We are well into a prolong entry level housing crisis. The U.S. housing inventory hit a historic low two years ago. Inventory has come off that low but not in any substantial way. There was a market lull in both sales and homebuyers a year ago when interest rates briefly reached 4.9% in November 2018 (Federal Reserve 30-year mortgages). But by March 2019, as we entered the busy homebuyer season, 30-year mortgages had dropped to 4.06% and rates have continued downward until hitting a recent low of 3.49% in September of this year.
You would think that several years of historically low mortgage rates would create a boom in homeownership. But it has not. Homeownership hit its peak a little above 69% in 2004 when mortgage rates were in around 5.9% to 6.3% (all Federal Reserve data). Today, homeownership (64.1%) is at lows not seen since the late 1960s. Clearly, historically low mortgage rates are not increasing homeownership.
There are many other factors driving down homeownership. But it’s all about available inventory. When looking over long periods of time, you cannot simply look at inventory as the number of houses available for sale because that is not relevant to the increase in population size over the years. That is the major reason why the industry more or less measures inventory by months of supply. That is how many months it would take to sell all of the inventory at the current pace that sales are occurring.
In the 1960s when homeownership was growing, there was approximately a 7-month supply of inventory. A balanced market is generally considered to be about a 6-month supply. That would make the late 1960s a buyers’ market. A buyers’ market makes homeownership affordable because sellers are competing for buyers. One of the fastest growth periods in homeownership occurred from 2004 through 2006 when inventory was growing rapidly and stayed above 6 months all of the way through the Great Recession.
Since the 1960s, the inventory has gone through many cycles that often coincide with recessions. Over all of those years, inventory hit its highest at 12.2 months in 2009 during the Great Recession (when people couldn’t afford to buy). Inventory didn’t fall below a 6-month supply until late 2011 when interest rates were around 3.9%. Since late 2011, the monthly inventory only got back to 6 months briefly in late 2018 when interest rates were also briefly up close to 5%. Otherwise since 2011, the monthly inventory has favored sellers more than buyers. This is the same period of time when homeownership has seen its steepest decline.
A reasonable conclusion is that low interest rates are NOT increasing homeownership. The lack of inventory is by far the biggest contributing factor to the decline of homeownership from 69% in 2004 to 64% today. If we want to improve the chances of obtaining the American dream of homeownership, the single biggest impact is increasing the number of homes available for sale. Especially at the entry level. That means building more entry level homes.
The national housing inventory fell 2.5% annually last month (September) at an even faster rate than the 1.8% August decline. That’s the overall market. For houses costing less than $200,000, the supply dropped another 10% annually this past summer.
Over recent years, approximately 5 million more houses have become rentals rather owner occupied. Because of strong rental demand, investors will continue converting entry level houses into rentals rather than making them available for sale to become owner occupied.
At the same time, builders face their own challenges. Construction costs are high across the board from labor to materials to raw land. The permitting process is both time consuming and expensive. There was also a renewed surge in buyers this past summer for homes in the middle range between $200,000 and $750,000. This is where builders make the most money. This market had briefly been declining but lower interest rates revitalized the market causing the brief uptick in entry level building to again decline. The now dominant downward trend in entry level construction will continue as long as low interest rates cause builders to favor higher priced houses.
Robert Dietz, chief economist of the National Association of Home Builders, estimates that only about 10% of new construction is for entry level homes. The extremely low inventory of entry level houses will only become worse if nothing changes. Adding to this is the affordability problem. The mix of low inventory and affordability will not only continue but will also accelerate the 15-year homeownership decline that began in 2004.
Some people think the entry level housing crisis can be solved by increasing wages to solve the affordability problem. Affordability is not the root problem. Lack of new entry level construction is the root problem. Wage increases will only cause more dollars to chase fewer houses. The result will again be double-digit price increases. A few more existing entry level houses will briefly come on the market to grab the wage increase dollars but the overall supply will remain mostly unchanged.
Low interest rates are not causing a shortage of entry level houses. And wage growth won’t solve the affordability problem. The entry level housing crisis will continue to get worse until there is a fundamental change that increases inventory by building new entry level houses at a much faster pace.
What is your take on the entry level housing crisis? Please leave your comment.
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