The homeownership confidence shift

This article comes from First Tuesday Journal Online

This article examines the financial viability of homeownership in the wake of the housing crash, and how the housing crash impacted ideas about mortgage spending and commuting.

Recovery attitudes are on the move

Four years after the housing crash and the eruption of the financial crisis, the California residential real estate market still struggles to find a firm foothold on recovery. Even the unprecedented low interest rate/low housing price combination provides home sales volume only weak traction as it continues along the bumpy plateau recovery path.

So, how have opinions about housing changed in the wake of the housing crash and extended recovery?

To find an answer, a sample of adults aged 18-95 were polled about their views on owning vs. renting, mortgage spending and commuting by economists at the Federal Reserve Bank of Boston (the Boston Fed). The researchers then tracked the change in housing prices of the respondents’ neighborhoods — by zip code and from the peak to trough — to determine the severity of “crash” the respondents were exposed to. [To read the entire study, see the October 2011 Boston Fed paper, Shifting Confidence in Homeownership: The Great Recession.]

Owning vs. renting: direct experience and age matter

The Fed’s poll question: Which of the following five options best describes your opinion:

  • owning a home is without a doubt better financially than renting a home;
  • owning a home is probably better financially;
  • owning and renting a home are equally good financially;
  • renting a home is probably better financially; or
  • renting a home is without a doubt better financially than owning a home.

Overall, the majority of those polled still believed homeownership was better financially than renting. However, a significant portion of those who answered that homeownership was better than renting responded that homeownership was “probably” better than renting, rather than “without a doubt” better, indicating that confidence in homebuying has been shaken, or at least qualified, temporarily or permanently, for some reason.

To determine whether the housing crash had an effect on attitudes towards owning vs. renting, the Boston Fed measured the percentage change in pricing by measuring the CoreLogic home price index (HPI) from peak to trough. Surprisingly, the initial results revealed that a negative change in home prices had little effect on homeownership confidence across the entire respondent pool. Researchers then split the pool into two groups based on whether they had personal experience with the housing crash.

The Fed’s poll question: Have you or has anyone close to you experienced foreclosure or lost a lot of money in the real estate market in the last five years?

Those who had not directly (or through a close relationship) experienced the housing crash were not affected in their opinions by the change in home prices: their responses on whether it was better to own or rent bore no relation to the magnitude of the negative change in home prices. The result is not altogether unexpected after decades of homeownership propaganda. It reveals the continued existence of a serious disconnect between the reality of real estate conditions and the financial decision to purchase a home. [For more information on borrowers’ general lack of knowledge about the financial decisions behind purchasing a home, see the November 2011 first tuesday article, Homebuyer optimism uninformed about future pricing.]

Editor’s note — More proof in the pudding: respondents who lived in more-educated neighborhoods were less in favor of homeownership, the argument being those who are better educated tend to develop their opinions based on current events and ideas, rather than take an ideal, i.e., the American Dream, for granted.

Researchers then split those who directly experienced the housing crash into an 18-58 age group and a 59-95 age group. They found two diametrically opposed results (thus explaining the initial non-effect). The further home prices dropped, the less confidence the younger group had in homeownership. The opposite is true of the older age group: the further home prices dropped, the more confidence was expressed in homeownership.

The 59-95 age group: our previous 30-year housing paradigm

This difference-by-age makes more sense than appears at first blush: the 59-95 age group have an entire generation’s worth of experience in the housing market outside this particularly negative episode. Further, the conditions in real estate since the 1950s have vested in them the belief that prices will always go up, interest rates will always go down and homeownership is always a good bet.

Moreover, the older age group is more likely to have purchased their housing long before the run-up of the Millennium Boom, and thus they have still turned a profit on their homes (although these profits are driven primarily by consumer inflation and ever lower interest rates). Having had personal experience of the housing crash that proved (at least for them) it wasn’t so bad, they are more liable to have a positive outlook on homeownership. [For more information on the persistence of long-held housing opinions, see the September 2011 first tuesday article, Boomers will always be homeowners.]

These beliefs in the steadfastness of homeownership, as borne out by the past experiences of this particular age group, are not forward-looking based on current or future market conditions. Point in fact: the most recent housing crash wasn’t merely a turn in the real estate cycle, but was coupled with a financial crisis caused by the deregulation of mortgage lenders and Wall Street Banker interference in the mortgage market. In response to the financial crisis (lack of mortgage money), the Federal Reserve (the Fed) dropped interest rates to unprecedented lows, where mortgage rates currently hover at essentially a real rate of 0% (and a nominal or actual rate of 3.9%).

Thus, interest rates have nowhere to go but up. In fact, they’re set to buck the fully-exhausted 30-year downward trend and open the floodgates for an all-but-forgotten kind of havoc: the due-on clause mischief of the ‘60s and ‘70s. [For more information about what makes this cycle different, see the July 2011 first tuesday article, The rocky roads: recession and financial crisis; for more information about the interest rate dilemma, see the upcoming first tuesday article, The due-on time bomb; for a look at interest rates affecting real estate, see the first tuesday Market Chart, Current market rates.]

The 18-58 age group: the paradigm shifters

In contrast to the misplaced and myopic reliance on the past exhibited by the 59-95 age group, the reality inherited by the younger, better-educated and up-and-coming generation of housing consumers is much less accommodating. The current and future repeat clients of brokers and agents are primarily comprised of the 18-58 age group, which includes both existing homeowners and tenants. The members of this group are either entering into their household formation years, or are themselves homeowners with mortgages — individuals who are the most sensitive to the adverse shocks of foreclosure or the negative equity plague from this Lost Decade.

Unlike many of the individuals in the older age group, the households forming/new households of this youthful age group do not have prior personal experience in the housing market other than the recent crash. At the same time as the housing crash, a huge percentage of the individuals in this age group are also experiencing huge education debt and one of the worst employment pictures in the country’s history: the Lesser Depression. [For more information on Generation Y’s (Gen Y’s) troubled financial start, see the July 2010 first tuesday article, College debt makes graduates hesitant to become homeowners.]

While the poll did not explicitly consider employment, the 18-58 year olds build the ranks of prime-age workers who have been excessively impacted by layoffs and cut hours and are viewing their foreclosed housing or money losses in this light: jobs are scarce and a full jobs recovery will not be likely until 2016. This is not a concern (or a lesser concern) with those who have left or are about to leave the labor pool, i.e., the 59-95 age group. [For more information on prime-age workers and housing demographics, see the October and November 2010 first tuesday articles, The demographics forging California’s real estate market: a study of forthcoming trends and opportunities, Parts I and II; for more information on Gen Y’s feelings about homeownership, see the May 2011 first tuesday article, Gen Y continues to shy away from homeownership.]

The negative experience of the housing crash has a silver lining: this group of homebuyers and homeowners is less credulous and thus less apt to embrace homeownership without first questioning its financial advantages over renting. Although this financial prudence is forced by current necessity, it’s a foundation for a stable future real estate market.

And consider that the overall outlook for homeownership is not bleak. This poll and others of its kind merely point to a reduced confidence in homeownership, not a flight from it. There will still be homeowners aplenty; they’ll just be more discerning about their purchases and the agents with whom they will work — good news, in the long run. [For more information on stabilizing the real estate market, see the October 2011 first tuesday article, The 20% quagmire.]

Opinions on mortgage spending

The Fed’s poll question: Suppose that a family of average size has an income of four thousand dollars a month after taxes and that the family wants to buy a home. In your opinion, what is the maximum monthly payment that this family should make on its mortgage?

As home prices drop, the respondents strangely believed they should spend more on mortgage payments. This inverse opinion was expressed primarily by the 18-58 age group who had direct experience with the housing crash (see poll question above).

Those who did not have hands-on experience of the crash believed they should spend more on a mortgage as the prices went down, but to a lesser degree than those who had direct experience. The rationale is speculative: if prices are lower (and especially if interest rates are the same or less), real estate is a better investment and will yield better returns when rents and prices go up. Good economic theory, but not likely to be experienced over the next decade or more as inflation will remain low and interest rates can do nothing but rise.

However, the study also indicated that the higher the home prices at the respondent’s address in 2011 (versus in 2008, when the housing crash hit bottom), the higher the amount they allocated towards a mortgage payment in the poll. This suggests that the key relationship here is not where they lived when the housing market crashed, but where they currently live. Even those who had seen their past neighborhood’s prices tank were more influenced by their current surroundings than their past ones.

This reflects, incredibly, that today’s homebuyers may not understand their predecessors’ role in the housing crash — paying too much for real estate and contributing to a bubble — as they are willing to move on and adjust their thinking to the “market” anew: an indication that guidance from a broker or agent is necessary to right the thinking of the crowd. But the source of that guidance also needs to be inculcated anew. [For a tool to use when helping your client shop for a mortgage, see the February 2011 first tuesday article, Get your buyer the best financial advantage; submit multiple loan applications and compare.]

Housing prices and commuting

The Fed’s poll question: We are interested in your attitude towards commuting to work — specifically, how willing are you to increase your commute to work if that would reduce your housing expenses? Which of the following five options best describes your opinion:

  • you are not at all willing to increase your commute if it would reduce your housing expenses;
  • you are somewhat unwilling;
  • you are neither willing nor unwilling;
  • you are somewhat willing; or
  • you are definitely willing to increase your commute if it would reduce your housing expenses.

By itself, the poll indicated a relatively even spread of responses, with a slight lean towards a willingness to commute to reduce housing expenses. However, no significant relationship exists between the responses given and actual changes to home prices experienced in the respondent’s neighborhood. This lack of relationship held steady, even when considering responses categorized by age groups and level of experience with the housing crash.

Finding no correlation to housing prices, the researchers then reviewed available data on commuting and gas price volatility. As anticipated, the greater the expected increase in gas prices, the less willing respondents were to commute. It’s a damaging irony of popular consumer sentiment that immediate short-term costs such as gas nearly always trump the larger, more important longer-term costs of such items as a mortgage rate and payment. An understanding of the creation of wealth is either missing due to ignorance or ignored out of peer pressure to move on into the American Dream of homeownership. [For more information about the need to shop around for a mortgage, see the December 2010 first tuesday article, Homebuyers shop around for everything but their mortgage.]

Brokers and agents can bear this relationship in mind and push urban living as an alternative to suffering the vacillations of gas prices — and throw in a pitch for energy-efficient living accommodations to appeal to that fast-growing contingent of youthful housing consumers. [For more information about the increasing appeal of urban living, see the July 2011 first tuesday article, From city to suburbia then back; for more information about energy-efficient housing, see the August 2010 first tuesday article, Energy efficiency in the home: not just for hippies.]

Times, they are a-changin’

Attitudes are changing out of necessity, but that is a good thing. The existing homeowners and the new generation of homebuyers are wary, but better-informed and still willing to buy — a perfect audience for an agent’s practical advice on pricing fundamentals and trends, interest rate realities and sustainable long-term market conditions. [For more information about housing prices, see the first tuesday Market Chart, California tiered home pricing; for more about interest rates, see the November 2011 first tuesday article, Historic mortgage rates herald momentous change.]

While the state and the nation struggle to fix the laws and practices which derailed our economy bit by bit over the past 30 years, the practical lessons of the housing crash remain to be reinforced by an informed and active real estate brokerage industry. The industry must do this, all the while aware that the nation floats in a fiscal limbo: people, including the poll respondents, still don’t know what Congress and the Administration intend to do about housing, and how this will impact future housing costs. Until that big question is answered (or definitively NOT answered), brokers and agents need to seek out new ways of protecting their clients on entry into ownership by being advocates for legal changes which favorably impact the stability of the future real estate market. [For more on the ever-polarizing solution of re-introducing cramdown authority for bankruptcy judges as a means of correcting the housing problem, see the November 2011 first tuesday article, Surprise: Frannie says “no thank you” to cramdowns.]

Most important among these coming changes is the repeal of lender domination over sales transactions in the form of the due-on clause which homebuyers and sellers will need when interest rates rise as they will; they cannot go down. To that end, brokers and agents must consider harnessing the public energy underlying the concept of the Occupy Wall Street (OWS) movement to further their cause for increased sales volume through mobility of title without lender interference. [For more information about the due-on clause and its negative effects on the housing market, see the March 2011 first tuesday article, The due-on-sale clause: barricading homeowners since ’82 and the December 2011 first tuesday Letter to the Editor; for other recommendations for a stabler real estate market, see the first tuesday feature, Change the Law; for more information about improving the law through OWS, see the November 2011 first tuesday article, A new age for fair housing.]

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