Did you ever marvel at something from a distance, only to find fundamental flaws upon closer inspection? Today's housing market could fit that description.
On the macro scale, the market appears to be in a good place. Demand is relatively high, as millennials who were shut out of the market by economic conditions are achieving greater economic stability. Mortgage rates are still near historic lows and wages are starting to increase – theoretically allowing consumers to take advantage of those rates. Conditions are ripe for a boom in housing starts and strong increases in sales.
Unfortunately, the market hasn't followed this scenario. As of this writing, new and existing home sales are both down from the previous month's levels. According to the Census Bureau, there are now 8 million more renter-occupied homes today as compared to the pre-recession housing peak in 2007.
Why are first-time homebuyers being driven toward rental properties instead of a purchased home? Affordability is a major factor. A report from Trulia notes that 95 of the top 100 U.S. markets have fewer affordable starter homes than they did in 2012.
Homes are available, but at a price that first-time homebuyers can't afford. As of July, the median price of a purchased home hit a record high of $258,300 nationwide. Sales of homes $100,000 or less dropped 14% compared to the previous July – in part because prices are rising so quickly that there are fewer homes falling into that category. According to National Association of Realtors Chief Economist Lawrence Yun, home prices have appreciated by over 40% in the past five years.
Many existing starter homes were scooped up by investors during the housing crisis and returned to the market as rental homes. Homebuilders aren't filling the gap, in part because the margin on starter homes is relatively low even though demand is high. High land, material, and labor costs force developers to maximize the value of every square inch of land through high-value homes.
For reference, in the existing home market, over half of the homes sold during August were priced below $250,000. Compare that to new homes, where only 14% of the newly built homes sold in August on the market were priced below $200,000 and only 5% were priced below $150,000.
As a result, millennials entering the housing market are faced with a difficult choice. Try to find a suitable home in your market despite low demand, higher prices, and increased competition, or choose the rental market and save whatever funds you can for a future home purchase. Is it any surprise that millennials are increasingly choosing the rental market – or staying with Mom and Dad for a few years until the supply of starter homes improves?
The trend toward rentals can affect the entire housing market. Current homeowners wishing to upgrade can't proceed without willing buyers to purchase their existing home. Meanwhile, millennials wanting to move from a rental to a home purchase are still stuck in the entry market – they haven't been building any equity in their home to finance an upgrade.
How do these factors affect your potential entry into the housing market? In most markets, you will face stiffer competition for a home and are likely to pay more for it. Under these circumstances, it's even more important to have a suitable down payment and stable finances. Keep your debt low and your credit score high to ensure that you qualify for loans at reasonable rates, and continually check the market for bargains. In a tight market, it's important to be up to date on options and prepared to strike quickly.
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