these first-timers; few have yet been sighted.
In March, the Federal Reserve Board noted in its Beige book on regional economic activity, "Potential buyers … expressed greater confidence, including entry-level purchasers, who had been increasingly opting to rent since mid-summer." However, the latest existing-home sales figures show that the share of first-time home purchases remains historically low at 30 per cent, 10 percentage points below normal.
When we're talking about first-time home buyers, we're mainly referring to youth, since the median age of a first-time home buyer is 31 years. A scan of young-adult balance sheets and income statements reveals just why first-time home buyers remain on the sidelines. Few have the income, savings or credit history to qualify for even the most generous mortgage terms offered by the Federal Housing Authority (FHA).
Youth have very little savings for a downpayment, according to the latest Federal Reserve Survey of Consumer Finances. The median nest egg for the under-35 age group is $6,000 (U.S.) – perhaps sufficient for a car downpayment but far short of the $22,000 needed for a 20-per-cent downpayment necessary to purchase a home at the median price of $174,000. For this reason, about half of first-time home buyers must secure mortgage insurance from the FHA or a private insurer, but even here the credit requirements are more stringent than they have been in the past.
In the aftermath of the Great Recession, youth lack the income and employment history of to satisfy a mortgage lender. Mortgage lenders want to see three years of work history (and a "career" in burger-flipping is not going to cut it). Unemployment remains rampant among youth, at well above 16 per cent for the past four years, and even this figure is flattered by an epic drop in labour force participation.
Poor job prospects have led youth to opt for Plan B – stay in school. College and university enrolment has surged since 2008. So far, however, grads have had scant success parlaying that diploma into a career. A recent study by the Center for College Affordability found that almost 40 per cent of university graduates are working in jobs that only require a high-school diploma.
In fact, the cost of higher education is increasingly holding back the first-time home buyer. Student debt is the only debt category on the rise. Default rates on student loans in repayment have soared to well above 30 per cent.
A recent report on student loans from the New York Fed shows that a student debt default means a zero probability of obtaining a mortgage in today's tough lending environment. Even more sobering is that a student debt default can never be discharged in bankruptcy under current U.S. law. Not surprising then, with such a high probability of slipping into delinquency, that even student debt holders who haven't yet skipped a payment now have a much harder time getting a mortgage than they have in the past.
Since the credit prospects for first-time home buyers are likely to remain poor, and could even worsen due to the crisis in student debt, chances are the U.S. economy is not yet on a sustained growth path generated by a virtuous cycle of low rates, home buying, rising job growth and income. Instead, chances remain high that the housing recovery will falter as rental-building activity tapers off, and the Fed decides to stick with its current $85-billion a month of balance-sheet expansion, or even pick up the pace of purchases.
Sheryl King is an independent macroeconomic strategist with more than 20 years experience in the international financial industry and central banking.