As the real estate market warms, Millennial home buyers are poised to capitalize on low rates and affordable homes.
In the US, buying a home was long considered a milestone that symbolized financial success and a transition to adulthood. Yet for many, the Great Recession—dominated by the collapse of the real estate market—meant putting that dream of homeownership on hold, or perhaps questioning it altogether.
But change is afoot. After a recovery that at times has felt maddeningly slow, the US economy is on the upswing and the country's real estate market is rapidly warming. And with interest rates at near historic lows, a generation of sidelined Millennials—typically defined as 18-29 year olds—are finally poised to purchase their first homes.
The US economy has been steadily—albeit leisurely—improving for the past six years. According to Morgan Stanley & Co. Research, nominal GDP, the key indicator of economic health, is likely to grow by 2.5% this year as compared to 2014. And that growth should pick up slightly the following year, with 2.7% forecasted for 2016.
Home prices are following suit. An avalanche of foreclosures and few qualified buyers spurred a glut of inventory, which depressed home prices in the years immediately following the 2008 recession. However, prices began a mostly upward march in 2011. The national median home price is expected to increase by about 6.5% this year to $221,900, matching a record high set in 2006, according to the National Association of Realtors.1
Much of that appreciation is due to a burgeoning demand that has so far outpaced an increased supply. After years of riding out low prices, current homeowners are taking advantage of rising home values to sell and move up or downsize. But because they're usually buying another home, there's been little net increase in inventory, NAR reports.
In addition, home buying activity at the higher-priced end of the market, which typically represents move-up buyers, has actually ramped up faster than at the low end. Mortgage transactions for homes priced at more than $500,000 have grown in excess of 5% (nearly 8% for homes valued at more than $1 million) over the past year, according to the National Association of Realtors.
It may seem unbelievable, especially to buyers in hot markets such as San Francisco or New York, but in general, US homes remain affordable. Home prices are currently about 5% under long-term average values, though they are on the rise, according to the Case-Schiller Home Price Index.
Surprisingly, for current homeowners, monthly mortgage payments comprise only about 18% of their total monthly income. The long-term average is about 21%. That happy decline can in part be attributed to historically low interest rates. Post-recession homebuyers have benefitted from interest rates on 30-year fixed mortgages that have hovered around 3% and 4% since 2010.2 Such low rates help offset appreciating home prices and have allowed recent home buyers get more for their money.
But the halcyon days of cheap mortgages may be nearing an end. The Federal Reserve Board hasn't raised its target rate since 2006 (when the bulk of Millennials were still in high school). However, heartened by the country's economic improvement, there is speculation that the Fed may raise interest rates by the end of the year, perhaps as soon as September.
Even a small uptick may slow home buyer activity and thus price appreciation, but the potential for increased monthly payments will also likely put some currently affordable homes out of reach for potential borrowers.
The first wave of Millennials faced an uncertain economic future as they graduated college in the midst of a recession. Laden with debt and few job prospects, many moved back home with their parents. Now it appears that many young adults are finally leaving the nest. According to Bloomberg, household formation has been on a notable rise, increasing by 1.5 million in the first quarter of 2015 compared to the same period last year.
And the nexus of low rates and relative affordability is certainly convincing many Millennials who've either been renting, or perhaps living with family, to buy. People under the age of 34 accounted for the largest share of homebuyers for the second consecutive year, according to the NAR 2015 Homebuyer and Seller Generational Study. Millennials accounted for 34 percent of buyers in 2014 and Generation X—typically defined as the generation born between the mid-60's to mid-70's—followed close behind with 27 percent.3
According to a Redfin survey, some of these younger buyers consider their home a pragmatic investment—one they're even willing to prioritize over a wedding or honeymoon.4 They're not wrong. With the exception of the 2008 recession, home prices have been on the rise since the mid-80s and its likely that trend will continue. Despite their rough start, this next generation of home buyers is ready to capitalize on a rising real estate market.