Feature

The State of the Nation’s Housing in 2004 - Part I

by Harvard University�s Joint Center for Housing Studies

The Impact of Today's Housing Trends on Tomorrow's Communities
Despite job losses in the rest of the economy, housing had another record-breaking year in 2003. Home sales, single-family housing starts, residential fixed investment, homeownership rates, mortgage originations, refinances and home prices all reached new peaks. The only weak spots were the uneven rental market and the depressed manufactured housing sector.

This housing boom has been both longer and more broadly based than previous expansions (chart 1). Construction activity has remained strong in most states, and real house prices have climbed in nearly all metropolitan areas. Rents have increased in more areas than they have decreased, and industry indicators suggest that rents are stabilizing in some locations that have seen recent declines.

With the economic recovery under way, the question now is whether housing will achieve a soft landing in which house prices, sales and new construction ease rather than drop off sharply. Several factors favor the former. Housing construction appears to be in line with long-run demand, and a strengthening economy should support house prices. In addition, changes in the housing finance system have made markets more resilient and better able to adjust quickly to interest-rate movements. Although refinancing activity would drop off significantly if interest rates rise even gradually, construction would probably hold near its current pace and inflation on housing prices would become moderate rather than turn negative. If job growth falters or interest rates spike, however, housing could be in for a rougher ride.

Uninterrupted Growth
The housing boom has outlasted an international finance crisis in 1998, an economic recession in 2001 and job losses in 2002–03. Throughout most of this period, low interest rates kept housing markets thriving as home prices and sales continued to climb. Rising home values in turn generated wealth effects that helped to sustain consumer spending. In fact, the wealth effects related to home price appreciation, realized capital gains and heavy home equity borrowing appear to have contributed more than one-quarter of the growth in personal consumption in both 2002 and 2003.

Residential construction has been on the rise for most of the last 12 years, adding significantly to the housing stocks in both metropolitan and nonmetropolitan areas—particularly in the South and West. Large metros such as Atlanta and Las Vegas have seen spectacular increases in new construction, while the rate of growth in many small and medium metros exceeded 25 percent.

Despite growing concern over the pace of development, housing construction over the next 10 years is likely to exceed that over the last 10. The Census Bureau's newly revised population estimates imply that household growth from 2005–15 will be as much as 1.1–2.0 million more than the Joint Center for Housing Studies previously projected. Add to that the growing demand for second homes and the replacement of units lost from the housing stock, and the total number of homes built in 2005–15 could reach 18.5–19.5 million units. This compares with 16.4 million homes added in the 1990s.

In the meantime, house prices in many areas of the country have risen considerably faster than household incomes. This rapid appreciation has raised concerns that housing is headed for a crash. Although more locations are now at greater risk of a home-price decline than a year or two ago, a sharp correction is unlikely unless the economy unexpectedly contracts. Sharply higher interest rates would, however, quickly erode affordability for homebuyers. In that case, home prices would come under pressure unless employment and income growth were strong enough to offset the rate increases.

The first line of defense that potential homebuyers can take against rising interest rates is to choose mortgages that adjust annually or hybrid mortgages that have fixed rates for a set number of years before adjusting. While these maneuvers blunt the short-run impact of higher rates, they do expose owners to higher monthly payments if interest rates continue to climb.

Demand Transformed
The changing demographic structure of the population is reshaping housing demand. Immigration has been, and will continue to be, an important driver. Immigrants have accounted for more than a third of household growth since the 1990s, adding not only directly to the number of households but also indirectly as their native-born children begin to live on their own. Although recent immigrants have lower homeownership rates than native-born Americans of comparable races, ethnicities and ages, with time many foreign-born households eventually join the ranks of owners.

Owing to immigration and higher rates of natural increase, the minority share of households increased from 17 percent in 1980 to 26 percent in 2000 and will likely reach about 34 percent by 2020. Minority household growth over the next 10 years will add significantly to the growth in household heads aged 55 to 74 and will help to offset losses of white household heads aged 35 to 54 as the baby-bust cohort reaches middle age (chart 2).

This will only add to the already important contributions that minorities have made to housing demand in recent years. In particular, without the rapid growth in minorities, the number of renter households would have fallen during the 1990s. Instead, the renter population increased modestly, and the minority share of renter households surged from 31 percent to 39 percent over the decade.

In addition to keeping rental demand from sagging, minorities also accounted for fully two out of every five net new homeowners from 1994 to 2003. Despite these strong gains, though, minority homeownership rates still lag behind those of whites by nearly 25 percentage points. Narrowing this persistent gap remains a challenge for both the government and the mortgage finance industry.

Meanwhile, social and economic trends have given women a more powerful presence in housing markets. Between 1980 and 2000, the number of households headed by unmarried women increased by almost 10 million (chart 3). Over the same period, the median contribution of wives’ earnings to dual-earner households rose from 30 percent to 37 percent. As a result, unmarried women now head a larger share of households, and married women make larger contributions to household income than ever before.

While both women and minorities make up increasing shares of middle-income households, they are still overrepresented in the lowest-income category. The incidence of housing problems is therefore higher among minorities than whites and among unmarried women than unmarried men of comparable ages.

Housing Finance Innovations
Several changes in the finance industry have served to strengthen housing markets. Consolidation has brought new economies of scale, reducing the costs of mortgage originations and servicing. The ability to fund mortgages in domestic and global capital markets has also reduced the risk of credit crunches by tapping a larger investor base through the broadening of secondary mortgage markets.

In addition, automation has accelerated approvals, lowered costs, expanded access to credit and reduced blatant discrimination. Loan loss mitigation tools have also limited the share of problem loans that end in foreclosure, which is costly to all parties. And finally, multiple mortgage products are available with a range of amortization lengths, loan terms and repayment options, helping to keep homebuyers in the market even when interest rates rise.

Today, capital is far more readily available in low-income and minority communities. While the number and share of prime loans to these borrowers have increased steadily since the 1990s, the growth of higher-cost subprime loans has been even greater. Indeed, the subprime share in low-income, predominantly minority communities mushroomed from only a few percentage points in 1993 to 13 percent of home purchases and 28 percent of refinance loans in 2001.

Although innovation in housing finance has expanded access to credit, it has also brought new risks and challenges. The proliferation of mortgage choices and prices can confuse homebuyers and provide fertile soil for predatory lending. In addition, statistical credit scores now govern both access to and the pricing of mortgage credit. These scores are lower on average for minorities than for whites of comparable incomes, implying that some minority borrowers pay more for their loans. Furthermore, the growth in subprime lending has resulted in rising foreclosures in some of the low-income and minority communities where these loans are concentrated.

Housing Challenges
Although the overwhelming majority of Americans are well housed, nearly a third of all households spend 30 percent or more of their incomes on housing and 13 percent spend 50 percent or more. In addition to widespread affordability problems, crowding is on the increase, some 2.5 - 3.5 million people are homeless at some point in a given year and nearly 2 million households still live in severely inadequate units.

Not surprisingly, housing challenges are most severe among those at the bottom of the income distribution. Fully half of lowest-income households spend at least 50 percent of their incomes on housing. Severely cost-burdened households in the bottom quintile by expenditures have little left over to pay for other basic necessities, spending just $161 on average each month on food and $34 on healthcare. By comparison, households in the bottom expense quintile that devote less than 20 percent of their budgets to housing managed to spend $80 more a month on food and $49 more on healthcare on average.

Unfortunately, affordability pressures are unlikely to ease. Many of the low-wage jobs created by the economy do not pay enough for a household to afford (at 30 percent of income) even a modest one-bedroom rental anywhere in the country. Similarly, retirement incomes are so meager that many seniors face heavy housing cost burdens on top of escalating healthcare costs.

Adding to the pressures on low-income households is the cost of supplying new affordable housing. Restrictive regulations and public resistance to high-density development make it difficult to replace or add lower-cost units. Prospects for additional income supports or housing subsidies are equally bleak. As the federal deficit balloons, the calls to cut spending on social and housing programs are growing even as the demand for and costs of these programs continue to escalate.

The opinions expressed in this article are those of the author and do not necessarily reflect the viewpoint of the SFAA or the San Francisco Apartment Magazine. This report serves as an essential resource for both public policy makers and private decision makers in the housing industry. To read the complete report, please visit the Joint Center's Web site at www.jchs.harvard.edu. Reprinted from the State of the Nation's Housing 2004 with permission from the Joint Center for Housing Studies of Harvard University. All Rights Reserved.