Here are 10 trends likely to come amidst a full-circle return to housing finance and economics like it was before homeownership became a policy priority.
Humpty Dumpty sat on a wall,
Humpty Dumpty had a great fall.
All the king's horses and all the king's men
Couldn't put Humpty together again.
Traditional English Nursery Rhyme
One of the advantages of writing occasionally is that one has the opportunity to sit and reflect without the pressure of deadline or expectation. Sometimes waiting for things to “sort out” takes longer than one would imagine.
I first started writing the occasional “By George!” articles back in the spring of 2010 in the depths of the housing recession. At the time, I think that all of us knew that it was pretty severe, but there was a belief among many that the pullback, although significant, would still lead back to a housing system that we all knew.
At the time, I thought of what we were going through was much like the experience of Humpty Dumpty, where Humpty was the residential housing ecosystem that had evolved over decades. The system had fallen off the wall and the question was what Humpty would look like in the future.
It has taken a while, but it now appears that the “new” Humpty is looking more like the Humpty of the 1920s and 1930s, rather than the 2004 version.
If so, we are looking at a rollback of nearly 80 years of housing evolution.
If one returns to those times, around 40% of households owned a home and 60% rented. It took huge down-payments (40% being somewhat of a norm) in order to purchase a home. Scarce supply of rentals meant that it was not uncommon for large portions of income were dedicated to rent payment. 50% was not uncommon.
Renters became caught in the “rent trap” and could not save enough to get a down-payment to buy.
Sound like recent newspaper stories to anyone?
It was also not uncommon for families to live together multi-generationally out of necessity. Many sources of income from many hands helped to pay for the rent and the food. It is still the norm in much of the world today.
Local banks took the savings of the local population and pooled the money that enabled the investment in mortgage loans for those who could buy a home. The bankers knew the borrowers and the borrowers were embedded in the community. If one defaulted, the social stigma and shunning were horrible results and that fear kept the obligations of home ownership and borrowing as nearly sacred objects.
The Depression and the 25% unemployment that followed led to the demise of banks, the loss of homes and an inability to rent. The society began to become nomadic. FDR’s policies, including the institution of federal deposit guarantees at banks and agencies to provide direct government lending to borrowers (FHA) were used to help stabilize the system. FDR also saw the need to get people out of the rent trap and began to look at smaller down-payments for purchase as a tool.
Home ownership was seen as a key policy goal. It helped to stabilize communities and helped to lift people out of poverty.
After World War II, the GI Bill encouraged returning veterans to purchase homes and its success led to the predecessors to FNMA, FHMLC, HUD and the other government sponsored entities and departments created in the 50s, 60s, and 70s.
Tax deductibility of mortgage interest and real estate taxes also helped push the ownership and social mobility goals.
It is no surprise that the home ownership rate climbed from the 40% level in the 1940’s to its zenith of around 70% at the time of the downturn in 2007.
As we all now know, dysfunction became embedded over time in this system and, with the downturn, the inevitable finger pointing, lawsuits, and financial losses have led to a world where the government has a very large share of the mortgage market under its control
No bureaucrat wants to be called before Congress for not protecting “our money”, so the result is a much higher credit threshold and fewer people able to purchase under those new rules. The new standards, designed for risk aversion rather than the policy advancement of home ownership, seem to be here to stay for a while.
The major banks are only now coming out of the soup, having paid billions in fines and penalties and being made out to be demon whipping boys, sometimes appropriately and sometimes not. It is no surprise to see them retreating from the residential mortgage lending market. Recent announcements from Bank of America and Wells Fargo are the latest evidence of this retreat.
With fewer big lenders, what residential mortgage lending that is left is being done by “non-bank” entities, such as Quicken Loans. But with a miniscule securitization market (compared to prior), their scope and capability of lending are also limited. Maybe it will grow. I don’t know. But this seems to be a new norm, too.
In the last decade, changes in Federal tax law have somewhat limited the deductibility of mortgage interest and taxes and there continues to be talk of taking away those deductions all together. Piece by piece, this incentive for ownership is drifting away.
It is not surprise, then, that since the downturn started, home ownership has reverted into the low 60% range, single family production is at levels lower than 50 years ago when the population was one half of what it is now, and multifamily production is at levels higher than at almost any time in the last 50 years, too.
The countervailing force of money and lobbying that kept housing policy and home ownership on the upper reaches of the federal policy agenda became severely diminished in the downturn, also. Health care, defense, and social safety net policy now seem to have all of the attention and the lobbying dollars to back it up.
In the new world, no money means no seat at the table. This has come into full view in the primary debates as housing policy is almost totally absent, despite unconscionable homelessness and the angst of a whole generation about how and where they are going to live.
The new Humpty Dumpty is looking like his great-grandfather in the 1930s, unfortunately.
If this is the new reality that we are going to be dealing with, what does it mean for housing strategy?
First, as I first proposed back in 2010, single-family homes for rent are going to be with us in a greater proportion than we have been used to. Lennar and others have dabbled in the new single family for rent business, but it is a sideline. New companies such as Higley Homes in Phoenix are making it their primary business model. Look for more.
Second, even though it will continue to grow at 10-15% per year, single-family production will still be smaller than we need or what we have been used to for longer than we would like to think. Expect large public and privates to have a larger portion of a smaller market than before and for their margins to be underwhelming.
Competing with those builders on commodity single family homes that do not look markedly different than those built in the past 30 years will be the business equivalent of sword-fighting with Zorro.
Third, I think that stagnant incomes and tough underwriting standards will mean that multifamily building will continue to be important. Even more important, though, will be attacking niches: homes for single person households and multigenerational households are two that come to mind. These are product types that the new demographic need and production over the past three to five decades has not provided. Supply-demand says that there is more shot at a better than commodity margin here.
Fourth, look for new financing types to emerge. Some will fail and some will grow, but look for the innovation. Private funding deals for individual communities are one. Shared equity lending to borrowers who do not fit the government underwriting box are another.
Fifth, look for non-industry players to come in and drive the innovation. The Waypoint Homes folks who were one of the roll-ups of foreclosed homes for rent came from outside of the industry, as have the Higley Homes owners. Quicken, an accounting software company, saw the opportunity in replacing banks in mortgage lending and took it.
Sixth, we are seeing urban infill and mixed use projects being where both millennials (before kids) and empty nesters would like to be. It will continue. In the process, we will be getting back to more urban neighborhoods (like prior to the end of WWII and the start of suburbanization).
Seventh, expect that housing will not get back to any kind of national priority in terms of policy support for a while. There will be local angst on unaffordable housing and calls for inclusionary zoning and rent control in the vacuum. All will make land both more and less valuable.
Eighth, existing housing stock will become more valuable and will be densified where it can be. I don’t know, but McMansions might be chopped up into condos or apartments. In-law, granny-flat, or AirBnB additions will be created when they can on existing houses. All of this means that there will be a lot of remodeling and renovation work, opening up opportunities for the roll-up of what are now mom and pop businesses by entrepreneurs.
Ninth, expect to see community velocity to become ever-more important. By including more demographic slices in a community, as well as both for-sale and for-rent product simultaneously, velocities will triple or quadruple.
Tenth, expect that the old project underwriting standard will have to address stagnating selling prices and increasing costs. Diversification of product and velocity will help to alleviate this. Projects that cannot easily be diversified will be at a disadvantage. Builders with such inflexible land on their books right now might have an over-valued asset.
If the past 8 to 10 years have shown us anything, Humpty Dumpty is not going to be like he was for the past 50 years and we better get used to it and figure out how our population houses itself in this new reality that looks a lot like a very old reality.
But in that is opportunity for those who have the courage and foresight to innovate and look the new-old Humpty Dumpty square in the eye.
Originally published in Builder Online on March 7, 2016 http://www.builderonline.com/builder-100/strategy/the-new-old-humpty-dumpty_o