In todays blog (also recorded as a podcast) I share my thoughts on the serious decline in homeownership in the United States, the key factors that are driving this trend and how real estate investors can leverage it to their advantage.
The American Dream...
Owning a home, owning a piece of America, was always something that people strove for historically in the United States. In the past 30-40 years, most US Presidents (Democratic & Republican) have given major speeches and approved legislation that made it easier for people to purchase their own property. However, that has all changed since the Great Recession and homeownership rates have been falling for more than a decade.
Back in late 2004, homeownership in the USA peaked at a rate of almost 70%. Today, the rate of homeownership is less than 64%. While a 6% drop may not seem all that substantial, in a country this size we are talking about millions of households.
More importantly than this headline fall, the majority of new households that have been created since 2004 are renters rather than home owners. More specifically, of the 14 million new households added in the past 10 years, 80% of them are renters! That is a massive shift hidden behind the overall drop from 70% to 64% homeownership.
So what are the factors driving this trend towards renting versus owning? There are many interlinked causes and I have summarized them as follows:
1. Tight credit markets
2. Huge student debt
3. Declining housing affordability
4. Low personal savings rates
1. Tight credit markets
This is a big fallout from the Great Recession. Lots of people (particularly bankers and builders) got very greedy between 2000 - 2006 and the economy was only saved by massive government bailouts. Nobody wants to go through that pain again and one of the consequences is that it is now much more difficult for regular people to obtain a mortgage. I don´t see it getting better any time soon either.
Put simply, you need a much better credit score than before to qualify for a mortgage. When you count the credit scores of millions of people that took a big hit between 2007-2016, the gap between the "can borrow" and "can´t borrow" gets even bigger.
According to the latest data from Core Logic, the average credit score for borrowers is 739. Even the lowest 1% of borrowers in 2016 had better credit scores than the average back in 2001. With a threshold that high, large numbers of potential borrowers that would have qualified in the past won´t qualify in today´s market.
While you might think that having mortgages with tiny rates of defaults is a good thing, the flip side is that very strict credit requirements will reduce the pool of potential borrowers and increase the pool of potential renters.
Can´t they just improve their credit?
Can I envisage a situation where millions of people can improve their credit scores and qualify for these loans? When you are thinking in that kind of scale, peoples credit scores will improve when the economy improves. The good news is that US is pretty strong now with solid economic growth and solid job growth.
However, a growing economy usually leads to inflation and to counter inflation, we increase interest rates. So while a rising tide will increase the number of people with high credit scores, the factors that caused that will eventually increase the cost of borrowing as well.
2. High student debt
People haven´t been talking about this as much as they´re going to be, but the big noisy elephant in the room for the US economy is exploding student debt.
In the last 10 years, the total student debt in the US has almost tripled from $480 billion to $1.4 trillion! Needless to say, the population didn´t increase threefold during that time and there certainly aren´t three times as many students now compared to 2007. The vast majority of this increase is simply down to universities charging much higher fees and to students borrowing a lot more money to pay their way through college.
Swapping one bubble for another
While housing debt is $1 trillion dollars below its previous peak in 2008, the increase in student debt and car loans has made up for that decrease. Back in 2003, student loans made up 3.1% of total US household debt. Now it is 10.4% and growing fast. (See graph below).
You could argue that we have swapped a housing bubble for a student debt bubble. Back when student loans were a small part of the US economy, most of them were underwritten and held by the private sector. Not any more though - 90% of new student loans are originated in the Department of Education. Sound familiar to anyone?
Let´s get away from the billions and trillions of dollars and back to numbers we can all understand. There are 44 million people with student debt and the average debt is $34,000. Compare that with what students were borrowing 20, 15 or even just 10 years ago. It is like night and day!
That $34,000 debt is real money that can and will severely restrict a persons ability to save for a deposit and buy a house. While there are many valid reasons for people in their 40s and 50s to give out about the attitudes of the young people or "millennials" of today, the fact remains that these kids are saddled with debt that older people just didn´t have to deal with.
3. House affordability
We are all aware that home prices have been appreciating substantially in practically every major US metro area since 2011.
In Tampa Florida where I am an active real estate investor, median sales prices increased by 14.4% between December 2015 and December 2016. That is a big increase which is great news for landlords who like to see their assets appreciating, but not so much for people trying to get on the property ladder in the first place.
With house prices increasing quarter after quarter, people need bigger deposits and they need to qualify for bigger loans. Again, that restricts the pool of buyers, increases the pool of renters and with very limited new construction, it also increases the rents that landlords can charge.
4. Low personal savings rates
Personal savings rates are strongly linked to student debt and rising house prices. Put simply, if people aren´t saving for deposits, they won´t be able to afford a house. Nowadays, the average American household saves 5-6% of its personal income, which is certainly higher than it was during the boom but it is starting to fall again.
Some of this can be explained by changing technology and habits. People today are spending way more money on gadgets, holidays, cars and all sorts of leisure activities than previous generations. That is only part of the answer though.
There are plenty of sensible hard working people out there who do not buy a new iPhone every year, who live quite sensibly but still don´t have enough left over to save for a deposit on a house after they have paid their rent, their student & car loans and their regular bills.
So we have a situation across the country where banks make it very hard to qualify for a loan, where house prices, rents and student debt are all increasing very quickly and where wages are either steady or rising at a much slower rate. You don´t need a degree in Economics to figure out that this is a combination that will create a huge new generation of renters.
The good news for investors
You might think that I´m painting a pretty bleak picture here but I´m not trying to because (a) I believe the current environment is excellent for property investors and (b) I think we have an important role to play by renting stable, long term properties to people that deserve them.
America is a bit obsessed with home ownership (it´s not the only country) but there is no need to be. A high percentage of owner occupiers doesn´t mean an economy is healthy and history has shown that there is little to gain (and a lot to lose) by making it easy for people to buy their own home. I don´t think convincing more Americans to buy their own homes is necessarily a good idea, because it often makes things worse (think of the millions of foreclosures we´ve witnessed recently) and home ownership isn´t for everyone.
Look at Germany. Economically, it is right up there with the most powerful countries in the world right? Well, if you are worried about homeownership in the US falling from 70% to 64%, consider that the homeownership rate in Germany has been steady at 52% and most Germans are perfectly happy with that. In Switzerland, which is one of the richest countries in the world, it is just 44%.
When I was a kid growing up in middle class Ireland, there was a bit of a stigma attached to renting. If the people down the street were renters, people just assumed it was because they were a bit poorer than the rest and that they didn´t have great jobs.
There has been a big shift in attitudes since then and not just among younger generations either. In any urban area across America, you can be a successful professional with a lovely family and a happy long term renter all at the same time. I know plenty of people with good jobs that are renters and I´m sure most of you do too.
Win win situation
At the most basic level, everybody needs somewhere to live. I´m guessing that plenty of you will remember Maslows Hierarchy of Needs from your student days. Shelter was right there on the first level beside food and water.
Investors have a huge opportunity to be key suppliers of inventory as America continues its shift away from homeownership and towards renting. Investors can provide great rental properties to people who want a safe place to live. In exchange for doing that, the renters will pay back their mortgages, build equity in their homes and provide passive income streams to fund their lifestyles and retirements.
At the moment the US economy is very strong and yet we still have large and growing numbers of renters due to the tight credit markets, high student debt, low savings rates and low housing affordability described above.
What do you think will happen if/when the economy gets worse? Will you see less people renting and more buying houses in a recession? No way! If the economy is in trouble, people will just start downsizing and/or renting cheaper houses.
If you want my recommendation on how best to take advantage of this changing market then it would be to invest in properties that can be rented or bought by lower middle class families and younger renters. You don´t want to be renting a big house for $4,000 a month to a software engineer, because he is just going to move somewhere else whenever the market turns on him. Much better to own property rentals that will always be affordable. For my money, that includes nice suburban houses in the $90,000 - $150,000 range that rent for $1,000 - $1,400 per month.
These are the Goldilocks properties that aren't so expensive that people will stop renting in a crisis but they aren´t so cheap that you´ll be continuously stuck with problem tenants either. There are lots of places in the Tampa Metropolitan area that meet these criteria and these are what we buy, renovate and sell to investors every month.
If you can take one thing away from this blog it is that the pool of renters in America is going to continue growing no matter what happens in the general economy and that you can make a lot of money by finding the right kind of homes for them.
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