Requiem for the American Dream

Housing Markets: Different Paths of the Recovery

Is the U.S. housing market recovering? We were quite puzzled and didn’t really know the answer to this question until recently. On one hand, we have seen bubbles and fizzles in the luxurious apartment buildings in large cities such as New York City, Boston, Washington DC, Chicago, Los Angles, San Francisco and Seattle, on the other, we have noticed that the average home price had not recovered much from the previous trough. Indeed, it was nothing but our ignorance that we did not recognize the housing market was bifurcated into two segments, Single Family and Multi Family, and these two housing markets are behaving very differently.

Source: Bloomberg (Moody’s/RCA CPPI – Apartment and Case-Shiller US National Home Price)

We found that the recovery paths of Single Family homes and Multi Family homes in the United States were significantly different: while the Single Family Home Price (Case Shiller Home Price Index) is still 2% below the previous peak, the Multi Family Home Price (Moody’s/RCA CPPI – Apartment) is already 47% above the previous peak.

Source: Bloomberg (Moody’s/RCA CPPI – Apartment and Case-Shiller US National Home Price)

The History of the Homeownership

After the second world war, America’s homeownership surged from c.44% to c.62%, led by two age groups: 25-34 year-old (up 22.7%) and 35-44 year-old (up 26.0%). The economists believe that changes in population composition and economic and social policy changes were two primary factors for the increase (The Post-War Boom in Homeownership: An Exercise in Quantitative History, Matthew Chambers, Towson University, January 2011).

Source: U.S. Census

Source: U.S. Census

After growing steadily from 1960 to 1993, the homeownership rocketed upward again as the US government attempted to make homeownership possible for all Americans. To promote its goal, Congress and the U.S. Department of Housing and Urban Development made several key provisions. Beginning in 1990 with the Cranston-Gonzalez National Affordable Housing Act, Congress created the National Homeownership Trust to provide interest rate buydowns and down payment assistance for first-time homebuyers. In 1992, Congress passed the Federal Housing Enterprises Financial Safety and Soundness Act of 1992 (FHEFSSA), which amended the Cranston-Gonzalez bill to make first-time homebuyers also eligible for second mortgages with deferred payment of interest and principal. In 1995, the U.S. Department of Housing and Urban Development established affordable housing targets that required Fannie Mae and Freddie Mac to purchase mortgages given to low-income first time homebuyers. While the policy change may have been well-intended, HUD allowed subprime securities that included mortgages for low-income homebuyers to count toward the affordable housing purchase goals. The end result of these policy and legislative changes was a wave of new homebuyers who pushed the homeownership rate higher. As the loosened standards and most dangerous practices of the mortgage industry were removed in the aftermath of the financial crisis, the homeownership rate fell back toward and below its previous level. Americans’ increasing demand for renting over homeownership is clearly shown in the next chart. The number of US households increased from 117 million to 125 million since 2006, reflecting that 9 million net households formed. During the same period, there was no net increase of the Owner-Occupiers and the entire increase of the households decided to rent.

Source: U.S. Census

Source: U.S. Census, Green Street Advisors

While the supply of the new homes remains subdued and only recovered to the half of 2005 level when almost 2 million homes were built. What is important here is not how many, but what kind of new homes have been built since the crisis. The U.S. Census data shows that the number of Single Family Homes built in 2015 was almost 40% of the number built in 2007. In contrast, the number of Multi Family Homes built grew by 13% during the same period primarily and 90% of the Multi Family Homes were built for rent. Then, why did Americans change their preference from the Single Family home to the Multi Family home after the crisis? Did the home ownership fall because the Millennials (those who were born after 1980 but before 2000, or the age group between 25 and 34 years old; also known as Generation Y) give up on the American Dream?

Source: U.S. Census, 1,000 unit

Source: U.S. Census, 1,000 unit

Interesting, our analysis shows that Millennials, whose homeownership rate fell from 43.1% to 35.0% between 2004 and 2015 (-10.2%), are not solely responsible for the falling homeownership. On the other hand, the age group between 35 and 44 years old experienced the largest drop of 10.7%. The age group between 45 and 54 years old also experienced a meaningful decline of the homeownership (-7.3%).

Changes of the Homeownership by Age Group

Source: U.S. Census, Star Magnolia Capital

Source: U.S. Census, Star Magnolia Capital

U.S. Census provides additional data for the homeownership by income group, which is further divided into two subgroups: Households with Mortgage and Households without Mortgage. This data provides additional color to understand today’s housing markets. We noticed that there was significant decline in the percentage of Owners with Mortgage in the Above Average Income group. The higher the household’s income level is, the more prominent the decline is. The households in the higher income group rely more on mortgage to purchase a new home and this data apparently suggests that the lack of mortgage led the households from homeownership to renting.

Change of Homeownership Breakdown

Source: U.S. Census, Star Magnolia Capital

Comradely Capitalism

The Economist ran an excellent article titled How America Accidentally Nationalised its Mortgage Market, in which they pointed out several key changes in the mortgage markets. Firstly, the banks largely exited from the mortgage markets after paying $110 billion of fines for misconduct. Although they still own some mortgage-backed papers for wealthy clients, the loan balance is now very small. Secondly, the Government Sponsored Agencies, such as Freddie Mac and Fannie Mae, expanded its role in the mortgage industry although they are now in “conservatorship” and have very thin capital layer. Together with the Veterans Affairs department, the Federal Housing Administration and Ginnie Mae, they own or have guaranteed $6.4 trillion of loans, and had over 60% market shares of new origination since 2008. While private lenders cannot compete with the public ones, the lending standard was tightened-up considerably.

We cannot ignore the benefit of higher credit origination standard, but it also resulted in the lack of funding even for the qualified buyers. Based on the Federal Reserve New York’s data, the borrowers with FICO score below 719 have very little opportunity to borrow. Basically, the mortgage is no longer available for ordinary American households, which resulted in lower homeownership rate. Those who are not able to buy their own houses decided to rent, which led a bubble in the Multi Family home markets. After all, the American Dream was a dream manufactured by the American government with a subsidized mortgage program.

Requiem for the American Dream

“She gradually became aware of how dumb the damn show was she was watching and she stared at it, wondering how in the hell they could put anything so absurdly infantile and intellectually and esthetically insulting on television, and she started asking herself over and over how they could do it, what kind of nonsense this is, and she continued to stare and shake her head, more and more of her mind being absorbed by the absurdity she was watching, suddenly leaning back on the couch as a section of the show ended and a commercial came blaringly on and she stared at them too, wondering what sort of cretins watch this garbage and are influenced by it and actually go out and buy those things, and she shook her head, unbelievable, it is simply unbelievable, how can they manage to make so many obnoxious commercials, one right after the other?”

― Hubert Selby Jr., Requiem for a Dream

The concept of the American Dream is rooted in the Declaration of Independence, which proclaims that “all men are created equal” with the right to “Life, Liberty and the pursuit of Happiness,” and it has been an important driver of the prosperity of the United States over the last two centuries. In 1931, James Truslow Adams, a writer, historian and winner of Pulitzer Prize, coin the term “American Dream” in his book The Epic of America. The American Dream is “that dream of a land in which life should be better and richer and fuller for everyone, with opportunity for each according to ability of achievement. It is a difficult dream for the European upper classes to interpret adequately, and too many of us ourselves have grown weary and mistrustful of it. It is not a dream of motor cars and high wages merely, but a dream of social order in which each man and each woman shall be able to attain to the fullest stature of which they are innately capable, and be recognized by others for what they are, regardless of the fortuitous circumstances of birth or position." Despite of Adams’ empyreal definition, the meaning of the American Dream changed over the course of history, and is now, almost always, associated with home ownership. This conveniently modified concept of the American Dream, supported by the loosen credit standard for the home loans, created a vicious boom-and-bust cycle of the housing markets in the past.

The 2008 financial crisis was a bless, not the requiem, for the American families as they are now freed from the curse of the homeownership. However, the shift from the homeownership to rentership created another bubble in the multi family home industry. Over the past few months, we have witnessed the weakness in the luxurious apartment markets in the U.S. major cities and think this trend will continue. At the same time, the price of the single family homes is now very attractive, not only for a homeowner-occupier, but also for an investor. It is not very difficult to find a property with a 10+% gross rent yield in many suburban cities and towns in the United States. As the mortgage becomes more accessible for American families in the future, we see a nice upside in the single family homes. It is a rebirth of the American Dream.