The steady decline in homeownership post-crisis has been well documented, with millennials being held most responsible and receiving most of the headlines. Given that they represent the largest generation thus far and that their median age now falls on the steepest part of the homeownership curve (see my April 2016 blog post U.S. Home Prices: More buyers than sellers), the significance placed on this age cohort is appropriate. However the negative narrative may be shifting, as data over the past year indicates that they are returning to the market with enough strength to reverse the overall trend.
The homeownership rate touched a record low of 62.9% in 2016, a sharp fall from the 69.2% high reported pre-crisis (Chart 1). In the most recent U.S. Census Bureau report for the period ending 2017, national levels have now retraced 1.3% off the lows, with the largest gains in the <35 year old cohort (Chart 2). While it may be too early to extrapolate a larger trend, the tailwinds are in place for further improvement.
The headship rate (the number of households divided by the adult population) is a key driver of household formation. A higher headship rate translates into more households relative to the population, which leads to formations. Since the crisis, headship rates have been depressed, as younger generations live with their parents for longer and delay typical milestones like marriage or having children. What was once a common accomplishment in one’s 20s is now occurring in their 30s or 40s. For example, in 1990 the median age at first marriage was 23.9 for women, but that has increased to 27.4 in the most recent Census Bureau report. This naturally pushes out formations and homeownership, but the desire is still present, as a 2016 Pew Research Center survey reports that 72% of renters say they would like to buy a home in the future.
Rent vs. Buy
Housing formations can take one of two paths — renting or owning. The trend since the crisis has been heavily skewed towards renting (see Chart 3). In fact, roughly 7.6 million households were created between 2006 and 2016, but owner occupied households remained relatively flat over that same period. However, 2017 saw conditions reverse, as total household formations increased by 1.4 million, with owner occupied households increasing by 1.5 million and rental occupied units declining by 100k. The headwinds facing potential buyers post-crisis were steep and included tighter lending standards, concerns around the economic recovery (job security and wage growth), and lingering impacts of falling home prices. However, these obstacles are dissipating just as higher rental prices weigh on millennials. Rents as a percentage of income are now at a historic high of 27%, compared to mortgage payments at 25%. Homeownership remains marginally affordable, although the gap continues to shrink.
Student debt has more than doubled since 2009 to more than $1.4 trillion, hampering the ability of millennials to own homes. The spike in debt has also coincided with a tightening of the credit box as the post-crisis mortgage lending landscape looks sharply different than the pre-crisis environment. The infamous ‘NINJA’ (no income, no job, no assets) loans have been replaced with full underwriting and full down payments for good reason! Credit availability reached a cycle low in 2011, but has been slowly improving across both government and private label channels. Ginnie Mae has become the most popular loan type for first time homeowners by accepting down payments as low as 5% and allowing lower credit scores in return for higher fees. The fees increased steadily from 2010 through 2014, but were cut significantly in 2015 as Ginnie Mae returned to profitability. Fannie Mae and Freddie Mac have also increased market share by introducing down payment assistance programs and by opening the credit box slightly. Finally, private lenders remain competitive across high loan balance mortgages supported by strong credit scores, typically offering lower mortgage rates than available through the Agencies.
Rising homeownership should boost economic growth even further. The National Bureau of Economic Research estimated that households on average spend $3,700 more in the first year following a home purchase. Additional housing demand also has the potential to push home prices higher, especially with inventory levels currently at a record low. We’ve already seen home improvement activity soar post-crisis, another positive for GDP, as some homeowners struggle to find a suitable upgrade or become priced out of market. Finally, it’s also worth emphasizing the central risk to millennial homeownership, affordability. The level of mortgage rates and home prices are key inputs, but just like the rest of the market, we’ll be focused on wage growth.
A week is a long time in politics! Political developments in Europe were the main market focus during the past week. In Italian politics, it was all change and yet no change. Last Sunday, the populist (left wing) Five Star Movement and the anti-immigration (right wing) League polled materially better, at the expense of the left-of-centre ruling Democratic Party (PD) and right-of-centre Forza Italia led by Berlusconi, whose political resurgence now appears to have stalled. No party or coalition of like-minded parties has enough votes to form the next government and whilst mathematically possible, a left-right coalition between Five Star and League (the most volatile outcome for markets) would make strange bedfellows, as the gulf between them on the political spectrum is so wide that one could ride a coach and horses right through. On the positive side, whilst both sides have made negative comments on the Euro in the past, they are unlikely to want to start a financial crisis during a period of relatively healthy growth and market stability. A Five Star-PD coalition is also possible but strongly opposed by outgoing leader and former PM Matteo Renzi. A centre-right coalition between the League and Forza Italia, led by the former rather than the latter (reversing pre-election wisdom), is also technically possible, but with 37% of the votes, other parties would still have to join that coalition. There are many more permutations, and the final result may involve many rounds of political horse trading. One economic outcome investors will watch for is any backsliding on the reform agenda, including potential reversal of some recent pension reforms.
Yet Italians may shrug their shoulders and say “so what”? Political instability is the norm in Italian politics and the current electoral law was specifically designed to deliver coalitions (one could say the law was drafted a little too well). During the past decade, Italy has been run by Prime Ministers Prodi, Berlusconi, Monti, Letta, Renzi and Gentiloni. A new Premier this summer will mean seven leaders in ten years, pretty much par for the course in Italy. As far as markets are concerned, whilst Italy has high public sector debt, this is offset by a wealthy private sector. Debt servicing costs remain low (thanks in large part to the ECB’s easy monetary policy) and Italy also runs a primary budget surplus. Crunch time could come later if ruling populist parties flout Brussel’s fiscal rules. It could also come after the ECB stops its Quantitative Easing (QE) programme, which we expect to last until the end of the year. We believe the risk of a repeat of the Eurozone crisis involving Italy is not negligible in the long term, but is quite low in the short term. As investors, we need to get the timing right, and whilst we have concerns about the medium to long term horizons, Italy may soldier on without a full blown financial crisis for a considerable period of time.
Meanwhile, in the UK, Theresa May presented version 3.0 of her Brexit strategy. Here she acknowledged that the UK cannot “enjoy all the benefits without all the obligations” and that “access to each other’s markets will be less than it is now”. Nevertheless her proposal for “managed divergence” still sits uncomfortably with the EU’s four indivisible freedoms — the free movement of goods, services, capital and labour — and preceded a Brussels proposal which “no UK Prime Minister could ever accept”. Her sector by sector approach, particularly when it comes to trade in services, has already been rebuffed by Brussels, and as we near the second anniversary of the Brexit referendum, progress remains slow, whilst the countdown to when the UK formally leaves the EU (in March 2019) draws ever closer.
As spring approaches, we are also confronted with prospects of a trade war. President Trump’s intention to raise tariffs on aluminium and steel has been predictably met with threats of retaliation. From an economic perspective, global growth has been positively synchronised for over a year now and has finally made the recovery feel somewhat more normal, after years of what we termed “muddle through”. Today growth looks relatively healthy, both from a broad geographical perspective as well as across economic sectors; the fear is that tit-for-tat retaliation could throw a spanner in the works. We keep a wary eye on an escalation of trade friction into more goods sectors and/or into high value sectors such as intellectual property.
Amidst all the above turmoil, it was business as usual with the reappointment of Angela Merkel as Chancellor of Germany, her fourth and final term. But even this stability has been bought with some key concessions, including the Finance Ministry to the Socialist party (although these pale in comparison with the political drama in the prior mentioned countries).
In the face of shifting political tectonic plates, soothing balm came from the “steady” signal from the ECB. At its meeting today, following sustained strong growth, the ECB dropped its easing bias and made a very slight upward shift to its growth forecast for this year and a very small downward trim to its inflation forecast for next year. QE continues and we retain our forecast of an end to QE, either at the start or the end of Q4, and for no rate hikes before this time next year. Another year of easy monetary policy will do much to help the financial world adjust and prepare for a medium term outlook that is threatening to look less benign — higher US fiscal deficits, potentially more trade friction, and simultaneous tightening of monetary policy by major central banks next year. We spot some storm clouds gathering, whilst the broad economic and market outlook currently remains sunny. Our investment decisions need to balance the two.