Things are looking up for American homeowners and investors. In most markets real estate prices are up, debt is down and equity has increased. It’s a financial picture that positively glows when compared with much of the past decade, but what does it mean for future real estate demand?
American homeowners had equity worth $13.1 trillion in 2005, according to the Federal Reserve. But then, as the mortgage meltdown unfolded, things went very wrong. By 2011 the equity in American homes had shrunk to $6.1 trillion and almost 50 million Americans saw their credit scores fall by at least 20 points. In addition, CoreLogic reports that some 7.8 million homes have been lost to foreclosure since 2004.
But now American equity is coming back. At the end of 2014 homeowner equity had increased to $11.3 trillion according to the Fed and as things now stand it’s possible that by some measures we will soon pass the 2005 peak.
Higher Home Values
Part of the reason for higher equity levels is that home values are increasing in most markets. Home prices were up in 148 metro areas in the first quarter according to the National Association of Realtors but down in 25.
The catch is that higher home values do not assure more equity. Property prices might rise but if homeowners keep borrowing it’s entirely possible for equity levels to remain stable or even drop.
What’s interesting about today’s growing equity is that it stems in large measure by the willingness — and need — of Americans to hold down mortgage debt. For instance, according to the Federal Reserve mortgage debt in 2005 amounted to $8.913 trillion, rose to $10.613 trillion by 2007 and then fell back to $9.403 trillion in 2014.
Why has mortgage borrowing declined since the high point in 2007?
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One reason is surely that non-mortgage debt has grown significantly. The result is that with most borrowers facing a 43 percent debt-to-income cap the ability to borrow is limited.
Between the end of 2005 and the first quarter of 2015 non-housing debt rose from $2.33 trillion to $3.13 trillion, according to the Federal Reserve Bank of New York. The big gainers were auto loans ($790 billion at the end of 2005 versus $970 billion in the first quarter of 2015) and student debt ($390 billion versus $1.19 trillion at the end of the same period.)
"Non-mortgage debt is squeezing out mortgage debt in large measure because such costs as auto loans and student debts are typically incurred before mortgage debt," said Rick Sharga, executive vice president at Auction.com. "By the time prospective buyers are ready to purchase a home they’re often already burdened with big monthly bills. In part this is the reason why purchases by first-time buyers have been reduced from the usual 40 percent or so market share to 32 percent."
Additional mortgage debt might be very tolerable except that household income remains stagnant: Figures from the Census Bureau show that the median household income in 2013 was $51,939 — that was 8.7 percent lower than in 1999, the peak year.
Higher Home Prices
What do growing equity, declining mortgage debt and increasing levels of non-housing obligations really mean?
First, more equity means fewer foreclosures because people can increasingly sell for enough to pay off outstanding real estate loans. Indeed, RealtyTrac reports that foreclosure starts reached a 10-year low in the first half of 2015.
Second, less debt combined with lower interest rates means ownership costs are a lot more tolerable than they used to be. Think how the economy would look if we went back to the 5.87 percent average mortgage rate in 2005 — or the 16.61 percent average seen in 1981.
Third, homes sales and mortgage borrowing are being constrained by the combination of growing non-mortgage debt and weaker incomes.
"The addition of more than $800 billion in new student debt during the past decade especially hurts potential first-time buyers," says Sharga. "This is a problem because the real estate market does better with a higher level of first-time buyer participation."
Fourth, if people can’t get into homes then they’re effectively being forced to rent or live with friends and family. Rental rates are outpacing inflation and many investors are prospering as a result, something that can be seen with the buy-to-rent (BTR) movement on Wall Street.
According to data released by RealtyTrac in December, "properties purchased by Blackstone/Invitation Homes over the past three years have the most potential dollar value in gained equity, $523 million, followed by American Homes 4 Rent ($409 million), Colony American Homes ($198 million) and Fundamental REO/Progress Residential ($67 million)."
Will real estate owners and investors continue to roll up big profits and rising rental rates? As with stocks and bonds, past performance does not guarantee future results and real estate is a localized commodity so national trends may not apply.
That said, as the old expression goes, we live in interesting times….