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
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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
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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 are identified as having had no difficulty obtaining credit in the previous three to five years, but remaining families are only potentially constrained. And the preference for homeownership is only fully observed among those households which are not credit‐constrained.
As noted, there is a persistent gap in homeownership rates between white, black, and Hispanic households; however, some share of these differences can be explained by correlated differences in age, family type and other demographics. For example, Wachter and Megbolugbe (1992) find 81 percent of the white‐black homeownership gap, and 78 percent of the gap with Hispanics, can be attributed to differences in income and household demographic. Gabriel and Rosenthal (2005) find that credit constraints account for no more than five percentage points of the racial gap in homeownership. Most of the gap is attributable to other household characteristics. In contrast, Quercia, McCarthy and Watcher (2003) find that after controlling for underwriting constraints, blacks and Hispanics actually exhibit higher rates of homeownership than whites.
Gabriel and Rosenthal (2005) also examine the extent to which changes in the homeownership rate in the 1980s and 1990s were driven by demographics, as opposed to by the economic environment and underwriting regimes. The authors employ a shift‐share analysis: they predict the homeownership rate while holding constant either the cohort of households or the tenure choice model coefficients from a single year, but not both. For example, the demographic composition of households in 1998 is used to simulate the homeownership rate in 1992, 1995, and 1998 based on changes in the coefficients of the tenure choice model. This effectively demonstrates the cumulative effect of changes in the general homeownership environment, including economic factors, mortgage underwriting standards, and household tastes, while controlling for demographic changes. “Assuming that tastes for homeownership remain unchanged, coefficients from different years capture the influence of year‐ specific macroeconomic and lending market conditions that affect housing tenure decisions, including interest rates, business cycle risk and uncertainty, and innovations in housing policy and mortgage
1 To further complicate matters, Stein (1995) raises the connection between credit constraint, mobility and reservation prices. Droes and Hassink (2014) find that credit constrained households expect to sell their house for a higher price. This may confound the ability to estimate optimal house values.
3 finance” (Gabriel and Rosenthal 2005, p. 105). By contrast, holding estimated coefficients constant across cohorts captures changes in the socio‐demographic attributes of the population over time.
Gabriel and Rosenthal (forthcoming) undertake a similar shift‐share analysis using census microdata from 2000, 2005, and 2009, but find that model coefficients capturing household attitudes and market conditions have greater impact than socioeconomic demographics—the reverse of their earlier study. There are also several improvements in the analysis, including model stratification by age, which is possible given the size of the census database, model re‐estimation using only a sub‐sample of recent movers, and the creation of household attitude variables. Specifically, the authors include median house values, expected price change, and house price volatility. On the other hand, census data does not provide information on wealth and assets.
As part of an ongoing series, Wilson and Callis (2013) use the Survey of Income and Program Participation to determine how many families could afford to buy a modestly‐priced home. Affordability was based on sufficient income and assets to cover a 5 percent downpayment as well as 28 percent front‐end and 36 percent back‐end debt‐to‐income ratios. A modestly‐priced home is defined as the lowest quartile value of owner‐occupied homes in the American Community Survey. The authors find 50.3 percent of families could afford to buy a modestly‐priced home in 2009, the lowest estimate since the Census Bureau’s “Who Could Afford to Buy a Home?” series began in 1984.
On the other hand, the Census Bureau’s affordability constraint is not necessarily determinative; some households that could afford to buy will instead choose to rent, while some household that may be considered constrained by the affordability indicator will nevertheless purchase a home.
Psychology and household preferences play a role. Case and Shiller (1988) find homebuyers focus more on expectations of future house price increases in boom markets than market fundamentals. At the other extreme, several articles in the aftermath of the housing crisis proclaimed that the American Dream no longer includes homeownership, and that the United States is becoming a “renter nation” (e.g., Epstein 2010; Olick 2012; Haynes, Craighill and Clement 2014; Woellert 2014). Nevertheless, Fannie Mae’s National Housing Survey found in 2013 that the large majority of renters thought homeownership was preferable for people wanting control, privacy, security, seeking to raise a family or investing wisely. Belsky (2013) notes responses in the University of Michigan’s Survey of Consumers to whether it is a good time to buy a home is highly cyclical, but that the recent drop is less severe than in previous recessions.
Meanwhile, the ability of affordability‐constrained households to purchase their homes has been clearly affected by changes in underwriting standards that have restricted mortgage credit. Goodman, Zhu and George (2014) quantify the decline in mortgage originations due to tighter underwriting standards using HMDA data and CoreLogic information on FICO credit scores. While originations fell across the range of credit scores, purchase originations to borrowers with credit scores under 660 fell 70 percent between 2001 and 2012 compared to just 18 percent among credit scores over 750. Using this information, Goodman, Zhu and George estimate that between 273,000 and 1.2 million purchase mortgages (or between 12% and 55%, respectively, of the decline between 2001 and 2012) were “missing” in 2012 due
4 to tighter underwriting. Similarly, Bhutta (2012) finds the trillion dollar decline in mortgage debt between 2009 and 2011 was driven more by a reduction in new loans, particularly among first‐time homebuyers with poor credit history, rather than an increase in outflows through mortgage amortization and default.
Household formation is also related to the decline in homeownership and mortgage originations. Paciorek (2013) finds that rising housing costs contributed to declining headship rates between 1980 and 2000, and that high unemployment led to a sharp decline between 2006 and 2010. He also finds that poor credit scores and a history of foreclosure negatively impact household formation. Himmelberg et al. (2014) note the decline in housing turnover using American Community Survey data. Only 3 percent of the population moved into their current owned home in 2012, compared to 4.5 percent in 2001, corresponding to 1.3 million fewer home purchases. Further, of those that did purchase new homes, fewer reported a mortgage in 2012 than in 2001 (74% to 79%, respectively). The decline in mortgages is more pronounced among low‐income households, households with less education, and Hispanics. Himmelberg et al. estimate that approximately half of the decline in housing turnover between 2001 and 2012 was due to credit standards, with another 35% driven by cyclical factors and the remainder due to demographics.
If changes in household formation disproportionately occur among owner‐occupied households relative to renter‐occupied households, then the observed homeownership rate will be affected. Haurin and Rosenthal (2007) find lower headship rates are associated with lower homeownership rates and that declining household formation between 1970 and 2000 contributed to a lower homeownership rate among younger households. In contrast, however, Yu and Myers (2010) find that declining household formation between 1990 and 2006 elevated homeownership rates.
We know lack of affordability reduces the level of homeownership. This paper builds on the existing literature by updating the research in light of the dramatic swings in underwriting standards and homeownership levels over the past fifteen years. In addition, this paper uses existing demographic projections to forecast possible ranges of future American homeownership.
Methodology The analysis consists of two parts. First, a tenure choice model is used to estimate the likelihood of homeownership in a given year after accounting for household demographic factors and affordability. Following Gabriel and Rosenthal (forthcoming), the tenure choice model is stratified by age and survey year: “Stratifying the sample in this manner greatly enriches the analysis as it provides a clear indication of how the drivers of homeownership vary over the lifecycle.” The probability of homeownership can be estimated using a logistic regression model, which can be represented as