“Old normal” will not be part of housing recovery

WASHINGTON (January 27, 2010) – As the U.S. economy recovers, emerging trends in demographics and consumer behavior will become major drivers of new housing opportunities, resulting in a residential market vastly different from the one that existed prior to the recession, according to Housing in America: The Next Decade, a new research paper authored by John K. McIlwain, senior resident fellow, Urban Land Institute/J. Ronald Terwilliger Chair for Housing.

In a presentation of the research to Urban Land Institute trustees during the Institute’s Midwinter Meeting in Washington, McIlwain discussed the implications of the rising numbers of foreclosures, re-establishing a private-market residential finance system, as well as shifts in housing demand triggered by baby boomers, their children, and by immigrant households. “The old ‘normal’ will not return,” McIlwain predicted. “Over time, a new mode of metropolitan development will emerge, presenting opportunities and stiff challenges. Those who fail to understand these new trends will find themselves building what is no longer in demand.”

Despite the housing stabilization that has begun in the nation’s strongest employment markets, overall home prices will likely decline an additional 10 percent this year, contributing to what is already an unprecedented number of foreclosures and “underwater” mortgages (loan amounts that are higher than the current value of the homes), McIlwain said. The growing number of consumers who are choosing to walk away from those mortgages suggests a fundamental change from the long-held notion of homeownership as the ultimate American Dream, he explained. This disillusionment over homeownership as a way to build wealth could persist for decades to come, as those entering the housing market will be more apt to rent longer, and to place more emphasis on buying for shelter rather than investment purposes.

Two key predictions from Housing in America for the decade ahead: home appreciation will slow considerably, to about 1 percent to 2 percent annually; and the current U.S. homeownership rate, now at 67 percent (a decline from the record high of 69 percent at the height of the housing boom) will fall further, to about 62 percent.

According to McIlwain, the lasting stability of the U.S. housing market depends on how, and when, the private home mortgage finance system is revived and how such a system might be structured. The federal government now supplies virtually all new mortgage funds through mortgage purchases or securitization. Reducing this massive support, he said, will entail revamping or replacing mortgage suppliers Fannie Mae and Freddie Mac, and tightening risk requirements for mortgage issuers to restore investor confidence in mortgage-backed securities.

“Re-establishing a robust private mortgage market will require both strong market fundamentals and a reformed mortgage securitization structure that eliminates past abuses,” McIlwain said.

Such reform will influence the flow of capital, affecting the volume of debt, its cost and to whom it will be available, he noted. While reform efforts are still sketchy, the end result “will have a fundamental impact on housing markets for years to come.”

The report cites four major U.S. demographic waves to watch in the new decade:

  • Aging baby boomers (55 to 64 years old) – Although they are nearing retirement age, many will keep working out of necessity or by choice. Some will be forced to stay in their suburban homes until values recover. Those who are able to move will not choose traditional retirement locations or senior housing, opting instead for more mixed-age living environments that cater to their active lifestyles. Suburban town centers with a walkable urban “feel” will appeal to this group.
  • Younger baby boomers (46 to 54 years old), now in or entering their prime earning years – This group will also face a tough time selling suburban homes, hampering the ability of these boomers to move. Because the recession has left many younger boomers with flat incomes and less home equity, their ability to purchase second homes will be greatly diminished, curbing prospects in general for the second home market. However, like their older counterparts, they will be drawn to more connected, compactly designed communities when they are able to switch houses.
  • Generation Y – This tech-savvy generation has a population of about 86 million, more than the baby boomers. Gen Yers place high value on community; on places (either virtual or actual) to gather and share information, ideas and opinions. As they enter the housing market, they will be far less interested in homeownership than their parents were when they were young adults. (The recession, said McIlwain, has “tempered the interest of Gen Yers in buying their own homes and they will be renters by necessity or choice for years ahead.”) Despite having small incomes, Gen Y will gravitate toward walkable, close-in communities, choosing isolated housing on outer edges only as a last resort because it is the most affordable. Green, “net zero” homes powered exclusively by alternative energy will have strong appeal to this group.
  • Immigrants – Already 40 million strong, the total population of legal and illegal immigrants in the U.S. has an even greater impact when the children and grandchildren are included as a factor. The tendency of immigrants to cluster, and to live in multi-generational households, suggests that they would prefer larger homes if they could afford them and if the homes were in neighborhoods with a strong sense of community. All of these groups have some characteristics that reflect a desire to live in more pedestrian-friendly, transit-oriented, mixed-use environments that de-emphasize auto dependency, whether the location is urban or suburban, McIlwain noted. Among the majors factors driving urbanization: 1) growth of two-person households and single households without children (among both baby boomers and Generation Y); 2) a halt to baby boomer migration to the suburbs; 3) the likelihood of Generation Y to rent rather than own; and 4) public policies encouraging compact development.

Economic and land constraints make it impossible for urban infill development to accommodate all the housing demand represented by all the demographic groups, McIlwain said. As a result, suburban development “must adapt or it will be obsolete,” he concluded. “The suburban century is over. This is the urban century.”

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