There is no housing bubble in the USA: housing activity will remain at high levels in 2005 and beyond

Business Economics, April, 2005 by James F. Smith

There is no evidence of a housing "bubble" in the United States and housing demand should stay strong for years to come. Three major factors lead to this conclusion. First, the 77 million baby boomers are approaching the peak home ownership ages of 65-75 (over 83.0 percent versus a national average in 2004 of 69.0 percent). Second, immigrants, a growing share of the U.S. population, tend to buy houses ten years later than people born in the United States of the same income group and family size. Third, mortgage rates are not likely to go high enough (8.0 percent or more for 30-year fixed rate mortgages) to put a crimp in demand. Despite some areas of concern, overall homeowners' equity is at record levels above $9 trillion. Delinquencies are still less than one percent of mortgages outstanding.

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For over a decade now, the level of housing activity has been surprising analysts, participants, and observers of financial and mortgage markets; those involved in producing new housing and the repair and modernization of existing housing; material and equipment suppliers; and the myriad of other people involved with any aspect of a housing transaction. All of these surprises have been on the upside, which is very unusual--especially for a sector that is such a huge part of the U.S. economy.

As shown in Figure 1, homeownership rates remained in a narrow range from 62.8 percent in 1960 to a then-record 65.6 percent in 1980. The financial turmoil of 1980 and the recessions from January to July 1980 and July 1981 to November 1982 caused the homeownership rate to decline to a low of 63.8 percent in 1986, the same level as in 1968. (1) By 1994, the homeownership rate was still only 64.0 percent. A new record was finally set in 1997 at 65.7 percent. Every year since then has seen the rate rise. In 2004, it reached 69.0 percent.

While no one knows how high the homeownership rate could go (it's 96 percent in Singapore, the world's highest rate), many housing experts think that 75 percent is a realistic ceiling, given U.S. demographics and mobility habits. Moving toward that number would mean many more new houses being built and continued high activity in housing markets for many years to come.

Homeownership rates vary widely by state and by metropolitan statistical area (MSA). In 2004, the lowest homeownership rates were in New York (54.8 percent), California (59.7 percent), Hawaii (60.6 percent), and Rhode Island (61.5 percent), while the highest rates were in West Virginia (80.3 percent), Alabama (78.0 percent), Delaware (77.3 percent), Michigan (77.1 percent), Minnesota (76.4 percent), and South Carolina (76.2 percent). Among the 75 most populous MSAs, the lowest homeownership rates in 2004 were in New York, NY (36.6 percent), San Francisco, CA (50.6 percent), Los Angeles-Long Beach, CA (51.6 percent), Fresno, CA (54.7 percent), Houston, TX (58.0 percent), and Boston, MA and Honolulu, HI (both at 59.4 percent). The highest rates were in Monmouth-Ocean, NJ (86.9 percent), Nassau-Suffolk, NY, (85.7 percent), Akron, OH (79.1 percent), West Palm Beach-Boca Raton, FL (78.1 percent), Detroit, MI (76.5 percent), and Pittsburgh, PA (74.9 percent).

Homeownership rates vary greatly by age group, as well. The lowest rate is for households where the head is not yet 25 years old. This group had a rate of 25.2 percent in 2004. There is a sharp increase in the 25-29 year old group to 40.2 percent and a further sharp increase to 57.4 percent in the 30-34 year old group. It continues to increase by age until it peaks in the 65-74 year old group at about 83 percent.

With the baby boomers making up about 77 million of our population of over 290 million, the homeownership rate should continue to edge up for many more years. The baby boomers (all those people in the United States born between January 1, 1946 and December 31, 1964) have changed most other aspects of life in the United States as they've aged, so it shouldn't be surprising that their impact on the housing market has been, and will continue to be, enormous.

A major reason for this strong demand for houses over the past decade has been that more and more households who had been renting can afford to become homeowners; or, as one observer recently put it, "Any one with a brain and a decent credit rating has already bought a house." Of course, as more people buy a first home, many longer term homeowners have been moving up to a more expensive home.

Figure 2 shows the housing affordability index. It is reported monthly by the National Association of REALTORS[R]. Any number above 100 indicates that the median household (one earning $43,318 in 2003) can buy a median-priced home ($158,100 in 2002, $170,000 in 2003, and $188,900 in 2004). The index is a combination of income levels and mortgage rates. It suggests that affordability is a major reason for the pattern of rising homeownership rates since 1995. The index was 131.8 in the fourth quarter of 2004.

While the stock market has rebounded from the collapse from its March, 2000 peak, it has still only restored about $3 trillion of the $6 trillion in consumers' wealth destroyed by the fall. This has led many people back to the old notion of thinking of their home as an investment as well as a place to live.