Feature
by Harvard University's Joint Center for Housing Studies
Editor’s note: Harvard University every year assesses housing trends nationwide and releases an annual overview of its findings. The San Francisco Apartment Magazine will serialize this year’s report over the next few months. This is the first installment.
The housing boom came under increasing pressure in 2005. With interest rates rising, builders in many states responded to slower sales and larger inventories by scaling back on production. Meanwhile, the surge in energy costs hit household budgets just as higher interest rates started to crimp the spending of homeowners with adjustable mortgages. Nevertheless, the housing sector continues to benefit from solid job and household growth, recovering rental markets, and strong home price appreciation. As long as these positive forces remain in place, the current slowdown should be moderate.
Over the longer term, household growth is expected to accelerate from about 12.6 million over the past ten years to 14.6 million over the next ten. When combined with projected income gains and a rising tide of wealth, strengthening demand should lift housing production and investment to new highs. But with the economy generating so many low-wage jobs and land-use restrictions driving up housing costs, today’s widespread affordability problems will also intensify.
Stretching to Buy Homes
Although monthly mortgage costs to buy a median-priced home with a fixed-rate loan have risen only in the past two years, affordability in the nation’s hottest housing markets has been eroding for some time. Unlike in metropolitan areas with more moderate appreciation, the interest rate declines in 2000–2003 did not offset the impact of skyrocketing prices in these markets. Affordability pressures are now spreading, with median house prices in a growing number of large metros exceeding median household incomes by a factor of four or more.
Even so, homebuyers scrambled to get in on still-hot markets last year. In stretching to afford ever more expensive homes, borrowers increasingly turned to mortgage products other than fixed-rate loans to lower their monthly payments, at least initially. The most popular of these loans was the standard adjustable-rate mortgage, followed by interest-only loans, with payment-option loans a distant third.
In just two years, interest-only loans (which defer principal payments for a set number of years) went from relative obscurity to an estimated 20% of the dollar value of all loans and 37% of adjustable-rate loans originated in 2005. Payment-option loans, which let borrowers make minimum payments that are even lower than the interest due on the loan and roll the balance into the amount owed, accounted for nearly 10% of last year’s loan originations, but a much smaller share of outstanding loans. While these products helped to shore up housing markets last year by blunting the impacts of rising interest rates and home prices, proposed federal guidelines may limit their use in the future.
Although borrowers with interest-only loans will see their housing outlays jump when their principal payments come due, these increases are still several years off. Borrowers thus have time for their incomes to catch up, for interest rates to fall, or to either refinance or move.
Fortunately, most homeowners have sizable equity stakes to protect them from selling at a loss even if they find themselves unable to make their mortgage payments. As measured in 2004—before the latest house price surge—only 3% of owners had equity of less than 5%, and fully 87% had a cushion of at least 20%.
House Price Risks
The greatest threat to housing markets is a precipitous drop in house prices. Fortunately, sharp price declines of 5% or more seldom occur in the absence of severe overbuilding, dramatic employment losses or a combination of the two. The fact that these conditions did not exist and that interest rates were so low explains why the housing boom was able to continue without interruption when the recession hit in 2001.
With building levels still in check and the economy expanding, large house price declines appear unlikely for now. But if the economy falters, both job growth and housing prices will come under renewed pressure. This would spark higher default rates, especially among subprime borrowers, and turn housing from an engine of economic growth to a drag.
Strong Demand Fundamentals
Despite the current cooldown, the long-term outlook for housing is bright. New Joint Center for Housing Studies projections—reflecting more realistic, although arguably still conservative, estimates about future immigration—put household growth in the next decade fully 2 million above the 12.6 million of the past decade. On the strength of this growth alone, housing production should set new records.
With each generation exceeding the income and wealth of its predecessor, growth in expenditures on home building and remodeling should match, if not surpass, the current pace. For example, the median inflation-adjusted income of households in their 40s was $1,800 higher in 2005 than in 1995, while that of households in their 50s was $1,900 higher. Similarly, between 1995 and 2004, the median wealth of those in their 40s was up by $33,600 and median wealth for those in their 50s was up by $46,600.
But incomes at the top are increasing much faster than those at the bottom and in the middle. These differences will likely drive rapid growth in the burgeoning luxury sector of the housing market, but present stubborn affordability challenges for households with low and moderate incomes.
As members of the baby-boom generation reach their 50s and 60s with record wealth, they will boost the market for senior housing and second homes. At the other end of the age spectrum, the baby boomers’ children, together with same-age immigrants and second-generation Americans, will buoy demand for starter homes and apartments. As this large generation moves into adulthood, demographic forces will favor rental over for-sale housing.
Meanwhile, foreign-born and minority households will continue to be the fastest-growing segments of the housing market. Thanks to strong immigration and slightly higher rates of natural increase, the minority share of households should expand from 28% in 2005 to over 32% in 2015. Foreign-born individuals already represent 13% of the US population, including 18% of young adults aged 20 to 29. Immigrants have added especially to the ranks of the baby-bust and echo baby-boom generations, bringing new life to center cities that once experienced population declines. Immigrants thus represent not only a key source of labor for the housing industry, but also a large and growing customer base.
Long-Term Housing Challenges
While the vast majority of Americans still pay a manageable share of their income for housing, affordability problems are worsening. In just the three years from 2001 to 2004, the number of households paying more than half of their incomes for housing shot up by 1.9 million. This increase brought the total number of low- and middle-income households with severe cost burdens to 15.6 million.
Working in no way protects families from the hardship of high housing outlays. In fact, 49% of poor, working families with children (working more than half time but earning less than the poverty level) had severe cost burdens in 2004 and 75% had at least moderate burdens. Among near-poor, working families with children (with incomes one to two times the poverty level), the share with severe burdens was 17%, while 52% had at least moderate burdens.
As households spend excessive shares of their incomes on housing, they have little left over for other basic needs. Accordingly, many choose to trade off longer commutes for more affordable housing. As evidence, households in every expenditure quartile with low housing outlays spent much more on transportation than those with high housing outlays. Among those in the bottom expenditure quartile, for example, the difference in travel costs between the two groups was $99 per month.
Meanwhile, Hurricane Katrina exposed the longstanding problem of concentrated poverty. Despite some progress at the national level, about one-tenth of the nation’s poor still live in neighborhoods with poverty rates over 40%. While the number of high-poverty areas has fallen in most metros, the problem nonetheless persists in nearly all metropolitan areas and in fact intensified in 70 metros during the 1990s. Indeed, even in neighborhoods that dipped below the high-poverty threshold of 40%, the median poverty rate was still a substantial 31%.
Government’s Role
With so many Americans struggling to afford housing, the federal government has stepped up by providing subsidies to about one-quarter of renter households with incomes of less than half of area medians. These subsidies typically hold tenant rent contributions to 30% of household income. In addition, states are authorized to issue tax-exempt bonds and housing tax credits, which have financed nearly two million low-income rental units, as well as assisted more than two million first-time homebuyers over the past 15 years. State and local governments also allocate federal block grants, along with housing trust funds, to assist in creating affordable housing and broadening opportunities for low-income homeownership.
At the local level, however, land-use regulations often make it difficult for builders to develop affordable housing. Large minimum-lot sizes, restrictions on the land available for residential development, impact fees that place the marginal cost of infrastructure and public services on new homebuyers, and approval processes that add risk and delays all play a hand in rising house prices. Because per-unit impact fees and permitting costs represent such a large share of the costs of developing modest units, they directly discourage the production of low-income housing.
While many land-use regulations address important public policy concerns, such as environmental protection and public health, they nevertheless make housing more expensive. Indeed, the stricter the development regulations, the more intense the affordability problems in that community.
But relaxing land-use regulations alone will not eliminate the nation’s housing affordability problems. The costs of owning and operating even modest housing far exceed the rents that many low-income households can afford to pay without deep subsidy. As a result, affordable rental housing is disappearing at an alarming rate. Between 1993 and 2003, the supply of rental units affordable to those earning $16,000 or less shrank by 13%. These dramatic losses increased the shortfall in units available to these low-income households to 5.4 million.
Federal efforts to address this challenge have been critical but insufficient to keep up with the growing demand. Making significant headway will be difficult without the combined efforts of all levels of government to expand housing subsidies, create incentives for the private sector to build affordable housing, institute land-use policies that reduce the barriers to development and educate the public about the importance of affordable housing.
Next month: The September issue will feature part two of the series, “Housing Markets.”
The opinions expressed in this article are those of the author and do not necessarily reflect the viewpoint of SFAA or San Francisco Apartment Magazine. Reprinted from the State of the Nation’s Housing 2006 with permission from the Joint Center for Housing Studies of Harvard University. To read the complete report, please visit the Joint Center’s website at www.jchs.harvard.edu. All rights reserved.