Renter Nation

The recession and shifting demographics will swell the ranks of people who will rent, not buy, housing over the next five years. This is according to an interesting blog I found in Yahoo Real Estate: http://finance.yahoo.com/real-estate/article/110173/renter-nation?mod=re.... Read below to see the entire blog:

The American dream of owning a home is still very much alive, but it will be no more than a dream for a growing number of people over the next five years. That's bad news for home builders, who already have big troubles, as June's reports on housing starts, existing-home sales, building permits and unsold-home inventories showed. But it is good news for anyone renting out a home, apartment or condo, or any real-estate investment trust specializing in residential rental properties.

Most U.S. households own the dwelling they live in, and that isn't likely to change. But demographic and economic forces, together with some perversities of government policy, are combining to push the share of ownership back to where it was in the early 1990s. Already, in the wake of the housing bust that brought on the Great Recession, the share of U.S. households owning homes has slid steadily—from 69% at its peak in 2004 to 67.2% in this year's first quarter. And the rate is likely to fall to its 1993-94 level of 64% by 2015.

The flip side of this trend is a rising rental rate, which probably will hit 36% by 2015, versus 32.8% in 2004. Every percentage-point increase represents nearly 1.3 million households, and the average household includes more than two people—so roughly 10 million extra folks could be moving into rentals over the next five years.

Why? From now through 2015, the long slog that will unfortunately characterize the economic expansion will bring slow growth in jobs and wages. That pace of improvement should be just strong enough to permit new households to form, but not robust enough for the members of those households to afford to own homes. In addition, lax lending standards, fraud and predatory lending practices— key factors in the unrealistic bubble in home ownership in the mid-2000s and the subsequent debacle—appear to have become rarer, at least temporarily.

At the same time, the once-exuberant Fannie Mae (OTC BB: FNMA.OB - News) and Freddie Mac (OTC BB: FMCC.OB - News), now wards of the government, could well become more stringent when buying mortgages from banks and other lenders. That's to say nothing of Uncle Sam's latest efforts to protect consumers, which could have the unintended effect of making it even harder for young households to get mortgages.

Demographics also will deal home sellers and builders a clear blow. Not surprisingly, the home-ownership rate tends to rise with age. For example, while the overall U.S. rate is 67.2%, the rate for households headed by someone under 35 is just 38.9%.

Thus, whenever the age distribution of households tilts in favor of younger adults, the overall home-ownership rate declines. That happened in the early 1980s, when young (and numerous) baby boomers began to form households. And, says demographer Peter Francese, former president of American Demographics magazine, a similar tilt is likely over the next half-decade.

Francese projects substantial growth in households formed by people under 35, who mainly rent rather than own. Worsening the shift will be a decline in the number of households led by people 35 to 49 years old—the very ages when there is normally a huge jump in ownership. Francese does expect a rise in households led by people 50 and older, but the boost to ownership from this won't be great. Home-ownership rates tend to level off when Americans reach their late 40s and early 50s.

In the 1960s, as the boomers—people born from 1946 through 1964—began reaching child-bearing years, demographers expected an imminent birth explosion. What happened instead was an extended birth dearth that produced a "baby bust" generation, born from roughly 1965 through 1977. Then, as though to confound the demographers even further, the boomers (along with some early busters), begot the echo-boom generation, through a jump in births from around 1978 through 1994.

Based on the years when the boomers, busters and echo boomers were born, the size of certain age groups will expand and contract as the years pass, creating imbalances that haven't been, and won't be, altered by the net influx of immigrants into the U.S. Through 2015, those imbalances point to a decline in the rate of home ownership.

Largely because the echo boomers are more numerous than the baby busters, there are now more U.S. residents aged 15 to 29 than 30 to 44. So five years from now, the nation will have more 20-to-34-year-olds than 35-to-49-year-olds.

Similarly, largely because the baby busters are less numerous than the baby boomers, there are fewer 30-to-44-year-olds than 45-to-59-year-olds. Thus, five years from now, expect a decline in the ranks of the group that historically has been the most keen to buy homes—the 35-to-49-year-olds.

At the same time, Francese sees the number of households headed by someone under 35—a prime rental group—expanding faster than the overall population.

The key to the housing outlook is household formation. As defined by the Census Bureau, a household is formed when one person takes separate living quarters, or when two or more people do, regardless of whether those people are married or unmarried, and provided that the quarters aren't in an institution, for example, a prison, nursing home or school dormitory.

The great recession of 2007-09 halted the growth in the number of households led by people under 35. The financial stress also led to the dissolution of some households that those in this age group previously had formed. Net result: The number of younger households fell, even though the ranks of younger Americans continued to increase.

Many of the missing young householders were "boomerang kids." As economist Greg Kaplan of the Minneapolis Federal Reserve has found, these individuals tend to move back with their families—thus dissolving their own households—when they lose their jobs. Others never left the family home, often because they simply couldn't afford to do so.

Still others entered college or graduate school. College enrollment jumped by an unusually large 850,000 in the fall of 2008, when the jobless rate among young people already had begun to rise. Regardless of the benefits that more education might bring to young people, there is an undeniable downside: more debt.

According to estimates by Mark Kantrowitz—publisher of FinAid, which guides students about all forms of financial aid—65.6% of bachelor-degree recipients held an average of $23,300 in student debt by 2007-08, with both figures setting records. While the burden of student debt isn't likely to prevent young people from forming households after they graduate and find jobs, it will inhibit their ability to take on mortgages.

Francese sees a 2.8 million rise by 2015 in the number of households headed by people under 35. But he expects this group's home-ownership rate to probably slip to somewhere below its current 38.9%.

Another problem: Ownership rates soar as people move into their late 30s and 40s, so a rise in households in this age group would naturally be expected to boost the overall home-ownership rate. But Francese sees a 600,000 decline in the number of households headed by those aged 35 to 49, simply because the number of folks in that age group will decrease.

The demographer does project a huge increase of seven million in households 50 and older, mainly because of the baby-boomer effect. The residential real-estate market might benefit somewhat, assuming people over 50 buy second homes as investments or vacation properties. But the impact probably won't be great.

The economy, as always, calls the tune in the housing market. The subpar recovery we are experiencing, which is likely to be followed by a subpar expansion, is tailor-made to help spawn a generation of renters.

Young people who need the down payment for a home have often been helped by what jokingly has been called the new "G.I. bill": generous in-laws. That will no doubt continue. But given the economic constraints those in-laws will be facing—imposed by higher taxes and the need to build (or rebuild) retirement savings—their generosity could be severely limited.

The generous in-laws could perhaps afford to retire, but can't sell their home at a decent price—in most of the U.S., housing in general isn't appreciating, or is appreciating more slowly than it was, pre-bust. Or, they might rent out part of it, while continuing to occupy the rest. Or, if they move to a retirement property elsewhere, they might keep a couple of rooms in the old homestead as a place to return to on visits to the kids. And maybe their tenants will be their own adult children—renting, of course, at a reduced rate—even zero.

More likely, however, the new version of the G.I. bill will take the form of, say, providing the adult offspring with the first two months' rent for an apartment, plus security deposit, rather than the much heftier cost of a down payment on a home.

Requirements on that down payment have climbed. According to the Federal Housing Finance Agency, the share of new mortgages requiring a down payment of less than a 10th of the house price was 8% last year, down from 29% in 2007.

Michael Frantantoni, research vice president of the Mortgage Bankers Association, says the early 1990s were the last time the share of new mortgages permitting a down payment of 10% or less ran in the single digits. In fact, the average down payment on all mortgages last year exceeded 25%. The last time it was that high was also the early 1990s.

Adds Frantantoni: "We've moved from a world where most of the effort was on streamlining the mortgage-application process to one where full documentation is the norm. Every data point needs to be checked and rechecked." One of those data points includes higher standards on credit scores.

Some observers, including David C. John, a Heritage Foundation research fellow, would call the current procedures a welcome return to sanity. But John also expects the new Consumer Financial Protection Board, authorized by the Dodd-Frank Wall Street Reform and Consumer Protection Act, to make it harder for low- and moderate-income households to get mortgages.

"Last year," observes John, "Congress made a high-minded attempt to fix credit cards, making it more difficult for issuers to change interest rates or to penalize people who misused the cards. The net result was that issuers backed away from higher-risk customers. I see the same scenario playing out with mortgage issuance."

The federal government's now-expired tax credit to spur home buying did help the residential realty market. But even with house prices scraping along the bottom and mortgage interest rates at historic lows, home sales were tepid.

In May, new-home sales, no longer helped by the tax credit, plunged to their lowest level since 1963, the year in which records of such transactions began to be kept. In contrast, the rental-apartment market, without any federal help, has been surprisingly strong.

Dallas-based Axiometrics tracks monthly price and occupancy data on apartments in 305 markets around the country. Its research chief, Jay Denton, reports that, on new leases written through this year's first six months, effective rents—those after all concessions are taken into account—rose a robust 3.2%, after declining through 2009 and much of 2008. And occupancy growth, adds Denton, is close to the best he's seen in the past 13 years.

Given this strength, Axiometrics President Ronald Johnsey believes nationwide job growth must be stronger than official estimates. Otherwise, he finds the rebound in the rental market hard to explain. Johnsey rules out the possibility that any great number of rental apartments were taken by former homeowners with jobs who lost their homes through foreclosure or who walked away because the value fell below the mortgage principal.

For one thing, says Johnsey, anecdotal evidence shows that former homeowners generally rent other single-family homes, rather than apartments, because that's where they're accustomed to living.

Axiometrics' findings auger badly for home builders, especially those that cater to entry-level and first-time buyers. But they auger well for the apartment market. As younger households start to rent, apartments probably will be their housing of choice. The problem for investors is that this probability already has boosted the share prices of real-estate investment trusts specializing in apartments.

Still, Alexander Goldfarb, associate director of investment banker Sandler O'Neill & Partners, does have Buys for three REITs: Colonial Properties Trust (NYSE: CLP - News), specializing in Sunbelt markets; Equity Residential (NYSE: EQR - News), with properties in major cities throughout the U.S., and Essex Property Trust (NYSE: ESS - News), with buildings on the West Coast. Analyst Andrew McCulloch of Green Street Advisors, a research firm specializing in real-estate securities, has a Long-Term Buy on AvalonBay Communities (NYSE: AVB - News). Part of his rationale: "The apartment market has begun to turn the corner."

That turn should last for quite a while.