Over the last few months, a number of national real estate reports have generated mixed results, and as I recently detailed, homebuilder stocks have thus been stuck in neutral. But in the past two weeks it seems as if the homebuilders have slid from neutral gear into reverse, as earnings reports from industry leaders like D.R. Horton (DHI) have failed to meet analyst expectations.
The 20-city Case-Shiller index report out this week showed a 9.3% increase overall from a year ago, but that was down from 10.8% the previous month, the first time we have seen that in many months. In addition, there was a 1.1% drop in the pending sales numbers, and pending home sales have declined each and every month in 2014.
So what’s going on? Has the real estate market reached a peak, and if so what are the reasons, and what is likely to happen next?
The No. 1 problem for the real estate industry today is the lack of first-time homebuyers, particularly among the Millennial generation (roughly ages 18-32). First-time homebuyers currently make up only about 27% of all real estate purchases, a historically low figure that in past years was as high as 40%.
In years past, previous generations would finish college by 22 or 23, establish their first career jobs by the mid 20’s, begin to marry and have babies by 27 or 28, and start looking for their first home before age 30.
But many among the Millennial generation appear to be frozen in time and unable to achieve the usual demographic trends of previous generations. Burdened with debt from student loans, car loans, and credit card misadventures, this is a generation that is unable to save any funds for real estate down payments and closing costs.
Furthermore, their debt-to-income ratios are too high to qualify for mortgages, and too many are still only working part time, or in low-paying jobs. Just filling up with gas once a week at $3.60 per gallon puts a large dent in their paychecks. Lenders simply will not touch them for fear of rising defaults down the road.
The problem goes deeper than that, though…
As The New York Times recently reported, 20% of Millenials in their 20’s and early 30’s are still living with their parents, and 60% still receive financial support from them. A generation ago, only 10% of this age group was in a similar situation.
Other Millennials, who have managed to achieve more independence but are finding it tough to make a good living, are sharing 2- and 3-bedroom apartments with roommates. Furthermore, with marriage and pregnancies delayed, their desire to purchase homes is attenuated. Many are still mistrustful of the housing market in general, having witnessed a volatile boom and bust period — along with neighborhoods filled with foreclosures — within their lifetime.
Obviously, homebuilders have reason to be concerned, and are now taking steps to address the Millennial market. D.R. Horton recently announced they would begin building bargain priced “Express Homes”, in an affordable range between $120,000 and $150,000. These are basic, attractive, turn-key new homes, but they are devoid of any options or upgrades. Horton will aggressively begin to turn these out in Texas, Florida, and Georgia in 2015.
At a recent news conference, Horton CEO Donald Tomnitz said, “We wouldn’t be getting into Express Homes if we didn’t think it was the next segment of the market to recover”
But is this really the case? Will the Millennials recover anytime soon from an economy that has failed to provide adequately paying full-time jobs over the past six years?
Health insurance costs are expected to rise again in 2015, and Millennials who are no longer on their parents’ health plans are going to experience sticker shock as a large percentage of their paychecks are swallowed up by taxes and health insurance. With the remainder of their pay carved up among student loans and automotive costs, it doesn’t leave much for saving for that down payment on an Express Home.
And yet, if the Millennials are unable to save the housing industry, who will? Investors with cash have been propping up the markets for the past two years, but as prices rise, investors cannot continue to do so. Those who flip properties will hit a wall of lack of affordability by buyers, and those who rent homes will find fewer and fewer tenants who can afford the rising rates.
The end result could be a decline in both the number of homes sold, as well as the values of homes as early as next year.
The only hope for the Millennials to be able to afford their own homes is better job creation, and the only hope for job creation lies with electing politicians who will put the strength of our economy ahead of strangleholds like higher taxes, excessive regulation, and politically motivated entitlement programs. To that extent, the November elections will be a key indicator of whether or not the Millennials can save the real estate industry from another decline.
Ethan Roberts doesn’t own any of the companies mentioned in this article.