Few builders would disagree that the lingering, agonizing housing recession has favored smaller, value-oriented, energy-efficient homes in close-in locations. As prices search for a bottom in former high-growth markets, most buyers today are either first-timers without a home to sell or people who must move due to a new job, divorce, or other life-changing event. Faced with brutal competition from bank sales, builders have had no choice but to get down and dirty on price, size, and location.
But that was then. Tomorrow may be very different. Foremost among the issues that face the industry today is whether more familiar and favorable dynamics will reappear as the recovery blooms. As jobs grow more plentiful, home prices rise, and consumer confidence builds, aspirational buyers may return to model centers.
To get a better handle on what's in store for the next decade, Builder convened a Housing Future Summit, soliciting ideas from more than a dozen experts. Several warned that any attempt to predict the future these days is dangerous. Most forecasts are based on historical patterns. The industry today is waist deep in uncharted waters, with record house-price deflation, persistently high unemployment, and scarce household growth. Only time will tell how these forces will affect buyer psychology.
When, If Ever, Will Housing Starts Return to Normal Levels?
Boom. That’s usually the sound of the housing industry coming out of the gate as the economy recovers from a recession. As pent-up demand is unleashed, the housing market typically grows two or three times faster than the overall economy in the first four quarters of expansion. Unfortunately, there was no starter’s gun for housing this time around. If anything, a paucity of housing activity is holding back the recovery, depressing growth.
After falling to impossible lows in the winter of 2009, housing starts had only managed to rise 26 percent through October 2010. New-home sales, seasonally adjusted and annualized, hit an all-time low of 283,000 in October. Americans just aren’t in the mood for buying new homes, and that may be because after losing 8.5 million jobs during the recession, employers have been slow to add them back. Even as profits climbed to record levels in some cases, private employers were on a pace to hire only 1.2 million new workers last year.
Despite stimulus efforts, the country still grapples with an unemployment rate in excess of 9.5 percent. One problem is that more and more people are looking for work. The U.S. population grows by 2.4 million people a year, according to Census estimates. “We need to generate 125,000 jobs a month just to stay even” with population growth, says noted author Joel Kotkin, who spoke at our symposium.
Another factor militating against a swift comeback to “normal” levels of housing starts—which most housing economists estimate is between 1.5 and 1.8 million annually—is that economic conditions have depressed household formation. Young people simply don’t have the money or the jobs to go out on their own. The latest Census data shows that only 350,000 new households were created in the year that ended last March. That’s way, way down from the 1.2 million that formed per year during the 1990s and early 2000s.
Deeper changes in personal finance, and even the psyche of American consumers, may stunt future housing demand. First, nearly one out of four households with a mortgage are under water on their home investments; they owe more on their mortgage than their house is worth. And, as John McIlwain, a fellow with the Urban Land Institute, points out, by the time the foreclosure epidemic ends, 11 million households may have lost their homes. These families won’t be in a position to buy a new home anytime soon; it takes five-to-seven years to rebuild a credit rating. In the meantime, they will have no choice but to rent. McIlwain thinks the homeownership rate, which peaked at 69 percent in 2005, may trough at 62 percent.
Several other strong undertows may pull people into rentals in the short term, McIlwain suggests. College graduates are saddled with big debts. The “bank of mom and dad” has closed due to a run on home equity, which has left parents scrambling to rebuild their retirement nest egg. “Also, young people may prefer mobility over ownership, especially if you consider 6 percent to 8 percent transaction costs of buying and selling a home over five years,” says McIlwain.
Research consistently shows, though, that a select group of Americans prefer new homes over resales. When prices and mortgage rates reverse course and start edging up, will this prime cohort storm the market, hoping to get a deal before they disappear? That’s not far-fetched—housing is more affordable now than at any time in 20 years. More than 70 percent of families making the median income in America can afford the median-priced home.
David Crowe, the NAHB’s chief economist, believes that at some point pent-up demand will drive housing production back to “normal” levels. Crowe calculates that there’s already pent-up demand of between a half million and 1.5 million households. He forecasts that it may not be until late 2013 that the industry returns to producing housing at a 1.5-million annual rate.
The Joint Center for Housing Studies at Harvard University is even more bullish. It recently estimated the need for between 16 million and 18 million new housing units over the next 10 years, though it doesn’t say in what years that demand will be met. The levels of activity would roughly equal the 17 million housing completions in the 2000s. (There were 16.1 million in the 1990s, and 17.4 million in the 1980s.) The forecast is based on immigration patterns, forecasts for household formations, the need to replace obsolete housing stock, and demand for second homes.
Michael Rehaut, a housing analyst with J.P. Morgan, notes that the current depressed level of housing starts, under 1 million for the last three years, is unprecedented in the last 50 years. “Normalized production won’t return until excess inventory subsides,” he says. When it does, he thinks the advantage will go to public builders with easy access to capital and big cash reserves, even though those builders lost share to the market from 2006 to 2009.
When Demand Returns, What Shape Will It Take?
First-time buyers, without a home to sell, account for most of the action today, with trade-up buyers largely relegated to the sidelines. Looking forward, trade-up buyers may wait to recoup some of their lost paper equity before they make a move, even if their home is worth more than it was 10 years before. “Homeowner equity has been cut in half since 2006,” notes Kermit Baker, an economist with the Joint Center,
Low mortgage rates may paradoxically impede move-up activity. As Baker points out, it’s hard to find a homeowner who hasn’t refinanced at rates below 5 percent. As sales activity picks up, mortgage rates will inevitably rise—the Mortgage Bankers Association believes they will be at 5 percent by the end of the year. Will homeowners with a low rate on their existing home want to move? Many may run the numbers and figure that they are better off staying put than buying a new home at a higher mortgage rate. That state of affairs may take some steam out of the trade-up market.
Baker believes that this “lock-in” dynamic will stifle already-low mobility rates. In the mid-1990s, roughly one in seven households, about 17 percent, would change residences in any given year, according to data from the U.S. Census. That figure had dropped to about one in eight, or 12 percent, by 2008, and it has likely fallen further since then. Moreover, migration from one state to another, a phenomenon that has fueled decades of growth in Sunbelt states, has slowed to a trickle.
Their incomes reduced, equity impaired, and prospects uncertain, it’s no wonder today’s buyers seem fixated on value. Housing, they’ve learned from the newspaper and even feature-length Hollywood movies, is no longer the safest and best investment on the planet. But it’s still the biggest. Instead of asking themselves how much house they can afford, prospects roll around in their heads how much they really need. Do we really need a home theater when we can put a big screen TV in the family room? Do we really want a fourth bedroom for guests when we could fit a bed in the home office? They question ornamentation. And they drive a hard bargain.
But memories are short, especially among U.S. consumers. Consider that full-sized SUV sales now outpace new-car sales overall. That’s after the gas scare of 2008 drove consumers to hybrids and other gas-conserving autos. There’s already evidence that American consumers, suffering from savings fatigue, are returning to restaurants, malls, and old spending habits. Before long, they may again aspire to buy the home of their dreams, even if it contains more than they actually need, especially if they believe, rightly or wrongly, that the home is likely to rise in value.
Where Does It Make Sense to Build?
The housing recession brought unparalleled choice to consumers. Buyers who had been priced out of the best school districts and neighborhoods, or forced to endure long commutes, could suddenly get in line to buy short sales or foreclosures. As buyers voted with their feet, builders and developers shut down far-flung master plan communities in favor of infill and even urban locations.
But what happens once close-in inventory returns to more normal levels? Will an inexpensive home on a big lot on the suburban fringe look more attractive then? Already, unsold existing-home inventory is down to only 4 million, 20 percent below historical averages, according to data from the National Association of Realtors (NAR). And data from the Mortgage Bankers Association shows the rate of new foreclosures is declining nationally, though banks still need to work off a large inventory of homes in the pipeline.
The suburbs are more popular than many urban planning critics want to believe. Kotkin likes to point to the National Survey on Communities done for Smart Growth America and the NAR that shows that more than half of Americans would prefer to live in a suburban setting, whether it’s close in or far away. The next most popular response? A rural setting (35 percent). The city finishes last at 13 percent.
“If the suburbs are so bad, how come people prefer to live there?” asks Kotkin, who argues that the same aspirations are held by newcomers to this country. The evidence is that immigrants, instead of locating in urban centers, are now moving directly to the suburbs, often the first-rung. More than 50 percent of foreign-born residents now live in large metropolitan suburbs, up from 44 percent in 1980. “People don’t come from Hong Kong so that they can live in a box in America. The [immigrant] desire for space is very strong.”
Kotkin trots out other data developed by Wendell Cox of Demographia, a research and advocacy firm, indicating that most jobs in metropolitan areas are not in the city. In Phoenix, for example, only 2 percent of jobs are in the central business district. In Los Angeles, the figure is only slightly higher—2.5 percent. Among major metro areas, New York (20.1 percent) and Washington, D.C. (18.7 percent) have the highest percent of jobs downtown. “That also happens to be where the media has the largest megaphones,” he quips.
A continued rise in telecommuting, Kotkin predicts, will give more Americans the opportunity to live where they choose. Forrester Research forecasts that the ranks of telecommuters will swell from 34 million in 2009 to 63 million in 2016, stimulating more demand for home offices. The exodus will be fueled by continued broadband adoption, even better work collaboration tools, and growing management experience with a dispersed workforce.
But the jury is still out on whether development patterns will shift in favor of the suburbs. McIlwain believes that close-in locations will continue to grow in popularity because they are more convenient. Buyers, he says, are increasingly looking at the “cost of place,” a calculation that includes the cost of commutes, errands, and picking up kids. “We don’t want to live in our homes. We want to live out of our homes.”
Then there’s the question of where young people really want to live. Surveys of Gen Yers and Xers done by RCLCO, a research and consulting firm that works with land developers and builders, indicate a strong preference for urban living—77 percent of Gen Yers, in particular, plan to live in an urban core. This desire is especially strong among WINKS—women with incomes and no kids. In coming years, WINKS “will dominate the urban landscape,” says Charlie Hewlett, managing director of RCLCO.
Gen Y women, better educated than their male counterparts, who are in turn better educated than previous generations, are already out-earning males. Most demographers believe that given their financial success these young females may delay marriage and child-bearing. They may establish careers and even homes before they do that. As a result, they may live alone in locations closer to work longer than previous generations.
Will Builders and Buyers Lose Their Energy Religion?
Many builders found shelter in an energy-efficiency niche during the housing maelstrom. They successfully marketed homes with low monthly operating costs against a flood of resales, often using third-party certification to their advantage. They found receptive buyers, worried about the long-term direction of energy prices and interested in doing good by the planet by buying a home with the lightest possible carbon footprint.
The question is whether builders and buyers will do an about-face once normal dynamics return to the market. Energy efficiency may now be the “new granite,” as McIlwain says, but will it be supplanted by big, jetted tubs, 20-foot ceilings, and other lavish creature comforts once the market improves?
Evidence suggests that energy-efficient new homes may not be a passing fancy. First, going forward, builders will still need a competitive edge against existing homes, and it’s easier and more cost-efficient to do energy efficiency in new homes. Plus, surveys of potential home buyers show that almost half will gladly pay an extra $5,000 to $10,000 for energy upgrades that will add $35 to $70 to their monthly payments. The more salient point, though, may be that spreading code requirements will require that new homes be increasingly energy efficient. Competition from a growing contingent of green builders will provide further impetus.
Not to be overlooked in this debate, a new generation of relatively inexpensive infrared cameras, selling for about $1,500, has hit the market. Suddenly, every builder’s dirty laundry—improperly sealed windows, leaking eaves—may be on digital display to any potential buyer or builder competitor. Sam Rashkin, who manages the Energy Star program for EPA and DOE, believes the proliferation of these cameras—which only energy inspectors used to be able to afford—will force builders to build energy-tight homes. Already, roughly one in five new homes is built to Rashkin’s Energy Star requirements.
The federal government plans to up the Energy Star ante this year. To get a stamp of approval, builders will need to form a completely sealed thermal envelope that will stand up to an infrared camera test. Also, they will be asked to size and design heating and cooling elements as a system; inspectors will check to see whether they were installed correctly. And they will need to incorporate more comprehensive water management measures to ensure water stays out of the home’s envelope. Infrared cameras can reveal water build up behind walls, too.
Continued increases in natural gas, electricity, and petroleum prices will provide further incentive to build homes that are energy misers. “It’s unlikely that we can keep the cost of energy at current levels,” says McIlwain, pointing to forecast data from the Energy Information Administration that shows steady price increases throughout the decade.
Right now, most American homeowners have almost no idea how much energy is consumed by various systems within their houses. Bill Ablondi of Parks Associates believes that will change very soon due to the spread of affordable home control systems. “Residential energy management is hot,” he says, noting that a variety of smart grid appliances and energy monitoring systems will hit the market in 2011. “Consumer awareness, interest, and willingness to spend is real and growing.”
Demand for more energy-efficient homes may grow as homeowners gain more insight into their energy consumption patterns. The introduction of more affordable home controls, linked to the Internet, will be a new awakening. They’ll be able to see how much energy they consume through lighting, computers, and individual appliances. They’ll be able to adjust the times at which they run the dishwasher and clothes dryer.
Who Will Buy Homes in the Future?
One of the biggest challenges for builders in future years will be adapting to changes in the types of people buying homes. The percentage of households in the home building industry’s sweet spot—growing families—will contract. The biggest growth will be among the youngest, who may further delay marriage and child rearing, and the oldest, who may behave differently in retirement and semi-retirement than previous generations. Both young and old buyers may tip the scales in favor of smaller homes in the future, though those decisions will also be influenced by wealth and other economic dynamics.
All eyes are on Gen Y (born in the 1980s and 1990s), who could potentially have a bigger impact on home building than the vaunted Baby Boomers. Why? Because there are 8 million more Gen Yers than Boomers, for one thing. The problem with determining the direction in which they will push and pull housing design and production is that they aren’t having much of an impact right now.
The bulk of this new generation only graduated from college two years ago. They are saddled with big college debts that will take a while to pay off. Then they’ll have to save some money before they buy a home. Many of these graduates are cooling their heels in their parents’ homes, or they are living in a group home or apartment, often subsidized by their parents. But when these youngsters finally get around to getting a place of their own, it could be big. “There [may] be more first-time home buyers in the market in 2013–2018 than ever before,” says Hewlett of RCLCO.
The early data on aging Baby Boomers reveals a different animal than the Eisenhower Generation. Recent steep losses in home equity and wealth have upset retirement plans, for one thing. Hewlett believes we’re likely to see more Boomers in “semi-retirement, with second careers, and continuing education.” At the very least, he says, “retirement is likely to look very different than in the past.”
Aging Boomers may want some of the same things sought by previous generations of active adults—maintenance-free homes, active social agendas, and close proximity to shopping, health care, entertainment, and exercise. But the settings in which they find these things are likely to change. Instead of creating large, highly amenitized communities, developers may be better off creating smaller enclaves—some age-restricted, others design-targeted—close to suburban hubs.
The other big change rolling down the pike is the growing influence of immigrant households. RCLCO estimates that 73 percent of population growth between 2010 and 2020 will be non-white. Already, 17 of the 100 largest metro areas are “majority minority.” By 2035, minority households will account for nearly half of all U.S. households.
Builders will need to rewrite their marketing and advertising messages to appeal to an increasingly diverse buyer population. And a rise in multigenerational families, stemming from the growing Hispanic population, may require larger homes with a higher bedroom count and a new generation of floor plans.
The growing prominence of single buyers, though, may offset any trend toward increased new-home sizes. (The size of new homes started by contractors has dropped from about 2,270 square feet in 2006 to about 2,120 square feet last year.) Joint Center projections show that persons living alone will account for the largest share of future household growth. More and more Boomers will find themselves widowed or divorced. And many young people will move out on their own, before they marry.
At some point during the decade, though, strong demand is likely to return from married or partnered couples with children. Nature will take its course; young people will marry and have children. That favorable demographic will play to the strength of builders who cater to family buyers.
Go to http://go.hw.net/burning_issues_2011 to view videos and PowerPoint presentations from the Housing Future Summit.