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The New Norm

February 7, 2013

The Real Estate World Has a New Look As the Economy Recovers

 

The black cloud that’s rained bad news on the real estate market for the past four years only seems like it will last forever. Sooner or later, the sky will clear.

The long-range forecast: increasing sun but with a 100 percent chance of change.

“There are still a lot of questions, but it’s going to be different, that much I know,” says John McIlwain, senior resident fellow and J. Ronald Terwilliger chair for housing at the Urban Land Institute (ULI).

Mcilwain is the author of “Housing in America: The Next Decade.” His report delivers an important message about the future of growth and development in this country. Even after unemployment rates fall and property values stabilize, the old normal is not returning.

The winds of change — shifting demographics, aversion to sprawl, enthusiasm for transit — were kicking up before the recession hit. Everything that’s happened since — tight credit, rising energy costs, the rethinking of homes as sources of quick wealth — makes the advent of a new normal all the more inevitable.

The recession ranks behind only the Great Depression in terms of the pain it’s caused thousands and thousands of families who’ve lost jobs and homes. However, as the real estate market evolves toward a new normal marked by growing urbanization, greater sustainability and more transportation choices, the re- cession may also be remembered as a tipping point for smart growth.

“I think the new normal is going to be very consistent with smart growth policies,” says Glenn Crellin, director of the Washington center for real estate research at Washington State University (WSU).

The connection between the new normal and smart growth starts with demographics. The housing preferences of two game-changing generations — the baby boomers and Generation Y — will dictate what the market will look like in the years ahead. And many members of both generations have a healthy appetite for the kind of compact, walkable, mix-used development that characterizes smart growth.

A fresh take on the meaning of affordability also will put a smart growth spin on the new normal. People are starting to under- stand they may get more house for their money in far-flung suburbs, but they’re spending all the savings at the gas pump. They’ll be looking for homes closer to their jobs in walkable neighborhoods with access to transit — a catalyst for urban infill and suburban retrofits.

That dovetails with another signature of the new normal: the quest to go carbon neutral. People will choose to live where they’re less dependent on their cars because reducing air pollution matters to them. They’ll seek out more compact neighborhoods because they believe in preserving open space. And they’ll demand greener and greener homes because they want to conserve resources as well as save money. “Energy efficiency is becoming the new granite countertops,” says McIlwain. “It’s a necessary feature to sell the property.”

Those are just some of the threads in a web of trends that will drive the new normal. “There are a lot of forces coming together,” McIlwain says. While few would disagree with that, it may be another year or two before the market begins to fully respond. The timing depends on unemployment continuing to fall and foreclosures beginning to recede. Once those things happen, strong population growth of about 2.5 million to 2.8 million a year — much of it driven by immigration — will rewind the demand for housing, says McIlwain, but with a dramatically rewritten script.

Count on a smaller percentage of people to own their homes. Homeownership peaked at nearly 70 percent in 2005 as a result of supportive government policies and loose lending guidelines, but has been falling ever since as a result of the mortgage meltdown and tighter borrowing standards. Expect the rate to continue sliding until settling in the low 60 percent range, says McIlwain.

One of the big reasons homeownership rates won’t return to their peak: members of Generation Y are waiting longer to both move out of the house and to buy their first home. Why? Because the recession has handcuffed them financially and because they no longer view homeowner- ship as a surefire investment given the current flood of foreclosures and mountain of underwater mortgages, says McIlwain.

Scott Rogers, a REALTOR® with Coldwell Banker Funkhouser REALTORS® in Harrisonburg, Va., says that’s exactly what’s happening in his market. “We’re seeing fewer and fewer first-time buyers here because [buying] is not considered as safe as it was,” he says.

The big question nagging Rogers is what the government’s role will look like in the new normal. Phasing out Fannie Mae and Freddie Mac, ending or limiting the tax deduction for mortgage interest and upping the down payment and mortgage insurance premium for FHA loans are all on the table — each a wild card that could raise the cost of financing and limit who can buy a house.

Although there’s no precise definition for Generation Y, it generally consists of people in their teens to early 30s and amounts to 83 million people — the largest generation ever. Once the employment picture brightens, they’ll swarm into the housing market — but as renters who will delay buying for a prolonged period. Accordingly, the new normal will include a growing demand for rental/multi-family housing, says McIlwain. In a survey released this spring, the National Association of Home Builders (NAHB) reported that developer sentiment regarding apartment and multi-family construction was at its highest level since 2006.

But don’t give up on Generation Y as future home-buyers, says Crellin, who recently questioned some of his WSU students about their intentions. “I was pleasantly surprised that the vast majority of them said they’re still planning to buy, but maybe five years later than they first thought,” he says.

A 2010 survey, by ULI, of people in the age group 18 to 32 years old supports Crellin’s observation. Within five years, two-thirds expected to own their own residences. Among those who said they were unlikely to own within five years, seven out of 10 said they expected to do so sometime in the future.

When buyers do pull the trigger, it will be with the knowledge that home values won’t resume climbing at a double-digit pace. In the new normal, says Crellin, prices will rise about 1 percent above the rate of inflation or 3-4 percent a year. That’s actually closer to the historical average than the so-called old normal that preceded the recession.

“Here’s my take on the new normal. We feel like the rug has been pulled out from under us, but we’re just going back to the same [conditions] we had in 2003,” says Bob Walters, chief economist with Quicken Loans.

People will once again look at their home first and foremost as a “place to raise their family and be part of a community” rather than as an investment they can use as a cash machine, says Walters. “People were looking to maximize their debt, but that thinking has gone away ... and that’s a good thing,” he says. Tighter lending standards also will reshape expectations in the new normal. “You’re going to see people buying less house,” Walters says.

That process already is underway. The average size of a new home dropped by 10 percent between 2007 and 2010, shrinking from 2,300 square feet to 2,100 square feet, says David Crowe, chief economist for NAHB. Builders also are scaling back on the quality of carpets, cabinets and other finishes, he says.

Another big home-building shift involves increased density — and not just because constructing more homes on less land can reduce cost. It also enables developers to build in, and around, urban cores where growing numbers of people want to live, says Crowe. The challenge will be to find infill sites where neighbors will accept higher density. That could lead developers to create new urban communities from scratch in the outer suburbs where land is more available, he says.

No look at the new normal would be complete without considering the influence of the baby boomers — the 78 million people who were born between 1946 and 1964 and who began turning 65 this year. “You’re going to see a mixed pattern in this group, but it won’t follow past patterns of people their age,” McIlwain says.

Fewer, for example, will retire to the sunbelt because they’d rather move closer to their children and grandchildren. More will defer transitioning into retirement communities because they’re healthier.

Many will work longer because the recession robbed their nest eggs. And, a whole bunch will remain in the suburban homes where they raised their children.

Some will have no choice because they owe more on their mortgages than their homes are worth and because Generation X — people in their mid-30s and mid-40s who are the most likely buyers of their homes — is relatively small. Yet many others will remain in their suburban homes by choice, says David Shotwell, senior director for livable communities with AARP. “If they do move, they want to stay in their own community,” he says.

The boomers have redefined every era they’ve entered and real estate’s new normal will be no exception. Expect communities to pursue a host of strategies to help boomers age in place ranging from developing walkable town centers to encouraging affordable housing near transit to tweaking their zoning codes to allow mother-in-law units. “Let’s face it,” says Shotwell. “This is a huge number of people and the new normal will be lots of things.”