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Tenure Choice and the Future of Homeownership WORKING PAPER Tenure Choice and the Future of Homeownership By Kevin A. Park, Chris Herbert and Roberto G. Quercia November 2014 Funding provided by the Ford Foundation The UNC Center for Community Capital at the University of North Carolina at Chapel Hill is the leading center for research and policy analysis on the transformative power of capital on households and communities in the United States. The center's in-depth analyses help policymakers, advocates and the private sector find sustainable ways to expand economic opportunity to more people, more effectively. Roberto G. Quercia, Director Lucy S. Gorham, Executive Director UNC Center for Community Capital The University of North Carolina at Chapel Hill 1700 Martin Luther King Blvd. | Campus Box 3452, Suite 129 Chapel Hill NC 27599-3452 (877) 783-2359 | (919) 843-2140 [email protected] | www.ccc.unc.edu Tenure Choice and the Future of Homeownership Abstract Using the Survey of Income and Program Participation, this paper estimates the likelihood of homeownership. A shift share analysis reveals the dramatic swings in homeownership over the past fifteen years were not driven by demographics but rather by the general housing environment, including housing affordability. A sub‐sample of recent movers reveals that housing affordability was not a statistically significant determinant of homeownership at the height of the housing bubble. Finally, the different general housing environments studied are used as scenarios to project the future number of homeownership and homeownership rates based on a variety of demographic forecasts. By 2035, the homeownership rate could be as low as 57 percent if restrictive housing conditions persist. Keywords: homeownership; tenure; demographics; projections; credit Kevin A. Park Corresponding Author UNC Center for Community Capital 1700 Martin Luther King Blvd., Suite 129 Chapel Hill NC 27599‐3452 [email protected] (828)545‐9919 Chris Herbert Joint Center for Housing Studies Harvard University Roberto G. Quercia UNC Center for Community Capital Tenure Choice and the Future of Homeownership Introduction The United States is experiencing significant demographic changes that will affect its housing markets and the future of homeownership for its people—the American Dream. As the Baby Boom generation ages, the Census Bureau projects that the population over the age of sixty‐five will increase from 15 percent of the population to 21 percent over the next twenty years. Older households typically have higher rates of homeownership, and have weathered the recent declines better than younger households (Figure 1A). In fact, the homeownership rate for households over sixty‐five years old was higher in 2012 than in 2004. Meanwhile, households between twenty‐five and fifty‐four had the lowest level of homeownership since records began in 1976 (Joint Center for Housing Studies 2013). At the same time, the Census Bureau projects that the country will become majority‐minority by 2043. Minority households typically have lower rates of homeownership due in part to less wealth and legacies of racial discrimination. For example, the homeownership gap between white and black households reached over 30 percentage points by the end of 2013 (Figure 1B). The arrival of new immigrants, who are typically younger and minority, will affect the rate of these demographic changes. Myers and Pitkin (2013) estimate that immigration will account for nearly one‐ third of the growth in all households between 2010 and 2020, including nearly 36 percent of the growth in homeowners. Nevertheless, demographics are not destiny. Although population trends provide a strong baseline for estimating housing demand and the likelihood of homeownership, other factors are also important. For example, not every household that would like to own a home has sufficient income and assets to purchase a house outright or qualify for a mortgage under prevailing underwriting standards, which can be affected by public policy decisions and overall conditions in the housing market. The housing cycle, which is not a single phenomenon but the result of multiple, mutually reinforcing dynamics, causes fluctuations around long‐term demographic trends. The homeownership rate reached a record high in 2004 at 69.2 percent, but has since fallen over the past decade to 64.8 percent (as of 2014Q1) the lowest rate since 1995 (Figure 2). Nationally, house prices continued to rise for another two years after the homeownership rate peaked. The ratio of house prices to owners’ equivalent rent rose to 45 percent above its long‐term average before collapsing. The declines in both homeownership and house prices were exacerbated by a tightening of underwriting standards for residential mortgage credit during the financial turmoil of 2008 and 2009. Both demographics and the dynamics of the mortgage market are important when considering the future of homeownership. This paper estimates the likelihood of homeownership at different points in the housing cycle between 1997 and 2011. Possible future trajectories of homeownership in the United 1 States are then projected using the results of these tenure choice models and the expected changes in the country’s demographics, particularly in the age and racial composition of households. Literature Review Homeownership has proven benefits, including stronger families (Grinstein‐Weiss et al. 2010), increased social cohesion (DiPasquale and Glaeser 1999), and greater community engagement (Manturuk et al. 2010). Further, there is even evidence of the financial benefits of homeownership, when properly managed, during a dramatic decline in house prices (Riley et al. 2009). Nevertheless, the foreclosure crisis has made abundantly clear that the financial risks of homeownership may outweigh the benefits for some households. And even households that may like to own their own home may be prevented by income and wealth barriers. This paper presumes that the mortgage underwriting environment is a major determinant of the likelihood of homeownership. Mortgage underwriting scenarios are explicitly modeled after different years in the housing cycle as well as an explicit affordability indicator. There is a twenty‐five year history in housing econometrics of identifying income and wealth constraints as determinants of tenure choice, while controlling for relevant demographic and household characteristics that might affect demand for homeownership. Linneman and Wachter (1989) model homeownership in 1977 and 1983 as a function of income and wealth constraints using data on recent movers from the Survey of Consumer Finances. To define wealth and income constraints, they use two common underwriting criteria. The first is that the loan‐to‐ value ratio—the mortgage amount as a share of the home’s purchase price—should not exceed 80 percent of the home’s purchase price. Consequently, a household’s net wealth must be sufficient to cover a 20 percent downpayment. In other words, the maximum purchase price can be no more than five times household net wealth. The second criterion is that the front‐end debt‐to‐income ratio—the annual payment of principal and interest on a mortgage as a share of income—should equal no more than 28 percent. The maximum purchase price of a home, therefore, is equivalent to 35 percent (0.28/0.80) of household income divided by the prevailing mortgage interest rate. Linneman and Wachter model optimal desired house values using a sample of “unconstrained” households, defined as households who have purchased a home valued at less than 85 percent of either constraint. If a household’s optimal desired house value, as derived from this model, is close to or exceeds the maximum value established by the income or wealth constraint, then the household is considered constrained. Categorical definitions of “moderately” and “highly” constrained, by both income and wealth, as well as the “gap” for highly constrained households between optimal and maximum purchase prices, are then used in a tenure choice model. Both constraints are found to be statistically significant, with the wealth constraint proving more binding. Haurin, Hendershott, and Wachter (1997) examine entry into homeownership among young adults (twenty to thirty‐three years old) between 1985 and 1990 using the National Longitudinal Survey of Youth. The authors build on Linneman and Wachter by, in particular, allowing LTV to be endogenous to 2 the tenure choice decision, which lowers the number of constrained households, and by using more sophisticated econometric modeling techniques. Quercia, McCarthy, and Wachter (2003) use the American Housing Survey to analyze the effect of underwriting standards on a variety of populations of interest. Income and wealth constraints are first defined and their effects estimated. But then, the constraints are redefined under less binding standards. The coefficients from the baseline estimation are applied using these new constraints to determine how rates of homeownership would change under the alternative underwriting regimes. However, the authors had to impute wealth by capitalizing non‐wage income. Like Linneman and Wachter (1989), Gabriel and Rosenthal (2005) use Survey of Consumer Finances data (from the years 1983 to 2001), but use an alternative method of identifying credit constraints. They note that the likelihood of being credit‐constrained and the likelihood a family prefers to own in the absence of credit constraints are both latent variables1. Families who are not credit‐constrained
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