Demographic terms bode well for the long-term health of housing markets, but the near term is fraught with uncertainty, according to a "State of the Nation’s Housing" report released today by the Joint Center for Housing Studies of Harvard University.

With the economy finally adding jobs this spring and house prices down dramatically, "two essential conditions for a sustained recovery in single-family starts and sales had fallen into place," the report said.

But it remains to be seen whether home sales will weather the expiration of the federal homebuyer tax credit, the report said. Initial signs of a recovery are also threatened by a "severe overhang" of vacant units, high unemployment, and record numbers of homes that are worth less than what’s owed on their mortgage.

The report concludes that deep cuts in homebuilding have already brought housing supply and demand back into better balance. It’s soft demand for housing, rather than a large oversupply, that’s holding back residential construction at the moment.

The recession wiped out 8.4 million jobs, which has forced some families to double up and delayed plans of many young adults to move out of their parents’ homes. Demand for housing is also down because the downturn has slowed the pace of immigration, and an estimated 1 million illegal immigrants have left the country, the report said.

Soaring unemployment and reduced immigration have slowed the pace of household formation from between 1.2 million and 1.4 million a year during the first half of the decade to less than 1 million a year, the report said.

In the long run, demographic forces are expected to lift household formation to about 1.25 million a year during the decade ahead, even if immigration remains subdued.

But whether those new households will be homeowners or renters remains to be seen.

Homeownership markets "are being tugged in different directions," the report noted. Lower prices have made homes more affordable, but tighter underwriting standards make qualifying for a mortgage more difficult.

During the boom, many lenders would fund mortgages carrying payments of up to 38 percent of borrower income. That standard would have allowed about 17.8 million renters to qualify to buy a median-priced home in 2008, the report said. At the more stringent 28 percent income standard often employed today, only 12.5 million renters would have qualified.

The swing in payment-to-income requirements means that home prices would have to drop more than 26 percent in order for households that qualified at the 38 percent standard to purchase under the new 28 percent standard.

According to the National Association of Realtors, median home prices fell 26 percent from October 2005 to March 2010. With mortgage rates near record lows, mortgage mortgage payments on the median-priced home are closer to median gross rents than at anytime since 1980, the report noted.

For borrowers making a 10 percent downpayment on a median-priced home, mortgage payments will amount to less than 20 percent of median household income, the lowest level in records dating back to 1971.

Assuming that household "headship rates" hold constant at 2008 levels, overall demand should support the construction of more than 17 million new homes between 2010-20, the report said. That number includes manufactured homes, and takes into account demand for second homes and the need to replace older housing stock.

Analysts are keeping a close eye on home construction because, with the exception of the dot-com crash and 2001 recession, housing tends to lead the economy into and out of recessions.

Residential fixed investment dropped 53.7 percent from 2005 to 2009, and represented just 2.5 percent of gross domestic product in 2009 — the lowest level since 1945. Builders started construction on only 445,000 single-family homes in 2009, compared with more than 1 million a year during the 1990s.

Declines in residential construction have been a drag on the economy for 3 1/2 years, before turning positive again during the second half of 2009. (According to the Bureau of Economic Analysis, investment in residential construction contracted again during the first quarter of 2010.)

While demographic trends indicate that household formation will return to or exceed household growth rates seen from 1995 to 2005, income levels may continue to deteriorate.

The first 10 years of the new century were a "lost decade" for household income, with median income falling 5 percent from 2000 to 2008, to $49,800, the report noted. After three decades of gains, "real median household incomes will almost certainly end (the decade) lower than they started," the report lamented.

The sheer size of the echo-boom generation — those born between 1986 and 2005 — will produce record numbers of households headed by young adults, who typically have lower incomes.

At 80.8 million strong, the echo boomer generation is already larger than the Baby Boom generation, and 42 percent are members of a minority group, the report noted. Minorities make up more than 50 percent of echo boomers in Hawaii, New Mexico, California, Texas, Arizona, Nevada, and Washington, D.C.

The median income of households headed by 35- to 44-year-old minorities in 2008 was $45,000, compared with $72,900 for whites in the same age group. The median wealth of minority households in 2007 was $26,900, or about one-quarter of white household wealth. Only 23 percent of U.S.-born minorities between the ages of 25-34 have college degrees, compared with 40 percent of whites.

The significant income and wealth disparities between whites and minorities threatens future growth in housing investment and the broader economy, the report said.

"Narrowing these disparities will depend on the ability of the nation to improve the educational achievement of minorities, and of the economy to create better-paying jobs that rely on skilled workers," the report noted.

The recession not only slowed household formation, but made it more difficult for families to move. Mobility rates fell 12.6 percent from 2005 to 2008, bottoming out in 2009, and the steepest declines were among homeowners.

An estimated 11.2 million homeowners are "underwater," owing more on their mortgages than their homes are worth. Some may choose to remain in place rather than sell their home or walk away with a loss.

Many older homeowners who had planned to retire and move to another home have delayed those plans.

"Unless housing and financial markets rebound sharply in the near future, some owners may never be able to retire elsewhere," the report noted.

The flip side for seniors is that they are more likely to have paid down much of their mortgage or to own their homes outright, and still stand to gain if they sell their homes. Price declines in retirement destinations like Arizona, Nevada and Florida help make them more affordable.

But Sunbelt retirement communities still face an uphill battle, the report said, because much of the boom in those areas was driven by construction and job growth.


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