[User] HOUSING AND THE ECONOMY 5 Joint Center for Housing Studies of Harvard University Housing continued to prop up the economy in 2002. Like the year before, significant interest-rate declines and robust home price appreciation lifted residential investment. Meanwhile, record cash-out refinances pumped $96.5 billion back into the economy. The steady escalation of home prices has given rise to concerns about a housing market bubble. The good news is that home prices have grown only about as fast as incomes in most areas. In addition, large nominal home price declines are relatively rare and it takes significant and concen- trated job losses—well beyond those in evidence in most places today—to precipitate a retreat. Nevertheless, a few markets have seen home price inflation outstrip income growth and a few have registered steeper job losses, making them more vulnerable to home price declines if their economies turn down. Rising rental property valuations, together with climbing vacancy rates and rent concessions in several markets, have also led to worries that recent rental transactions are overvalued. But because lower interest rates support solid leveraged returns on these acquisitions, they are financially viable. Absent further weakening in rental markets, they should remain so. REACHING NEW PEAKS An unexpected decline in mortgage interest rates—prompted by the slumping economy and the movement of capital out of stocks and into bonds—kept the housing boom going in 2002. New and existing home sales both set records. Estimated remodeling expenditures—including maintenance, 6 The State of the Nation’s Housing 2003 repairs and replacements—also hit another high in 2002, on top of a strong (inflation-adjusted) 8.6 percent gain between 1998 and 2001. THE CONTRIBUTION OF REFINANCES In 2001-2, homeowners refinanced a record $2.5 trillion in mortgage debt, more than doubling the 1998-9 high. According to a Federal Reserve Board survey, those who refinanced and took cash out in 2001 and the first half of 2002 withdrew an average of $26,700. While the top one percent of stockholders own 33.5 percent of total stock wealth, the top one percent of home equity holders own just 13 percent of total home equity. Home equity is an especially important source of wealth for those in the bottom fifth of the income distribution. In 2001, the median net wealth of these lowest-income owners was $68,000, while that of lowest-income renters was only $500. Furthermore, for half of these owners, home equi- ty accounted for 80 percent or more of their total net wealth. Because housing wealth is so broadly distributed, home equity gains influence the spending behavior of far more households than stock gains do. According to Federal Reserve estimates, households spend $0.15 for every $1.00 rise in their housing wealth, but only $0.03-0.05 for every $1.00 rise in stock wealth. This explains why home equity gains have been able to offset the dampening effect of large stock losses on consumer spending. HOUSE PRICE CONCERNS House price increases have been strong for so long that some analysts have predicted a slowdown, if not a drop, for two years running. Fanning the flames of concern, house price gains have outstripped income gains since 1997 in 48 of the 50 largest metropolitan areas. Nevertheless, inflation-adjusted home prices rose faster in 2001 than at any time since 1978, and nearly as fast again in 2002. The State of the Nation’s Housing 2003 tech-related job losses). More importantly, it takes concentrated job losses—the likes of which have not been seen during this business cycle—to drive down home prices. Prices fall when many people must sell their homes at the same time that demand is soft. With surplus inventory on the market, sell- ers are forced to accept lower prices. Even during national or regional recessions, most metro- politan areas do not experience severe job losses or hous- ing price declines. During the wave of house price defla- tion in the late 1980s and early 1990s, for example, nom- inal declines occurred in 47 of the 100 largest metropoli- tan areas. Just 24 of those areas saw a drop of five percent or more. Consequently, house prices in only one in four large metro areas fell enough to wipe out the value of a modest five percent downpayment. Moreover, when house prices deflate, they do so slowly. Because people live in, as well as invest in, their homes, many owners choose to stay put when prices soften. This reduces the number of homes on the market and helps bring supply and demand back in balance, thereby fore- stalling faster and sharper price declines. Slow declines in inflation-adjusted home prices following sharp run-ups, however, are common. In fact, real home prices have fallen at least 10 percent in 58 of the 100 largest metro areas at some point since 1987. These declines occurred over an average of 6 years. Furthermore, because housing is typically a leveraged investment, even when nominal home prices rise more slowly than general inflation, owners can earn a real return on their capital. In fact, as long as the gap between nom- inal home price inflation and general inflation is less than the leverage multiple, the owner comes out ahead. For example, an owner who puts $10,000 down on a home has a leverage multiple of ten. If nominal home prices rise by one percent, that owner receives a return of ten percent. Unless general price inflation is ten percent or more, the owner still profits. THE OUTLOOK While housing has held up remarkably well, the near-term outlook is clouded by significant economic and geopoliti- cal uncertainties. So far, the positive effects of rising real disposable incomes and low mortgage interest rates have offset many of the depressing impacts of higher unem- ployment.

[Assistant] Moreover, housing fundamentals remain solid. Production appears to be running in line with long-term Note: Estimates include prime conventional loans only and are net of retirement of outstanding second mortgages. Source: Freddie Mac.


[User] If interest rates remain low for the remainder of 2003, home sales, prices, and refinances could defy expectations yet again. On the other hand, even if interest rates increase by a point or more, housing investment should hold up well because borrowers can opt for more affordable, adjustable- rate mortgages. While support- ing continued strong home sales, this would also lift home prices and create higher hurdles for first-time buyers. Of course, if the economy slides back into recession, the downward pres- sure on housing markets would compound the lingering effects of the 2001 downturn. Mort- gage delinquencies and foreclo- sures would likely rise, while some rental markets would soften further. Over the longer term, housing’s direct contribution to the economy should remain strong. Spending within the housing sector (including rents, utili- ties, furnishings, maintenance, repair, and remodeling) has accounted for about one-fifth of national economic activi- ty for decades, and is likely to account for at least that large a share during the current decade.

[Assistant] Over the next ten years, the aging baby-boomers will continue to support the trade-up market, fuel spending on professional remodeling projects, and shore up demand for more expensive rentals. As the echo boomers move into their 20s, they will lift demand for smaller apartments and starter homes. At the same time, housing providers and the financial sys- tem will face the growing challenge of supplying units to low-income and minority households. Both household growth and new construction will remain concentrated in the South and West and at the far reaches of metropolitan areas. If recent trends are any indication, whites will account for the lion’s share of the households moving to the metro fringe and into non-metropolitan areas, while minorities will likely dominate growth in the center cities and in older, urbanized suburbs. Minorities are on track to add 7.5 million households between 2000 and 2010, and another 7.8 million between 2010 and 2020 (Table A-6). The minority share of US households is thus expected to grow steadily from about one-quarter to nearly one-third within 20 years. Shifts in family composition, while less dramatic, also have important implications for housing demand. The number of people living alone is expected to rise by nearly 5 mil- lion over the current decade. With divorce rates high and remarriage rates trending down, many of these single- person households will be relatively affluent, middle-aged baby boomers. This is already apparent in the sharp rise in people living alone in suburban and non-metropolitan areas. From 1992 to 2002, the number of single-person households in these locations increased by four million, compared with less than one million in the urban core.


[User] Meanwhile, growth in the number of married couples over age 55 without minor children living at home will be equally strong, up 4.3 million during this decade and 6.1 million during the next. Many of these households will, however, have their adult children living with them. As of percent of married-couple households in this age group included an adult child, while 11 percent of 25 to 34 year-olds still lived with their parents.

[Assistant] Indeed, the baby boomers do not seem in a rush to down- size their homes as their children reach adulthood. While fully half of the oldest boomers (aged 45 to 54 in 2000) moved during the 1990s, they typically traded up to newer homes with more amenities. Over this decade, the share of older boomers that move is expected to shrink to about 35 percent, but their sheer numbers mean they will still play a powerful role in home-buyer markets.


[User] Along with income, household wealth has also built over the past ten years. Despite the stock market dive, aggre- gate wealth at the end of 2002 was up significantly from 1992. Indeed, household wealth in the US has grown almost uninterrupted since the end of World War II. As measured by the Federal Reserve’s national balance sheets, inflation-adjusted household wealth more than doubled from $7.8 trillion in 1950 to $17.4 trillion in 1975, then more than doubled again to $40 trillion in 2002. PERSISTENT INEQUALITIES Even though income has been on the rise, its distri- bution has become increasingly unequal. According to the Current Population Survey, the mean infla- tion-adjusted income of households in the bottom fifth rose by a healthy 11.7 percent during the 1990s. During that same period, the mean income of those in the top fifth was up 25.7 percent. Moreover, the mean income of the lowest-income group fell a full 3 percent during the 2001 recession while the highest- income group eked out yet another small increase. Households with access to wealth are better able to achieve homeownership. Moreover, they may drive home prices up ahead of income growth, making it more diffi- cult for households with less wealth to buy homes. To compete in the housing market, less wealthy households may therefore have to take out larger home mortgages and devote larger shares of their incomes to pay for com- parable housing. IMMIGRATION AND MIGRATION PATTERNS Following longstanding trends, population growth con- tinues to cluster in the South and parts of the West (Table A-7). Foreign immigration nonetheless kept population growth in California and the rest of the Pacific division going strong. The southern and interior western states remain attractive locations, thanks to their relatively low costs of doing business, favorable climates, and healthy labor markets. But the fevered pace of employment and population growth in these areas has strained local resources and fueled anti-development sentiments.

[Assistant] While these and other regulatory pressures may eventually erode some of their attractiveness, the South and West will likely contin- ue to experience relatively rapid growth.


[User] Meanwhile, many urban core areas experienced their strongest population growth in decades. Among the 31 center cities of the largest metros that lost population in the 1970s and/or 1980s, 16 regained population during the 1990s. Many urban areas have now stabilized and some are beginning to gentrify, sparking concerns over the growing shortage of affordable housing. For households at the lower end of the income distribution, though, affordability has clearly eroded. When the economy slowed in 2001, households in the bottom two quintiles saw their incomes fall 2-3 percent, with little or no recovery in 2002. In addition, rising home prices have forced first-time buyers to come up with more cash, take out larger loans, or settle for lower-quality homes than they would have otherwise chosen. Some have been priced out of the market altogether. In 2001, minorities accounted for about 32 percent of recent, first-time buyers, up from about 19 percent just eight years before. Foreign-born minorities alone now constitute about one in ten first-time buyers, and account for even greater shares in the handful of metropolitan areas that are home to large foreign- born populations. Past and present gaps in homeownership rates have pro- found impacts on minority household wealth. Today, homeowners age 55 and older hold an estimated $3.3 tril- lion in home equity. If just three-quarters of these owners pass their properties on to their heirs over the next 20 years, the transfer of wealth would involve 12.3 million homes—fully 10.7 million of which are owned by non- Hispanic whites. Under the simple assumption that equi- ty in these homes does not grow at all in inflation-adjust- ed terms, the housing wealth passing to white heirs would Under and Over White Black Hispanic Asian/Other Notes: White, black and Asian/other are non-Hispanic. Hispanic householders may be of any race. Asian/other includes Pacific Islanders, Aleuts and Native Americans. Source: Table A-5. RECORD-LEVEL MORTGAGE DEBT As a result of strong homeownership gains and house price appreciation, mortgage debt outstanding has grown at a 7.5 percent compound annual rate since 1994, even after adjusting for inflation. Mortgage debt now accounts for 43 percent of residential value, up from 31.6 percent in 1980. To date, the run-up in mortgage debt has increased the exposure of only a small fraction of homeowners. Thanks to the interest-rate cuts of the 1990s, homeowners have been able to hold down their monthly mortgage payments even if they add to their housing debt. For many, substi- tuting mortgage debt for higher-cost consumer loans has also lowered their total debt burden. Moreover, strong home price inflation has quickly added to the home equi- ty of all owners—including those who opted for low- downpayment loans when they bought. PROBLEM LOAN RISKS The risks are, however, increasing. Mounting job losses hurt many homeowners in 2002, with both the number and share of problem loans on the rise. It is important to recognize, though, that the share of mortgage borrowers who are seriously behind on their payments or in foreclo- sure is still relatively low. Although at record levels, foreclosure rates on conventional loans are still under 0.2 percent while those on government-backed FHA loans are about 2.5 percent. Loan risks are rising among lowest-income homeowners. According to the 2001 American Housing Survey, 2.2 million borrowers in the bottom income quintile spent more than half their incomes on housing (including prop- erty taxes and utilities), up from 1.7 million in 1997. RENTAL HOUSING TRENDS With the strength of homeownership demand and the weakness of the economy, some rental housing markets have softened since 1999. Even though national measures indicate that rents have risen, high vacancy rates in some locations have pushed rents down or prompted landlords to offer concessions to attract tenants—especially for newer and higher-end rental units. The new multifamily apartments being built are substantially more expen- sive on average than the ones being lost. This trend—fueled in part by local resistance to multifamily construction and escalating development costs— threatens to leave the nation with a dwindling supply of modest rentals. Not surprisingly, then, vacancy rates on units affordable to households in the bottom income quintile are lower than those on more expensive units. The return of inflation-adjusted rent increases has made it more difficult for many renters to afford their housing. The recent recession made mat- ters worse, dragging median renter incomes down by 1.8 percent in 2000- 2. The share of income a typical renter spends on housing thus stood at 26.9 percent in 2002. 21 Joint Center for Housing Studies of Harvard University SOFTENING RENTAL MARKETS Vacancy rates for both single- and multifamily rentals have been on the rise since 1993. Although the number and share of renters living in single-family homes increased over this period, the grow- ing supply of single-family rentals overshot demand in most regions. The exception was the Midwest, where a fall-off in demand, rather than an increase in supply, was responsible for the rising vacancies. Meanwhile, multi- family vacancy rates began to climb more sharply as the economy slowed, hitting 9.7 percent by 2002. Properties with five or more units were particularly affected as their rates rose to 10.5 percent. Although information collected by M/PF and REIS show that higher vacancy rates drove down rents on some apartments that came on the market last year, the rent drop may be smaller and the recovery quicker than during the last cycle. In the 1980s, sig- nificant overbuilding led to soaring vacancy rates in structures with five or more units. Today, however, the soft- ening economy is more to blame for any excesses in the supply. The correc- tion in rents and in multifamily construction should therefore be more modest this time around. Note: Definition of single-family units changed in 1999 to include attached structures. Data collection procedures also changed in 1993. Source: Census Bureau, Housing Vacancy Survey. 22 The State of the Nation’s Housing 2003 In stark contrast, the prices of multifamily rental proper- ties have surged.

[Assistant] As interest rates dropped and capital flowed into real estate from the stock market, investors became more willing to accept lower returns on proper- ties. In 2002 alone, lower capitalization rates for multi- family rentals pushed valuations on transacted properties up by about 10 percent. With lower debt costs, investors can pay more for properties while still earning attractive returns. Investors are counting on a cyclical recovery and strong future demand to justify these valuations when they go to sell the properties in several years.


[User] With the number of white renters down by 2.1 million, the minor- ity share of renter households thus increased from 34 per- cent to 42 percent. Immigration has also added substantially to the demand for rental units. Foreign-born households now account for nearly one in five renters. Half of these renter households arrived in this country only within the past ten years. Moreover, foreign-born households now account for 73 percent of the growth in Hispanic renters since 1997 and are expected to have an even larger presence in rental mar- kets in the coming years. MAKING THE RENTAL CHOICE For some households, renting is the only housing option because they lack the income or savings to buy a home. For many others, though, it is the preferred housing choice because it offers greater flexibility than ownership. For example, people who are in the midst of major life transitions, such as a career or family change, often choose to rent their homes rather than buy. Another group that can particularly benefit from renting includes senior homeowners either facing significant changes to their fam- ilies or incomes, or simply looking for the convenience and community of renting. Reason for Moving Age Marital Status 24 The State of the Nation’s Housing 2003 these former homeowners accounted for one in six house- holds that moved into rental housing (Table A-8). While renting might be only a temporary choice for many of these former owners, the need for housing markets to satisfy this type of short-term demand is ongoing. Although many of these households may decide to buy homes again, other homeowners making the switch to renting will be there to take their places. THE OUTLOOK In the near term, rental housing markets appear headed for a modest correction. Rising vacancy rates should lower rents in many locations, particularly at the high end of the market. Dips in rents could well be fleeting, however, given the relatively small run-up in multifamily vacancy rates as well as the barriers to, and the high cost of, devel- oping new units.

[Assistant] Over the longer term, rental housing demand should grow even if the national homeownership rate continues its steady ascent. The number of renter households is cur- rently expected to increase by about a million in each of the next two decades. But if conditions turn unfavorable for homeowning, the number of renters could easily grow by five to six million. In any case, the renter share should hover near three in ten households for the next 20 years. Regardless of the overall growth in renters, the composi- tion of renter households will continue to reflect changes in the overall population. Given their strong household growth, minorities will make up an even larger share of renters in the years ahead. Current projections point to an increase in minority share from 42 percent today to over 50 percent in 2020. The increase in renter diversity, along with the aging of the population, will bolster rental demand at the margins. Growth in young adult households will increase demand for moderate rentals, especially when the echo boomers reach their mid-20s after 2010. Meanwhile growth among those between the ages of 45 and 64 will lift demand for higher-end rentals.


[User] 1 Joint Center for Housing Studies of Harvard University Executive Summary Despite job losses in the rest of the economy, housing had another record-breaking year in 2003. Home sales, single-family housing starts, residential fixed investment, homeownership rates, mortgage originations, refinances, and home prices all reached new peaks. The only weak spots were the uneven rental market and the depressed manufactured housing sector. With the economic recovery under way, the question now is whether housing will achieve a soft landing in which house prices, sales, and new construction ease rather than drop off sharply. Several factors favor this possible outcome. Housing construction appears to be in line with long-run demand, and a strengthening economy should support house prices. In addition, changes in the housing finance system have made markets more resilient and better able to adjust quickly to interest-rate movements. Although refinancing activity would drop off significantly if interest rates rise even gradually, construction would probably hold near its current pace and house price inflation moderate rather than turn negative. If job growth falters or interest rates spike, however, housing could be in for a rougher ride. Uninterrupted Growth The housing boom has outlasted an international finance crisis in 1998, an economic recession in 2001, and job losses in 2002–3. Throughout most of this period, low interest rates kept housing markets thriving as home prices and sales con- tinued to climb. Rising home values in turn generated wealth effects that helped to sustain consumer spending. In fact, the wealth effects related to home price appreciation, realized cap- ital gains, and heavy home equity borrowing appear to have contributed more than one-quarter of the growth in personal consumption in both 2002 and 2003. Recessions are defined by the NBER Business Cycle Dating Committee. The last time period reflects the recovery. Sources: Census Bureau, Construction Statistics and National Association of Realtors.® 2002 Q1–2003 Q4 1990 Q1–1990 Q3 1979 Q3–1980 Q1 2000 Q3–2001 Q1

[Assistant] Demand Transformed The changing demographic structure of the population is reshaping housing demand. Immigration has been, and will continue to be, an important driver.


[User] Owing to immigration and higher rates of natural increase, the minority share of households increased from 17 percent in 1980 to 26 percent in 2000, and will likely reach about 34 percent by 2020. In addition to keeping rental demand from sagging, minori- ties also accounted for fully two out of every five net new homeowners from 1994 to 2003. Despite these strong gains, though, minority homeownership rates still lag those of whites by nearly 25 percentage points. Narrowing this per- sistent gap remains a challenge for both the government and the mortgage finance industry. Although innovation in housing finance has expanded access to credit, it has also brought new risks and challenges. The proliferation of mortgage choices and prices can confuse homebuyers and provide fertile soil for predatory lending. In addition, statistical credit scores now govern both access to and the pricing of mortgage credit. These scores are lower on average for minorities than for whites of comparable incomes, implying that some minority borrowers pay more for their loans. Furthermore, the growth in subprime lending has resulted in rising foreclosures in some of the low-income and minority communities where these loans are concentrated. Many of the low-wage jobs created by the economy do not pay enough for a household to afford (at 30 percent of income) even a modest one-bedroom rental anywhere in the country. Similarly, retirement incomes are so meager that many seniors face heavy housing cost burdens on top of esca- lating healthcare costs. 5 Joint Center for Housing Studies of Harvard University Housing and the Economy Housing helped to shore up the economy again in 2003. Residential fixed investment alone accounted for about one-tenth of GDP growth, while commissions from home sales pumped an estimated $80 billion into the economy. Sales and Production Still Strong Low interest rates pushed home sales to new heights, fueling owner-occupied housing markets from coast to coast even as some rental markets softened. After dipping in mid-year to levels not seen since the early 1950s, rates on 30-year fixed mortgages averaged 5.83 percent for the year. This is more than two percentage points (or 38 percent) below their aver- age when the housing boom started to build steam in 2000. Buyers took advantage of the low rates to push sales of exist- ing single-family homes to 6.1 million units and of new single- family homes to 1.1 million units. Low rates also helped to hold down monthly mortgage payments and keep home prices on the rise. Indeed, the median sales prices of both new and existing single-family homes hit all-time highs in 2003. Homeownership rate is from the Housing Vacancy Survey. Percent change was calculated using unrounded numbers. Sources: Tables A-2, A-6; Federal Reserve Flow of Funds Accounts; Bureau of Economic Analysis, National Income and Product Accounts; Census Bureau, C-50. Just five states—Florida, California, Texas, Georgia, and North Carolina—accounted for 40 percent of housing permits issued in 2003. Of these, Georgia and North Carolina posted small dips from a year earlier, while permits in Florida and California continued a climb that began in 1997. After more than a nine percent surge in 2002, growth in homeowner spending on improvements and repairs fell in 2003. Rising home values have given homeowners a ready source of equity to finance remodeling projects, while simul- taneously providing an incentive to protect their increased equity. Strong home sales should support higher levels of improvement spending in the future, since buyers are most likely to remodel soon after purchasing their homes. After adjusting for inflation, home prices were up 5.9 percent nationally in 2002–3 (fourth-quarter to fourth-quarter). The largest real gains were in the Pacific states (10.6 percent), fol- lowed by the Middle Atlantic (9.4 percent) and New England (8.7 percent) states. Even though appreciation slowed in 81 of the 163 metropolitan areas tracked by Freddie Mac, inflation- adjusted house prices continued to rise in all but 4 (Austin, Boulder, Provo and Salt Lake City). Two of these areas were hard-hit by the end of the technology boom, while Utah suffered from a post-Olympics slump. 7 Joint Center for Housing Studies of Harvard University investment, owners may therefore still earn real capital gains even when nominal home prices rise more slowly than general inflation. What has made this possible is the unique confluence of strong house price appreciation, low interest rates, record cash-out refinances, high home-equity lending, and brisk home sales. Home price appreciation alone drove about half of housing’s contribution to consumer spending gains. The Joint Center and Macroeconomic Advisers estimate that households spend on average about 5.5 cents a year out of every dollar increase in house values. This additional spending hits its long-run average within a year of when the increase in value occurs—much more quickly than households spend gains in stock wealth, which they may view as less secure. Spending from home equity extracted through cash-out refi- nances and realized capital gains (made possible by home price increases) accounted for the other half of housing’s wealth effects. Freddie Mac estimates that homeowners with prime mortgages not insured by the government cashed out about $86 billion in billion in 2002, and $139 billion in 2003. The total of $333 billion dwarfs the next highest three-year level of $114 billion posted in 1998–2000. Sustaining the Boom Housing remains in uncharted territory. The strength and endurance of the boom have raised concerns that a significant correction may be in store. During a typical national reces- sion, housing investment, residential construction, employ- ment, and home sales all plunge while average home prices dip slightly. These cyclical downswings often set the stage for upswings as deferred demand and a strengthening job market push housing activity sharply higher. This time around, though, housing construction climbed straight through the recession and into the recovery—even as total employment declined. Rather than dropping precipi- tously before and during the recession, residential fixed invest- ment in fact rose 2.2 percent in 2001. Indeed, even without the typical slowdown in household growth, fixed investment grew faster two years into this recovery than it did after the 1990–1 downturn. And rather than edging lower (or even plummeting in some locations as they did in the early 1990s), average house prices continued to soar as lower interest rates kept monthly payments stable. At this stage of the cycle, the biggest threats are that job growth will stall or interest rates climb. If jobs are shed, the housing market will have a hard time sustaining its heady pace unless rates fall as well, setting up another scenario like 2003. A significant increase in mortgage rates would surely put an end to the refinance boom and, if large enough, also dampen both existing home sales and home price inflation. But even interest rate increases of one percentage point or more may not have much of an impact on home sales and prices as long as job growth and productivity gains continue. As for housing starts and new home sales, both depend less on interest rates and more on whether construction is grow- ing in line with demand. So far, household growth appears to be running near trend while the months’ supply of new hous- ing (a measure of the leanness of the inventory) has stayed low. During past cycles, new construction activity did not retreat until the months’ supply had reached at least eight months. For current inventory to exceed even a six-month level, though, new home sales would have to drop by more than a third—a magnitude of decline not seen since interest rates skyrocketed in the early 1980s. This makes a sharp inven- tory correction unlikely. Still, the blistering pace of home price appreciation in many metropolitan areas has heightened fears that price bubbles have developed in at least some markets. But steep declines even at the metropolitan level are rare in the absence of con- centrated job losses. In the event of such an employment drop, homes for sale often flood the market at a time when few are in a position to buy. In today’s market, though, house prices have continued to escalate even in areas where sizable job losses have occurred. In addition, labor markets are stabilizing or improving in most areas. With a resumption of job growth, overheated housing markets may well see only modest house price corrections. 9 Joint Center for Housing Studies of Harvard University of to 1 million) accounted for 22 percent of con- struction growth, small metro areas (with populations under for 8 percent, and non-metro areas for 16 percent, for a combined 46 percent of production gains. In fact, new construction has been so feverish in many locations that local ballot initiatives to limit growth have surged.

[Assistant] The Foreign-Born in Housing Markets Overall, more than one in ten households is now headed by a person born outside the United States. The shares among younger households are even higher. Furthermore, of the 12 million foreign-born householders in the US in 2000, 3.4 mil- lion (28 percent) arrived in this country during the 1990s alone. As a result, the foreign-born contributed more than a third of household growth over the decade and will likely account for an even larger share of growth in the years ahead. The Growing Contribution of Minorities Largely as a result of immigration, minorities make up an increasingly large share of households. From about 17 percent in 1980, the minority share climbed to 20 percent in 1990 and to 26 percent in 2000, and is expected to reach 30 percent by 2010 and 34 percent by 2020. As a result of this rapid increase, minorities will likely contribute at least two-thirds of household growth over the coming decades.


[User] At the same time, unmarried women accounted for 30 percent of the growth in homeowners from 1994 to 2002. Over this period, the number of unmarried females owning homes climbed from 13.9 million to 17.5 million, including increases in divorced owners from 4.2 million to 5.7 million and in wid- owed owners from 6.7 million to 7.1 million.

[Assistant] Looking Ahead The pace of household growth over the next 10 years is expected to surpass that over the last 10. Together with the wealth gains achieved by each age group in the 1990s, strong household growth should propel residential fixed investment, mortgage debt, and home sales to unprecedented heights. Immigration will continue to shape housing demand and lift both the minority and young adult shares of households. Meanwhile, as women continue to make economic progress, they will expand their participation in housing markets. In response to the rapid growth of these groups, the housing industry and housing finance system will continue to develop additional products and marketing strategies to better serve lower-income households in general, and minority, foreign- born, and female-headed households in particular. Unmarried Women Unmarried Men 15–24 25–34 35–44 45–54 55–64 65–74 All Ages As the number of immigrant, minority, and female-headed house- holds continues to grow over the next 10 years, demand for starter homes and for affordable rentals will increase.


[User] 15 Joint Center for Housing Studies of Harvard University Homeownership With interest rates near 45-year lows, home sales and mortgage refinances reached new heights in 2003. Existing single-family home sales climbed 9.6 percent and new single-family home sales rose 11.5 percent, while mortgage refinances shot up by an astounding 71 percent. Home prices were up in nominal terms in all 163 metropoli- tan areas tracked by Freddie Mac’s Conventional Mortgage Home Price Index. Even after adjusting for inflation, only four metro areas posted home price declines last year. Some 34 metros—15 of which are in California—saw double-digit increases. In markets with these outsized gains, housing affordability is a growing concern. Higher house prices force prospective buyers to come up with larger downpayments, choose less expensive homes, or increase the amount that they borrow. Over the short run, strong home price inflation has not seriously eroded afford- ability because lower interest rates enabled homebuyers to borrow more with little impact on their monthly payments. Fortunately, the introduction of automated underwriting and credit-scoring tools in the 1990s also coincided with growth in the share of applicants able to qualify for lower-cost prime loans. For example, Freddie Mac’s minority share of loan pur- chases increased from 8.5 percent in 1995 (when it first started using automated underwriting) to 14.9 percent in 2000. Over the same period, the share of loans to borrowers with incomes below the area median increased from 32 percent to 41 percent.

[Assistant] Favorable interest rates persuaded more borrowers to take out fixed-rate mortgages and reduced the monthly payments on adjustable-rate loans. If interest rates rise, the share of bor- rowers choosing one-year adjustable mortgages will likely rise as well. New and existing adjustable-rate mortgage borrowers will then be subject to higher monthly payments if interest rates continue to increase.


[User] At present, the states with the highest exposure to payment shocks from rising rates are California, Colorado, the District of Columbia, Illinois, Massachusetts, Michigan, and Minnesota. According to the Federal Housing Finance Board, the adjustable-rate share of mortgages originated in 2003 in each of these locations is 25 percent or more, com- pared with just 9 percent for the rest of the nation. At the met- ropolitan level, the adjustable-rate shares of originations in Denver, Detroit, San Diego, and San Francisco were one-third or more in 2003. Homeowners with severe cost burdens are also at risk. Source: Bureau of Labor Statistics and Mortgage Bankers Association. 19 Joint Center for Housing Studies of Harvard University property taxes and utilities). That number is likely even higher today following three years of sustained job losses and the expansion of subprime lending at high debt-to-income ratios. Looking Ahead The combination of rapid home price appreciation and low interest rates has produced unusually favorable conditions for homeownership. The scope of future gains and losses will depend on whether these conditions persist and what direc- tion job and income growth takes. In the meantime, risks in the system remain relatively contained. Most worrisome are the many homeowners with scant savings who are spending half or more of their incomes on housing, along with the growing share of subprime borrowers who are by definition more likely to default. If the recovery stalls, these owners will be at substantially higher risk of losing their homes. In response to the drop-off in demand, producers of multi- family (2+ unit) rental properties cut back on construction last year. Starts of multifamily rentals edged down from units in 2002 to units in 2003. This reduction was not enough, however, to stop the multifamily rental vacancy rate from climbing to a record-setting 10.7 percent. 21 Joint Center for Housing Studies of Harvard University Although rents for units in larger properties declined on aver- age last year, they did so at a slower pace than in 2002. Rents for newer and especially higher-end units were under the most pressure. In 2002, only 59 percent of newly completed units were leased up within 3 months. While the absorption rate began to improve in 2003, it fell off again in the second half of the year. Vacancy rates on rental units built since 1990 con- tinued their ascent, edging up from 15.3 percent in 2002 to 16.5 percent in 2003. With the economy improving, however, some soft rental mar- kets have begun to revive. All rent changes are shown net of inflation using the CPI-U. Effective rents are net of concessions. Large properties have 40 or more units except in California metros, which have 15 or more units. Rent increases/decreases are measured fourth quarter to fourth quarter. Source: M|PF Research, Inc. 22 the State of the Nation’s Housing | 2004 inflation-adjusted effective rents slowed to near-zero in 2003.

[Assistant] While welcome news to property owners, stronger rental mar- kets will likely erode affordability in a growing number of locations in the coming years.


[User] Although new construction over the past 10 years has been disproportionately concentrated in the top fifth of the rent distribution in individual metropolitan areas, building for the “middle market” (units with rents between the 40th and 80th percentile) has also been robust. Indeed, when summed across metropolitan and non-metropolitan areas, the middle-market share of new construction nationally is in line with its 40 per- cent share of the overall rental market. Looking Ahead Buffeted by the recession, sagging labor markets, and strong demand for homeownership, growth in rental demand has been weak for the past 10 years. Rents in many markets have been under pressure, with newer properties especially hard- hit. Nevertheless, more markets saw rents climb than fall in 2003, with a few reporting hefty increases. Any imbalances between supply and demand may, however, prove temporary if the economy continues to expand and generate new jobs. In fact, rental demand could even surge if interest rates and/or house prices rise, making homeownership less affordable. 25 Joint Center for Housing Studies of Harvard University Housing Challenges Despite unusually strong income growth in the 1990s, an astonishing 95 million Americans had housing cost burdens or lived in crowded or inadequate conditions in 2001. In fact, more than twice as many people in this country face housing problems as lack health insurance. The 2000 Census reported that about 128 million workers earned at least the equivalent of the federal minimum wage of $5.15 an hour. Of these, about 32 percent earned merely $5.15 to $10.30 an hour (one to two times the minimum wage), while another 26 percent earned $10.30 to $15.45 an hour (two to three times the minimum wage). Moderately cost burdened households are those spending 30–49% of monthly income on housing. Structural inadequacy is defined by HUD. Crowded households are those with more than one person per room. The cut-off for the bottom income quintile in 2001 was $17,500. Source: JCHS tabulations of the 2001 American Housing Survey. Elderly renters are of particular concern because they typical- ly do not have any home equity to tap into to meet basic needs. According to the 2001 Survey of Consumer Finances, 46 percent of elderly renters in the bottom income quintile (defined in that survey as $16,000 or less) had net wealth of less than $1,000 and 35 percent had less than $250. Moreover, the problem of crowding is not restricted only to the higher-cost metropolitan areas where many immigrants settle. Even in non-metro areas, 22 percent of foreign-born households live in crowded conditions. Looking Ahead Even at current levels, housing assistance programs reach only a small fraction of the lowest-income households who are in desperate need. According to the National Low Income Housing Coalition, three-fourths of eligible households receive no assistance. Nonetheless, the pressures to cut rental assistance for extreme- ly low-income families and eliminate the HOPE VI public housing revitalization program are mounting. A proposal is now on the table to cap tenant rental assistance funds at a level that does not keep pace with changes in housing costs and dis- tributes the funds solely through block grants to public hous- ing authorities. With rents rising ahead of inflation in many major metropolitan areas, this move would put many tenants at risk of losing assistance. In addition, this plan would reduce property income and thus owners’ ability to support debt, which in turn would threaten both new development and investment in existing rental housing. In the end, even fewer low-income households would be served. In the meantime, the economy continues to generate strong and growing demand for low-wage workers. According to the Bureau of Labor Statistics (BLS), the median wages in the industries adding the most jobs since the recession are fully 21 percent lower than those in the industries losing the most jobs. Over the next 10 years, the BLS expects 11 of the 20 fastest-growing occupations to be service jobs paying a medi- an wage of less than $20,000 per year.

[Assistant] Even at the peak of the full-employment economy in the late 1990s, housing problems in the nation failed to improve and some even worsened. Without fundamental changes, these challenges will continue to escalate, further dividing the two- thirds of Americans who are well-housed and the remaining third who are not—including a substantial minority who must struggle simply to keep a roof over their heads and meet other basic needs.


[User] The number of new homes demanded will also increase, thanks to immigration trends and the aging of the baby-boom and echo-boom generations. Over the next 10 years, the baby boomers will pass through the age range when second-home ownership peaks, while the echo boomers will move into the prime household-forming years.

[Assistant] After contributing more than a third of net household growth between 1995 and 2005, new immigrants will likely account for at least that large a share between 2005 and 2015. The children of immigrants born in the United States will also add significantly to household growth.


[User] The State of the Nation’s Housing Demographic Drivers Immigrant Population Patterns With both legal and illegal immigration on the rise, the foreign born are giving an increasingly large boost to population growth. The number of legal immigrants has reached nearly one million per year, while the net growth in illegal immigrants is conservatively estimated between and . Factoring in emigration of US citizens, net immi- gration has averaged about 1.2 million annually since 2000. Particularly in the 27 emerging gateways, most net growth of the immigrant population has occurred in the suburbs rather than The demographic underpinnings of long-run housing demand remain solid. Net household growth should climb from an average 1.26 million annual pace in 1995–2005 to 1.46 million in 2005–2015. Continued immigration, together with the large number of second-generation Americans and children of the baby boomers coming of age in the next decade, will reinforce demand for rental units and starter homes. Nevertheless, some of the most rapid recent growth rates in immigrant populations have occurred outside of metro areas altogether. Between 2000 and 2004, immigrants accounted for 31 percent of net population growth in rural areas, and for even larger shares in the resort communities of the West, major agricultural and manufacturing areas in the South and Midwest, and on the periphery of the traditional gateway metros. Three decades ago, both immigrants and second-generation Americans were concentrated among older age groups. Indeed, one out of every five people in the 25–34 age group (peak years for household formation) is now foreign born, and another nine percent are second-generation Americans. Moreover, a quarter of children under the age of 10 have foreign-born parents.

[Assistant] The Department of Homeland Security estimates that 10.5 million illegal immigrants resided in the United States in January 2005. This has given rise to political pressure to do more to curb illegal inflows. But even if the net growth in illegal immigrants were reduced to half of recent levels, US household growth would be at most five percent lower, shaving as many as households from net additions in 2005–2015. For their part, newly arrived legal immigrants are expected to contribute about 3.6 million households to total projected growth over the decade.


[User] 15 Joint Center for Housing Studies of Harvard University Softening Markets After weakening in 2005, the conditions that had promoted outsized gains in homeownership eroded further in 2006. Interest rates, while still low, were a full percentage point higher in mid-2006 than a year earlier, raising the mortgage payments on newly purchased homes. In addition, house price appreciation slowed in most areas, taking the sense of urgency out of the market. By the first half of last year, nearly all markets felt the crunch. Although mortgage rates receded from 6.76 percent in July 2006 to 6.14 percent in December and price appreciation slowed dramatically, uncertainty about the direction of rates and prices kept potential homebuyers at bay. The subsequent retreat in homebuying left new home sales down 18 percent from the record 2005 level, and existing home sales down 8 percent. Caught unaware, suppliers were unable to respond quickly enough to the large drop-off in demand. Home builders had to complete houses under contract even as buyers started to cancel orders. Meanwhile, sellers of existing homes kept their properties on the market, holding out for the prices they still believed they could get. As a result, the supply of both new and existing homes for sale rose sharply in the last quarter of 2006 and continued to climb in early 2007. Motivated sellers in many markets finally started to reduce their prices. Home builders led the charge with concessions, discounted mortgages, and other offers. But most sellers not forced to move continued to hold out, creating a lag before areawide prices started to respond to eroding market conditions. Prices are therefore likely to remain soft for a time in most places even if the economy continues to expand. In many smaller locations, the absolute decline was far more modest but the percentage drop was staggering (Table W-4). In Merced, CA, for example, investor loans plummeted by 70 percent. Second-home demand, which had accounted for over 30 percent of prime purchase loans in 2005 in resort areas like Atlantic City, Myrtle Beach, Naples, and Fort Myers, fell by as much as half. With higher interest rates offsetting even the largest price declines, affordability remained an obstacle for first-time homebuyers. In Detroit, where prices fell the most, the mortgage payment for a median-priced house bought in 2006 was still $30 more a month in real terms than for one purchased in 2005. In Los Angeles, where prices continued to rise at double-digit rates, the monthly mortgage payment for a newly purchased home shot up $590 in just one year and $1,500 over three years. While traditional ARMs lost market share last year as interest rates rose, nontraditional products saw meteoric growth. According to First American LoanPerformance, prime and non-prime loans with interest- only and payment-option features went from serving a fringe market to over 32 percent of all originations in 2006. While concentrated primarily in high-cost states, these products also took off nationally as a tool to help offset rising interest rates and home prices. From less than five percent in 2002, interest-only prime and non- prime loans accounted for almost 30 percent of all originations in 2005, before falling back to 20 percent at the end of 2006. Most of these are adjustables that entail not only interest-rate resets, but also higher payments to amortize the principal over a shortened term. At least seven percent of homeowners, or more than five million house- holds, have subprime loans. These mortgages carry higher rates to cover the risks associated with lending to people who have had prob- lems making payments in the past and many who choose not to state or confirm their incomes and assets when they apply for a loan. Meanwhile, Alt-A loans, which fall between prime and subprime loans on the risk spectrum, increased from 2.7 percent of originations in 2001 to 13.4 percent in 2006 (Table A-8). These loans allow some combination of low documentation, slightly subpar credit scores, and features such as interest-only or payment options. FHA loans, once the only haven for non-prime borrowers, went from a 10–15 percent market share in the 1990s to just 2.7 percent in 2006. Loans with interest-only and payment-option features have been pop- ular in states with high housing prices. Interest-only loans accounted for over 30 percent of originations last year in California, Nevada, Colorado, and Arizona, compared with 22 percent nationally. California also led with a 24 percent share of payment-option loans, followed by Nevada, Florida, and Hawaii at 13–17 percent, compared with 11 percent nationally. Uncertainty about credit availability hangs over the housing market. While it is clear that lenders underestimated subprime risks, it is unknown how much worse conditions may get. It is especially trou- bling that subprime losses have been heavier than expected at only the first sign of softer prices and loan rate resets. Much of the hope for a recovery in the for-sale markets now rests on the economy stag- ing a soft landing, markets drawing down the excess supply, and loan performance improving. Looking past the current correction, homeownership is still clearly the tenure of choice. In addition, strong gains in income and wealth will favor ownership of both first and second homes.

[Assistant] As a result, fully 88 percent of the net growth in households over the next ten years is expected to come from gains in the number of homeowners. Indeed, even if homeownership rates by age and family type remained at 2005 levels through 2015, the owner share of household growth would still be 72 percent.


[User] Demand strengthened in every region but the Northeast in both 2005 and 2006. The South showed the largest absolute increase in renters last year, accounting for three out of five net renter house- holds added nationally. Even with a faltering economy and stagnant job growth, the Midwest posted the second-largest increase in rent- ers and the biggest percentage gain. Despite anemic demand, rents in the West rose more than twice as fast as in any other region, with eight metros registering increases of at least five percent (Table W-5). These gains reflect the third straight year of vacancy rate reductions, driven by the declining supply of rental units in the West. In contrast, strong demand helped to reduce vacancy rates in the South and the Midwest, but left them still well above the national average. Meanwhile in the Northeast, the short- lived rental recovery ended in 2006 with slackening demand and rising vacancy rates. Rental Supply Changes Despite the completion of nearly one million units, American Community Survey estimates indicate that the multifamily rental sup- ply increased by less than units between 2002 and 2005. Many of the new units thus replaced apartments converted to condos With the economy generating jobs and homeownership faltering, rental markets continued their gradual recovery last year. In fact, the 1.2 million growth in renter households in 2004–2006 more than made up for losses in 2002–2004. This renewed demand helped to reduce vacancy rates and firm up rents across much of the country. The rush of condo conversions driven by the home-selling boom persisted into 2006, helping to reduce rental vacancies. According to Real Capital Analytics, the number of rentals in larger multifamily properties converted to for-sale units jumped from just a few thou- sand in 2003 to in 2005, before dropping to about 60,000 in 2006. At the same time, new construction of multifamily buildings intended for rental use dipped from units in 2003 to in 2006. But now that condo sales are softening in some locations, sellers unable to get their prices may return their units to the rental market, while some newly built multifamily properties intended for sale may also be converted to rentals. On the single-family side, the rental market has absorbed some of the net increase resulting from the heavy production of recent years. As a result, the single-family share of vacant for-rent units rose from 26 percent in 2003 to 31 percent in 2006, lifting the single-family rental vacancy rate by 1.4 percentage points over this period. Despite easing in 2006, the single-family rental vacancy rate may resume its climb if owners of for-sale homes decide to wait for the inventory cor- rection to play out, and rent their units rather than drop their prices. Rental Demand Changes While rental demand has barely increased in the past decade, the com- position of demand has changed markedly.

[Assistant] In particular, the minority share of renter households climbed from 37 percent in 1995 to 43 percent in 2005, and is expected to exceed 50 percent by 2015.


[User] Meanwhile, the share of renters living in family households declined from 54 percent in 1995 to 51 percent in 2005. This decrease reflects lower rates of remarriage as well as the longer lifespans of the wid- owed. Despite the sharp increase in Hispanic households with their much higher propensity to live in families, the family share of minority renter households also fell, from 66 percent to 62 percent. Minority renters, in particular, remain highly concentrated in center cities. For black renters, the median distance from the CBD increased from 4.3 miles in 1970 to 7.4 miles in 2000. But for white renters, the median distance started at 7.7 miles and then increased to 10.6 miles over the same three decades.

[Assistant] With minorities expected to account for all of the net growth in renter households but with most new rental opportunities located in the suburbs, the decentralization of minority renters should continue and may even accelerate. But for many low-income center-city renters, moving to the suburbs poses an economic hardship because they have to rely on public transportation to get to work.


[User] The Rent vs. Own Choice Over a million households joined the ranks of renters in the last two years. While part of this increase undoubtedly reflects the large num- ber of newly formed households that made the choice to rent, some share is likely due to an increase in households making the move from owning to renting. Normally, millions of owner households revert to renting every year. When last measured in 2005, fully 2.7 million former owners reported moving to rental units in the prior 12 months. Half of these owners became renters because of a change in their family or employment situation, but only a handful switched to reduce their housing costs. Indeed, the number of households that rent out of necessity may well grow. The combination of higher ownership costs, tighter underwrit- ing standards, and the erosion in credit quality among the current pool of renters will prevent many from buying homes. Even improved market conditions are unlikely to help, given that both house prices and interest rates would have to fall dramatically to make ownership as affordable as it was in 2000–2003. The State of the Nation’s Housing The Outlook Just how the recent run-up in condo construction and conversions, as well as the oversupply of single-family homes, will affect the rental market is hard to guess. It is possible that strengthening rental demand will stimulate more production and/or that weakening homeownership demand will encourage owners to rent their unsold properties. But whatever lift rental demand gets from today’s weaker homebuying conditions, it should be temporary. Indeed, a quicker- than-expected rebound in home sales could prevent discouraged sellers from renting out their homes, thereby keeping rental markets tight. Even if home prices continue to drop, the correction is unlikely to close the growing gap between the costs of homeownership and what many renters can afford.

[Assistant] At the same time, the share of renters in their 20s will increase as the older members of the echo-boom generation and young immigrants form new households. The share of renters in their 30s and 40s, in contrast, will shrink significantly as the baby-bust generation moves through these age ranges. The share of renters in their 60s and 70s will increase only slightly, given that many seniors prefer to remain in their own homes or to move to supportive housing rather than to rental units. All of these shifts in demand will keep the need for decent, affordable rental housing strong. Rental production will likely continue to be con- centrated in the suburbs, providing units for primarily higher-income renters who can afford to live some distance from public transporta- tion and other services. Meanwhile, cities will have to find new ways to stimulate in-fill production and preserve existing units to meet the housing needs of the growing low-income renter population.


[User] By early 2008, housing market problems had spread to the rest of the economy. The sharp drop in home building, the turmoil in the credit and stock markets, and the impact of falling home prices on borrowing and consumer spending all contributed to the slow- down. Mounting job losses in the first quarter of 2008 added to the misery, raising the risks of even sharper price declines and higher delinquencies ahead. In 2006 alone, existing home sales were off by 8 percent and new home sales by 18 percent. These declines accelerated in 2007 as falling home prices and the credit crunch deepened the crisis. With remarkable speed, the homeowner vacancy rate jumped from 2.0 percent in the last quarter of 2005 to 2.8 percent in the last quarter of 2007 as the number of vacant units for sale shot up by more than . Assuming the vacancy rate prevailing in 1999–2001 was close to equilibrium, the oversupply of vacant for-sale units at the end of last year was around units, or 1.0 percent of the owner stock. In addition, the number of vacant homes held off the market other than for seasonal or occasional use surged from 5.7 million units in 2005 to 6.2 million in 2007. Although the rental vacancy rate did not increase in 2006 and 2007, its climb earlier in the decade indicates that surpluses may exist in that market as well. Despite production cuts rivaling those in the 1978–1982 downturn, the number of vacant for-sale homes on the market did not shrink in the first quarter of 2008. The weak economy, tight credit, and concerns over whether house prices had bottomed out continued to suppress demand and delay the absorption of excess units. Until this oversupply is reduced, housing markets will not mend. The layering of mortgage lending risks at the peak of the market had serious and far-reaching consequences. As the economy weakened and mortgage interest rates rose, the number of home- owners unable to keep current on their payments began to climb. With prices falling, many owners could not sell their homes to avoid foreclosure. Meanwhile, many housing speculators defaulted even before their interest rates reset. Indeed, the Mortgage Bankers Association reports that absentee owners accounted for almost one in five loans entering foreclosure in the third quarter of 2007. Joint Center for Housing Studies of Harvard University 3 The full scope of credit market problems and the path to recovery remain clouded. Until credit markets return to normal, the economy will be in peril not only from the impact of falling home prices on loan performance and consumer spending, but also from the disrup- tions to corporate and consumer borrowing. Notes: Methodology is adapted from Freddie Mac. Oversupply is the difference between the average state-speciﬁc homeowner vacancy rate in 1999–2001 and the rate in 2007. The oversupply in Alaska was 1.1% and in Hawaii 0.5%. Heightened Housing Challenges At last measure in million households were at least mod- erately cost burdened (paying more than 30 percent of income on housing) and nearly 18 million were severely cost burdened (paying more than 50 percent). From 2001 to 2006, the number of severely burdened households alone surged by almost four million. Because of the unprecedented run-up in house prices and lack of real income growth, over half of this increase was among homeowners. The weight of high housing costs falls especially heavily on house- holds in the bottom income quartile. Fully 47 percent of low-income households were severely cost burdened in 2006, compared with 11 percent of lower middle-income households and just 4 percent of upper middle-income households. On average, households with children in the bottom quartile of spenders with severe housing cost burdens have just $257 a month left over for food, $29 for clothing, and $9 for healthcare. With food and energy costs climb- ing, these households will have less to spend on bare necessities. Four in ten low-income households with at least one full-time worker, and nearly six in ten households with one part-time worker, are saddled with severe housing cost burdens. The widening mismatch between housing costs and incomes reflects several forces—the growing number of low-wage and part-time jobs generated by the economy, the rising costs of operating and maintaining housing, and the upward pres- sure on construction and renovation costs created by local devel- opment restrictions. Indeed, in markets with the most stringent ■ Number of Loans ■ Share of Loans Source: Mortgage Bankers Association, National Delinquency Survey. Sources: US Census Bureau, Housing Vacancy Survey; Inside Mortgage Finance, 2008 Mortgage Market Statistical Annual. Joint Center for Housing Studies of Harvard University 5 regulations, house prices tend to rise faster and cost burdens tend to be greater than elsewhere.

[Assistant] With many former homeowners now turning to the rental market, the pressure on the limited supply of affordable rentals is mounting. Worse, losses of low-cost rental housing are alarmingly high. From 1995 to 2005, the supply of rentals affordable to households earn- ing less than $16,000 in constant 2005 dollars shrank by 17 percent. Unfortunately, these losses have continued in recent years even with the annual construction and preservation of about rentals under the Low Income Housing Tax Credit program. These credits are sold to investors at a discount to compensate them for the risk of real estate investing. But like investors in other assets, tax credit investors are demanding higher returns in this riskier envi- ronment. As a result, tax credits will likely support fewer additional rentals this year and perhaps longer.


[User] Meanwhile, only a quarter of eligible renter households receive housing subsidies, and the federal government does even less to relieve the cost burdens of low-income homeowners. While current interventions may mitigate the risk of massive mortgage defaults and foreclosures, any relief for cost-burdened homeowners is likely to be temporary at best.

[Assistant] Housing Demand Fundamentals With many housing markets in a tailspin, the underpinnings of long- term demand have come into question. But unless the economy enters a sharp, prolonged recession that dampens immigration or slows household formations, the current housing cycle in and of itself is unlikely to diminish the long-run growth of households. Meanwhile, the impacts of recent social trends are likely to be mini- mal. Although deferred first marriages, high divorce rates, and low remarriage rates will continue to make single-person households the fastest-growing household type, these trends have started to level off. Assuming that age-specific household formations remain about constant, changes in the number and age distribution of the adult population should lift household growth from 12.6 million in 1995 –2005 to 14.4 million in 2010–2020. With their high levels of immigration and high rates of natural increase, Hispanics and Asians will contribute significantly to house- hold growth. Minorities are expected to account for more than two- thirds of the net increase in households over the next decade, with the foreign born alone contributing at least one-third of the gains.


[User] Because minorities have lower average incomes and wealth, some have argued that their growing presence in housing markets will be a drag on home prices and rents. But when the minority share of households increased from 20.2 percent in 1990 to 29.2 per- cent in 2007, rents and house prices still rose ahead of household incomes. While their low incomes may force them to spend less on non-housing items as housing costs rise, minority households will nevertheless provide broad demand support to housing markets in the years ahead.

[Assistant] The Rocky Road Ahead With credit markets in such disarray, the for-sale housing inventory at record levels, and only small declines in interest rates, emerg- ing from today’s housing slump could take some time. Although demand fundamentals should support average annual completions of more than 1.9 million units over the next decade (including single- family and multifamily units plus manufactured homes), the housing market must first work off the one million or more excess units that were vacant and for sale or temporarily taken off the market at the beginning of 2008. This could trim underlying demand to an average of 1.8 million new units annually in the decade ahead. If the economy slips into a severe recession, the prolonged contrac- tion could drive down the sustainable level of housing demand by slowing the loss of older units, forcing more households to double up, and reducing sales of second homes. But in the case of a mild downturn, which most economists expect, the fundamentals of demand are likely to drive a strong rebound in housing once prices bottom out and the economy begins to recover.


[User] ■ Low-Income Households ■ All Households Notes: Full-time is deﬁned as working at least 35 hours per week for at least 38 weeks in the past 12 months. Low-income households are in the bottom fourth of all households sorted by pre-tax income. Severe cost burdens exceed 50% of total household income. The State of the Nation’s Housing 2008 6 Housing markets entered 2008 showing no signs of recovery. Credit markets seized up in the wake of higher than expected losses on subprime mortgages, and lending standards tightened. In addition, mortgage interest rates edged down only slightly despite aggressive cuts by the Federal Reserve in 2007. Although the slowdown in home building last year was not enough to drive the economy immediately into recession, tight credit markets and the impact of falling home prices on consumer spending now threaten to bring growth to a halt.

[Assistant] During the expansion that started in the early 1990s, demand fundamentals kept household growth going strong, real incomes were up, and interest rates were favorable. But just prior to the 2001 recession, the Federal Reserve began to cut interest rates to avert deflation and a deeper contraction of the economy. Soon after, home sales began to take off ahead of production. By 2003, these conditions helped to create the tightest housing mar- kets and the lowest interest rates in at least a generation.


[User] With excess supplies beginning to mount and the temporary lift from mortgage product innovations coming to an end, nominal house prices finally turned down on a year-over-year basis in the third quarter of 2006. Meanwhile, interest rates on some adjustable loans began to reset and mortgage performance deteriorated as poor risk management practices took their toll. Lenders responded by tightening credit in the second half of 2007, dragging the market down even more sharply and exacerbating the threat of a prolonged housing downturn. The homeowner vacancy rate continued to edge higher in the first quarter of 2008. Until the number of vacant for-sale units on the market, or held off the market for reasons other than seasonal or occasional use, falls enough to bring vacancy rates back down, house prices will remain under pressure. Working off the oversup- ply will require some combination of the following: housing starts fall even further, prices decline enough to bring out new bargain- seeking buyers, interest rates drop enough to improve affordability, job growth improves, consumer confidence returns, and mortgage credit again becomes more widely available. The intensity of the retreat in demand took builders by surprise. Cancellations soared, coming closer to the time of delivery than ever before. Phoenix provides an extreme example. According to Hanley-Wood, cancellations as a share of gross home sales climbed from 2.8 percent in the fourth quarter of 2005 to 48 percent in the fourth quarter of 2007, just as gross sales dropped from about 10,600 to 7,400. Even in a relatively strong market like Seattle, however, the cancellation rate jumped from 1.2 percent to 12.6 percent over this period. Note: New home sales and housing completions include single-family units only. Sources: US Census Bureau, New Residential Construction and Housing Vacancy Survey. These national statistics obscure larger price drops in many met- ropolitan areas and mask how fast declines spread across the country. At the start of 2007, quarterly nominal NAR median sales prices were still rising in metros. Meanwhile, prices in 33 metros had declined by 10 percent or more from their peak to the fourth quarter of 2007 (Table W-3). In previous cycles, employment losses and overbuilding played larg- er roles in how far metropolitan area prices fell. This time around, the extent of overheating is a much bigger factor in the magnitude of the declines. Still, job losses are likely to exacerbate housing market weakness, and overbuilt markets will suffer especially severe price corrections. In fact, prices are not expected to recover until excess inventory is absorbed, consumers are convinced that the bottom has been reached, and credit is less expensive and more available. Moreover, if the economy slides into a recession with significant employment losses, house prices are likely to take a further beating. The dramatic drop in prices has also sidelined more buyers than in the past, and foreclosure rates are the highest they have been since recordkeeping began in 1974. All of these factors may make this downturn more protracted than usual, and credit market woes may slow the eventual rebound. Improvement spending will also come under increasing pressure because it is sensitive to both credit availability and house price appreciation.

[Assistant] Nevertheless, demographic fundamentals still point to increased housing demand over the next decade. But the excess inventory must be worked off before the demand for new homes rebounds. This in turn requires a return to stable-to-rising home prices, sus- tained job growth, and accessible credit. When that happens, and assuming immigration remains strong, the inventory overhang will start to thin, prices will firm even more, and average annual produc- tion, including manufactured housing, will likely head back toward 1.9 million units.


[User] Demographic Drivers 3 Household Growth Trends After averaging 1.15 million per year in 1995–2000, household growth notched up to 1.37 million annually in 2000–2006. While some of this increase may be due to the unusually favorable home- buying conditions in the first half of the decade, much of it was expected as the echo boomers began to form independent house- holds and immigration continued to climb. When housing markets turned down in 2006 and then plummeted in 2007, the most consistent measure of households registered a slowdown in net growth (Table W-4). Estimates of last year’s fall- off, however, were especially sharp and contain some anomalies that make their reliability questionable. In particular, net household growth fell nearly in half last year as the number of owner house- holds swung from a gain of in 2005–2006 to a loss of in 2006–2007. If the dramatic plunge in 2007 were driven by the subprime mortgage crisis and rising foreclosures, the biggest decline in homeowners would likely be among minority households, who have a disproportionately large share of such loans. Instead, white households accounted for all of the reported decrease in homeowners while the number of minority owners increased by more than . And despite the large drop in homeowners, growth in the number of renters only rose from around in 2005–2006 to in 2006–2007. Moreover, though domestic in-migration increased in the South, the reported pace of household growth in the region—among both owners and renters—was down significantly last year. While this may indicate a sudden drop in immigration, it may also be the byproduct of a change in estimation methods in 2007 rather than a real decline. Another noteworthy change is that a larger share of each succeed- ing generation is choosing to live with a partner without marrying. This is true for households with and without children. According to new Joint Center household projections, unmarried partners will head 5.6 million households in 2020, up from 5.2 million in 2005. Of these households, 36 percent will include children under the age of 18.

[Assistant] In total, persons living alone are expected to account for 36 percent of household growth between 2010 and 2020. Although increasing numbers of people living alone will boost the demand for smaller units, the lift is likely to be modest given the nation’s strong appe- tite for large homes. In addition, three-quarters of the more than 5.3 million projected increase in single-person households will be among individuals aged 65 and older—a group that has shown a marked preference for remaining in their homes as they age. Seniors are more likely to remodel their current homes to improve accessibility, safety, and convenience than to move to new, smaller units. The aging baby boomers, however, are already showing a propensity to buy second homes and will therefore continue to add to demand in this way. White household growth in the next decade will be almost entirely among older couples without minor children and among older singles (usually widowed or divorced). With their higher birth rates and lower average ages, minorities will continue to post a net increase in married-couple households with minor children. Even so, nontraditional households are gaining ground among minorities as well, with the shares headed by single parents or including multiple unmarried adults expected to increase. This reflects both changing social patterns and the tendency for immigrants to share housing to shoulder high cost burdens. Single- person households will be the fastest-growing segment among minorities. Indeed, the number of minorities living alone is pro- jected to increase across all age groups, even outpacing the strong growth among white single-person households. As the numbers and shares of minorities and immigrants grow, the demand for affordable housing will increase. This is not to say, however, that these groups are not contributing to the demand for higher-cost housing.


[User] The State of the Nation’s Housing Sources and Patterns of Population Growth The movement of households to and within the United States profoundly shapes local housing demand. While rates of natural increase matter over the long term, foreign immigration and net domestic migration are more important in the short run because they directly add or subtract adults from the market. Domestic migration is even larger than international migration. But with the movement of international migrants already living in the United States counted as domestic migration, looking only at new arrivals understates the impact of immigration on a given area. International migration affects all regions of the country, but primar- ily the South and West. At the state level, the foreign born contrib- ute to growth by either replacing population lost to net domestic out-migration or by adding to domestic in-migration (Table W-6). Indeed, the arrival of 1.8 million immigrants to California more than made up for the net loss of domestic out-migrants in 2000–2007. In Florida and Arizona, where net domestic migration was strong, international migrants lifted population growth even more. And in Texas, the state with the highest total population growth over the period, international migrants added to the net gain of domestic migrants. In many cases, these are the outer suburbs of metropoli- tan areas that have traditionally served as immigrant gateways. But smaller cities and towns as well as rural counties are also becoming locations of choice. In many of these areas, domestic out-migration of young adults and the consequent decline in natural increase have left communities to depend upon foreign immigrants to fill jobs, buy houses, and keep up school enrollments.

[Assistant] With their economically competitive environments and desirable climates, the same locations in the South and West that have attracted both international and domestic migrants in recent years are expected to continue to do so. Foreign-born migrants are, however, increasingly likely to spread into more housing markets around the country where young domestic out-migrants have left a vacuum.


[User] Nevertheless, the growth in homeownership and the escalation in house values did nothing to narrow the wealth gap between whites and minorities. Median wealth among minorities more than doubled from $14,000 in 1999 to $37,000 in 2005 in inflation-adjusted dollars. At the same time, though, median wealth among whites increased more in dollar terms, up 50 percent from to Notes: High (low) immigration is deﬁned as 100 or more (99 or less) net international migrants added to the county in 2000–2007. High foreign-born share is above 11.1%, the national share in 2000. While rising incomes and wealth have so far placed each genera- tion on a path to higher housing consumption, the weak income performance earlier in this decade and the recent jump in energy costs have raised concerns that this upward trend may not con- tinue. Adding to this risk is the very real prospect that some of the recent gains in household wealth—which came largely from rising homeownership rates and home price inflation—will erode. Housing demand will, however, pick up once the economy begins to recover, home prices reach bottom, and homeownership again becomes an attractive way to build wealth. The markets most exposed to the cutback in loans with interest- only and payment-option features are the country’s most expen- sive. Indeed, a simple measure of affordability—the ratio of median home price to median income—alone accounts for almost 70 percent of the variation in the metro share of these products at the 2006 peak. Furthermore, the areas with the highest shares of these affordability products in 2006 saw the largest declines in 2007. For example, loans with affordability features accounted for more than half of all loans originated in San Diego, San Jose, and Santa Cruz in 2006 but less than a third in 2007. States with high 2006 shares and large 2007 declines include Nevada (from 41 percent to 25 per- cent), Arizona (29 percent to 18 percent), Florida (25 percent to 13 percent), and Washington, DC (26 percent to 15 percent). As they continued their exit from markets in 2007, housing inves- tors also contributed to the drop in mortgage lending. First American CoreLogic’s LoanPerformance data indicate that the investor share of all non-prime loan originations (including subprime, Alt-A, and non-conforming loans) peaked at 12.2 percent in the first quarter of 2006, before falling back to 8.7 percent in the third quarter of 2007 (Table W-8). The dollar volume of all non-prime investor loans plunged by two-thirds over this period, and of just subprime inves- tor loans by a whopping seven-eighths. According to the Mortgage Bankers Association, loans to absentee owners also accounted for almost one in five loans entering foreclosure in that quarter. Shares in states with distressed economies (such as Ohio and Michigan) or with widespread speculation (such as Nevada and Colorado) were even higher. The State of the Nation’s Housing At the same time, lenders enabled buyers to chase prices higher by offering products that lowered initial mortgage payments but exposed borrowers to the risk of payment shocks when their inter- est rates reset. Lenders also took on additional risk by requiring small downpayments, even though modest home price declines could wipe out an owner’s equity. On top of this, lenders were all too willing to relax income-reporting requirements to draw self- employed and other hard-to-qualify borrowers into the market. These borrowers were willing to pay slightly higher interest rates or fees in return for not having to verify their incomes. With payment- option, low-downpayment, and no-income-verification loans readily available, housing investors had access to low-cost, highly lever- aged capital as never before. Lenders layered risks on top of risks without considering the potential consequences for performance, while mortgage investors continued to buy up staggering volumes of these loans. The Foreclosure Crisis With borrowers defaulting in record numbers and lenders unable to restructure the loans, the number and share of homes entering foreclosure skyrocketed to their highest levels since recordkeep- ing began in 1974. According to Mortgage Bankers Association counts covering about 80 percent of loans, the number of loans in foreclosure more than doubled from an average of annu- ally in 2002–2006 to nearly in the fourth quarter of 2007. Meanwhile, the share of loans in foreclosure jumped from less than 1.0 percent in the fourth quarter of 2005 to more than 2.0 percent by the end of last year, and the share entering foreclosure rose from 0.4 percent to 0.9 percent. Joint Center for Housing Studies of Harvard University 21 For households, the consequences of foreclosures go beyond wip- ing out equity and even losing the roof over their heads. The impli- cations for their credit scores and long-term financial well-being can be disastrous. For lenders, foreclosures also mean significant losses. In 2002, TowerGroup estimated that the foreclosure pro- cess for a single property cost $59,000 and took an average of 18 months. These costs are no doubt higher today in markets where lenders cannot sell the properties for enough to recoup their losses. Moreover, foreclosures impose economic and social costs on the neighborhood and larger community, depriving municipalities of tax revenue and driving down prices of nearby homes. The wave of foreclosures will take months to process and the number of homes entering foreclosure could continue to rise even if the volume of loans with resets drops from last year’s level. Job losses and falling home prices are now adding to foreclosure risks. Meanwhile, mortgage credit will remain tight and larger risk premi- ums will offset much of the decline in short-term rates. Sources: National Association of Realtors®, Median Sales Price of Existing Single-Family Homes; Federal Housing Finance Board, Fixed Rate Contract Interest Rate for All Homes. With so much turmoil on the for- sale side, many households have reconsidered their financial choices and opted to rent rather than buy. Despite three years of increasing demand, however, apartment builders have trimmed multifamily rental construction in the face of stubbornly high vacancy rates. Whether the deepening homeownership downturn will result in tighter rental markets depends on how much of the excess supply of for-sale housing is converted to rentals and how quickly homebuying conditions improve. Demand Comeback Even at the peak of the homeownership boom, about a third of American households rented their housing. Many renters prefer the convenience and relative ease of moving that renting provides, or view renting as a safer financial choice. Others rent because they cannot qualify for a mortgage or afford homeownership. Not sur- prisingly, the majority of renter households are likely to have lower incomes and wealth or to be in life transitions—including the young, the foreign born, and divorced or separated individuals. Over the long run, the share of households that rent is shaped by changes in the age distribution of adults, household composition, and racial/ethnic mix. In the short term, however, economic condi- tions and mortgage lending standards can be even more important drivers of tenure choice. From 1995 to 2005, long-term demograph- ic trends slightly favored the rental market but price appreciation and low interest rates fueled a homebuying boom. Indeed, if the 1995 homeownership rates by age and race/ethnicity had held, the overall rate would have declined by 0.3 percentage point rather than surged by 4.2 percentage points. In late 2004, however, economic conditions started to tip back in favor of renting. As a result, the reported increase in the number of renter households was more than 2 million from 2004 to 2007. At first, the uptick was driven by how unaffordable homeownership had become, as well as by the release of pent-up rental demand in some regions where job and income growth had slowed after the 2001 recession. Black households led the revival of demand, fol- lowed later by gains among white and Hispanic renters. For reasons that are still unclear, growth in the number of Hispanic homeown- ers continued to outpace that of Hispanic renters.

[Assistant] More recently, the upheaval in housing and credit markets has made renting more attractive for a growing number and share of house- holds. Although a rising tide of former owners who have lost their homes to foreclosure are now turning to rentals, it is primarily the impact of tighter credit standards and the uncertainty generated by falling home prices that is driving growth in demand. Over the longer term, though, homeowners who defaulted on their loans will provide an enduring lift to the number of renter households because they will likely need years to undo the damage to their credit scores.


[User] Joint Center for Housing Studies of Harvard University 23 In addition, some former homeowners may even have problems qualifying for rentals. First Advantage SafeRent reports that the credit scores of applicants to large rental properties across the country—including public and subsidized housing—who had been delinquent on subprime loan payments were about 24 percent lower than those of typical applicants. Currently, about one-third of applicants with mortgage delinquencies are rejected at large rental properties. Unless managers of these large properties ease credit standards for new tenants, a considerable share of applicants that recently defaulted on mortgage loans will find their housing choices confined to mostly smaller rental properties. Renter Mobility With so much focus on failed owners who must now rent, it is easy to lose sight of the fact that many households rent by choice. Moreover, a sizable share stay in the same units for a consider- able length of time. More than a quarter of renter households surveyed in 2005 reported they had lived in their units for five or more years. After accounting for age, however, long-term renters are no different from short-term renters in terms of housing cost burdens, income, and race/ethnicity. In fact, the likelihood that non-elderly households will remain in the same rental units for at least five years is nearly equal across these characteristics. One group of renters that does tend to move frequently, however, is single-parent households—an unfortunate pattern that is proven to disrupt children’s educational progress and undermine their general well-being. Mixed Metro Performance Despite firming demand, the national rental vacancy rate held at near-record levels in 2007. This indicates that additions to the stock from new construction and conversion of for-sale units to rentals matched growth in the number of renter households plus losses from the inventory. At the metropolitan level, however, rental market conditions varied considerably. Changes in vacancy rates in the 75 metros covered by the Census Bureau ranged from a 4.5 percentage-point decline to a 5.0 percentage-point increase, with more metros reporting higher vacancies relative to 2006. Meanwhile, inflation-adjusted rents rose by as much as 5.3 percent in 9 of the 14 metros cov- ered by the Consumer Price Index (CPI), and fell by less than 1.0 percentage point in the other 5. By this measure, the largest rent increases were in Miami, Seattle, and Los Angeles, while the mod- est declines were primarily in distressed metros such as Detroit and Cleveland (Table W-10). The national median rent rose just 0.6 percent in real terms last year according to M|PF Yieldstar (which covers rental properties pre- ferred by institutional investors), but by 1.4 percent as measured by Notes: Long-term renters lived in their units from 2000 to 2005. Moderate (severe) burdens are housing costs of 30–50% (over 50%) of household income. Source: JCHS tabulations of the 2005 American Housing Survey, using JCHS-adjusted weights. The State of the Nation’s Housing the broader CPI estimate. But like the CPI, M|PF Yieldstar reported a wide variation in real rent changes across the country, with 27 out of 57 metros posting a decline between the fourth quarters of 2006 and 2007. According to this measure, some of the largest declines were in Florida (excluding Miami), where conversions of excess multifamily for-sale housing to rentals have glutted the market. In contrast, real rents in the West, and especially in a handful of coastal California metros, were up by as much as 9 percent. With housing markets in California under increasing pressure, however, these rent increases could soon end. The Rental Supply With the national vacancy rate climbing from 2000 to 2004, falling back slightly in 2005, and then flattening over the last two years, con- struction of new rental units declined for the seventh consecutive year in 2007. Completions of for-rent units in multifamily structures fell to just down 15 percent from 2006 and 38 percent from 2000. Even though completions of for-sale units also dropped, the rental share of all multifamily completions dipped below 60 per- cent for the first time in the 43-year history of recordkeeping. Sources: US Census Bureau, Housing Vacancy Survey; Bureau of Labor Statistics, Rent of Primary Residence, adjusted for inﬂation by the CPI-U for All Items. Joint Center for Housing Studies of Harvard University 25 On a national level, just nine percent of the rental housing stock was built between 2000 and 2006. For example, more than 20 percent of renter- occupied units in Las Vegas, Austin, and Fort Myers were added during this period. In some smaller metropolitan areas, new con- struction accounted for an even greater share of the rental stock than of the owner stock. While prompted by stronger rental demand in some areas, new construction in many others has replaced units permanently lost to abandonment, demolition, and disasters. This is especially true in slow-growing regions of the country where the housing stock is older. According to a Joint Center analysis of the 1995 and 2005 American Housing Surveys, center cities in the Northeast saw one rental unit permanently removed for every three built. In Midwestern center cities, the ratio was one unit lost for every two built. Even in a healthy construction market like the suburban West, where almost a half-million new rentals were built, two units were lost for every three added.

[Assistant] Some other net removals were due to the conversion of rental properties into condos by owners seeking to cash in on the home- buying frenzy. Real Capital Analytics reports that acquisitions of large multifamily rental properties (valued at $5 million or more) intended for condo conversion removed more than rental units in 2005 and 2006. These removals offset almost two-thirds of the multifamily rental units completed over this period. But when the pool of investors demanding these condos dried up, the bottom dropped out of the for-sale market in 2007 and condo conversions plummeted. Meanwhile, some for-sale units reverted to rentals. As a result, existing units are now flowing on net into the rental market and will likely add to the stock in the near term.