Starter Homes: Shortage Likely To Get Worse

Is a shortage of starter homes going to turn into the next housing crisis? A few weeks ago, I wrote an article called “Should Retirees Sell Their Rental Properties?”. My article showed that rentals generally do not provide a very compelling cash-on-cash return. Real estate is generally considered a “total return” investment vehicle, where free cash flow is likely to average only 2-5% of the value of the property (assuming no mortgage) and then price appreciation may provide another 2-4% in an average year. My conclusion was that most retirees, who are primarily interested in cash flow and peace of mind, should sell their rentals.

This week, I want to share a piece of information that makes the case for holding on to your rentals. The reason is potentially above-average appreciation over the next 10-15 years, especially for starter homes.

One of the most powerful drivers of real estate values is demographics. Below is a chart showing the US population by age. The population surge known as the millennials has been having a big impact on real estate, and that impact will continue and evolve over the next decade.

Millennials Have Driven Up Rents

Demand for apartments and their accompanying rents have grown consistently since 2011. One of the reasons is millennial’s have been hitting prime renting ages (18-30). Builders have tried to keep up with demand, but they have not been able to build enough new apartments in some markets. Median rents increased nationwide by 3.1% in 2017. This was higher than wage growth or the general inflation rate, but slower than rental increases of the past couple of years. (See largest median rent increases of 2017.)

Millennials Want Starter Homes

You can see in the charts below that in 2020 all the top 10 most common ages in the United States be 25-35. By 2030, they will all be 30-41. This is the proverbial pig moving through the python. Hello, millennials.

The question is: “What do people buy between their late 20s and early 40s?”

Answer…starter homes.

Another graph showing the millennial age wave was probably not necessary here, but I like this one, so humor me.

Shortage of Starter Homes Could Become the Next Housing Crisis

The generation of adults born after 1980 were slow to enter the housing market, but as they are getting married and having kids, they are buying homes at rates equal to their parents. However, there are not enough affordable homes in many markets. The inventory of homes for sale fell nationwide in 2017, prices rose, and new home construction picked up. The problem is the new residential construction is not at the price point where new inventory is needed most. Builders have found that building luxury apartments and luxury homes is more profitable.

Starter homes were the segment of the housing market that had the steepest price decline in the housing bust (2007-2011) and the strongest recovery since then. Last year, this segment continued to have the largest price increases (9.6%) and biggest inventory decreases. Some people think that rents and prices cannot continue to increase at the pace they have over the past 5 years due to lack of affordability. However, this article from the Wall Street Journal states that the combination of tougher zoning, a lack of construction labor, and a shortage of land in desirable areas means that the current shortage of entry level homes is likely to get worse.

Final Thought

I have always believed that home ownership is a crucial piece of financial security and wealth building. So young families should find a way to buy as soon as practical and owners of rental properties in some areas may enjoy above-average price appreciation and rental increases for the next decade.

Thoughts, questions, comments? Send me an email.

For more on this topic, check out:

Mismatched Markets: America Is Looking for Entry Level Homes in a Premium Home Market

Entry Level Homes Gaining Equity Faster Than Luxury Sector: Zillow