In the Recovering Housing Market, Starter Homes Remain Elusive – Reuters

By David Randall and Nichola Groom

NEW YORK/LOS ANGELES – In search of a yard for her two dogs and proximity to her new government job, Alison Owen embarked on a home-buying journey this spring in the competitive market of Austin, Texas.

Owen’s real estate agent cautioned the 28-year-old about the intense competition for entry-level homes—and he was right. To secure a 1,200-square-foot property listed at $198,000, Owen had to offer $215,000, contending with at least nine other bidders in the desirable Wells Branch neighborhood.

“I definitely spent a lot more than I thought I would,” Owen admitted.

Similar situations are occurring throughout the United States. Low interest rates and a recovering job market have boosted the number of prospective first-time homebuyers, but many are facing challenges due to a lack of available starter homes.

According to the National Association of Realtors, the inventory of homes priced at $250,000 or less fell by more than 12 percent between June 2015 and June 2016. The shortage is primarily due to increased labor, land, and building permit costs, which have led construction companies to focus on higher-end homes that yield better profits. Additionally, institutional investors are acquiring thousands of affordable homes in key markets and converting them into rentals.

The diminishing supply of affordable homes is one of several economic trends obstructing younger workers and families from accumulating wealth as their parents once did. Data from the Economic Policy Institute shows that real average hourly wages for often overburdened college graduates declined between 2000 and 2014, while the Case-Shiller U.S. National Home Price Index surged more than 25 percent, adjusted for inflation, during the same time frame.

Young individuals able to save for a down payment often find themselves in bidding wars for the limited number of homes within their budget. Others opt to stretch their finances for homes that would traditionally be considered a step up.

A Reuters analysis of data from listings firm Trulia indicates that the number of entry-level homes for sale—defined as those priced in the lower third of a local market—has decreased by 34 percent over the past four years. The situation is even more severe in certain cities; for example, the average number of starter homes on the market in Salt Lake City has dropped by 83% since 2012, and in San Diego, by 71.5%. Cambridge, Massachusetts, and Portland, Oregon, have also both experienced declines exceeding 60%.

THE NEW RENTING REALITY

From 2006 to 2014, the number of single-family homes occupied by renters increased by roughly 34%, as reported by the U.S. Census Bureau, a trend that traces back to the subprime mortgage crisis. Following the housing crash, institutional investors quickly acquired undervalued and foreclosed homes, converting them into rental properties.

Currently, nearly one-fifth of all homes priced under $300,000 that are not owner-occupied are owned by companies or corporations. While investor purchases have slowed since their peak in 2013, several publicly traded real estate investment trusts (REITs) in the U.S. focus exclusively on single-family rental homes. For instance, American Homes 4 Rent, the largest publicly traded REIT in this sector, owns almost 38,000 properties across more than 20 states.

Large-scale investors typically make all-cash offers when purchasing homes, giving them a distinct advantage over individual buyers. Laura Medina, a 25-year-old human resources manager, has experienced this firsthand. After six months of searching for a home for herself and her son, she lost multiple bidding wars to investors. “There are a lot of investors out there,” she noted.

The prospect of stable income from rising rents has also led many individuals to become "accidental landlords," renting out their homes rather than selling them when moving, as noted by NAR economist Lawrence Yun.

The growing renter population presents an appealing investment opportunity for rental housing. Young adults aged 18 to 34 now earn $2,000 less annually than they did in 1980, adjusted for inflation, and many carry record levels of student debt. As of the fourth quarter of 2015, outstanding student loan debt reached $1.2 trillion, ranking just behind mortgage debt in consumer debt categories, according to the New York Fed. Over the past decade, the average monthly student loan payment has risen by 50%, now totaling $351.

These factors have delayed many young individuals in entering the housing market; a June survey by the NAR found that 71% of non-homeowners with student debt reported it as a barrier to buying a home.

SLOW CONSTRUCTION

As both individual and institutional landlords absorb available rentals in the lower market segment, new construction has struggled to satisfy homebuyer demand. As of June, single-family housing starts were on pace for 778,000 in 2023, significantly below the more than one million starts seen during the 1990s and early 2000s.

This slowdown is partly due to the lingering effects of the recession, during which builders scaled back operations and many construction workers shifted careers. Labor shortages resulting from this shift continue to hamper construction, compounded by rising land costs and tight financing, observes Rob Dietz, economist with the National Association of Home Builders.

Average residential land values have surged about 79 percent over the last four years, returning to levels last observed during the housing market peak in 2007 and 2008, as indicated by the Lincoln Institute for Land Policy. The total cost of constructing a new home—including permit fees, labor, and material costs—has also risen, now accounting for 61.8 percent of the cost of an average single-family home, up from 48.1 percent in 2007.

PulteGroup Inc., one of the largest home construction firms in the U.S., reports that market dynamics have shifted its focus toward more expensive home construction. The company now sees first-time buyers making up just 32 percent of its business, a drop from 40 percent five years ago. PulteGroup has raised the average price of its entry-level homes to approximately $350,000, targeting more affluent urban buyers.

“We don’t see a lot of value today in running out into the exurbs and buying a lot of lots,” said PulteGroup’s Chief Financial Officer Bob O’Shaughnessy at an investor conference. If another housing downturn occurs, he warned, “that is the stuff that will shut down first.”