Housing and the future
of real estate demand

A significant demographic shift could impact all sectors within commercial real estate, not just housing

September 30, 2020
>> Quick takes:
  • Housing market run continues
  • Demographic trends fueling the boom
  • Population shifting toward suburbs and home ownership
  • Apartment market set for decline
  • High-rise urban should lag mid-rise or low-rise suburban properties

Amidst all the trouble the economy is experiencing, one bright spot continues to stand out: the housing market. This contrasts significantly with the previous recession when housing not only struggled, but also directly contributed to the downturn in the economy. Data from last week shows little sign of any fading from housing. New home sales in August grew faster than expected, reaching an annualized rate of over 1 million new homes sold for the first time since November 2006. Meanwhile, existing home sales increased to an annualized rate of 6 million homes sold, the fastest pace since December 2006. And housing prices continue to increase. Certainly, record-low mortgage rates have fueled the boom in the housing market. But that is only part of the story.

Demographic change represents the more important (and potentially more interesting) part. At the early part of the last decade, the housing market suffered after a pullback that helped cause the Great Recession. The housing-price bubble burst, residential mortgage standards tightened considerably, inventory for sale evaporated which caused transaction volume to decline considerably. This held implications beyond the for-sale housing market. With the for-sale housing market ossified, many older Millennials that would have otherwise moved from city centers to suburbs became effectively stuck – geographical mobility declined because many households that transition from city centers to suburbs become homeowners in the process. Unable to do so, they remained in cities, predominantly as renters. At the same time, many younger Millennials continued to move into city centers from suburbs as they entered the workforce. 

Large city population growth rates


In the process, something novel occurred. City center population growth accelerated relative to the last few decades and suburban population growth slowed relative to the last few decades. This combination created a demographic tsunami that produced a significant increase in demand for rental housing. Multi-housing vacancy rates started to decline sooner than many had projected because supply growth slowed significantly during and initially after the recession. New supply eventually responded but demand exceeded new supply until the middle of last decade. Around that time, the for-sale housing market started to convalesce with prices stabilizing and the residential mortgage market easing. Transaction volume in the for-sale began rising as once-stuck older Millennials transitioned to the suburbs. Suburban population growth rebounded and outstripped city-center population growth during the latter half of last decade, reverting to historical trends. During that period, multi-housing supply and demand remained largely in check. But older Millennials continued to transition out to the suburbs, becoming homeowners. The home ownership rate bottomed in the second quarter of 2016 at 62.9%, rising thereafter as we forecasted. By the first quarter of this year, the homeownership rate reached 65.3%, almost identical to the long-term average. Over the last couple of years, the population of major cities such as New York, Chicago, and San Jose declined due to people moving out – some to the suburbs and some to other areas. Other cities, including Dallas and Houston, have seen their population growth effectively stall while the population of their respective metro areas continues to increase. Expensive housing caused some of this shift, but shifting demographics played an important role. 

The homeownership rate in the second quarter reached 67.9%, the highest rate since the second quarter of 2008 when the housing bubble was deflating… we do not doubt the shift toward homeownership.

Changing the composition of inventory?

The brings us to the current crisis. Much has been made of the seeming exodus out of expensive cities, partially into their own suburbs. Relatedly, many have also noticed the shift from apartment rentals into homeownership. The homeownership rate in the second quarter reached 67.9%, the highest rate since the second quarter of 2008 when the housing bubble was deflating. While we believe that data point likely overstates the increase in homeownership due to methodological problems with the survey, we do not doubt the shift toward homeownership. And the national apartment vacancy rate started rising in the second quarter and will almost certainly continue that trend when the third quarter data is published. We also expect both asking rents and effective rents to show third quarter declines, potentially pronounced in some markets. We expect those trends to continue over the medium term, the only question is magnitude. Our view is partially reflected in the housing starts and permits data. Between just July and August, single-family permits and starts increased by 6% and 4% respectively on a seasonally adjusted basis. Meanwhile, multifamily permits and starts declined by 14% and 3% on a seasonally adjusted basis. Unsurprisingly, a correlation exists between single-family construction activity and the demand for suburban locations where single-family inventory concentrates. 

If the apparent geographical shift continues during the pandemic, that could produce changing patterns in geographical demand for the other major property types, which increasingly and generally focused on city centers during the last decade. 

The path forward and implications for CRE

With these trends likely to persist over the medium term until the pandemic subsides, we could be witnessing a shift in demand for much commercial real estate (CRE) across property types. Prior to this crisis, we were relatively bullish on the suburbs across property types because of the underlying demographic trends. The pandemic is apparently accelerating existing trends. The shift toward the suburbs should manifest itself by apartment subtype. Vacancy rates will likely rise faster for high-rise projects than mid-rise or low-rise, reflecting geographical patterns. That could hold knock-on consequences for other major property types. If the apparent geographical shift continues during the pandemic, that could produce changing patterns in geographical demand for the other major property types, which increasingly and generally focused on city centers during the last decade. Although we expect substantial variation by geography and property subtype, this shift could produce different opportunities for investors. 

| What we are watching this week |

This week should provide a good view on any loss of economic momentum late in the third quarter. The employment situation for August should show continued improvement, but at a declining pace with net job gains below 1 million and a smaller decline in the unemployment rate. Personal spending for August should show another increase but fall well below the growth rate from the previous few months. Consumer confidence and sentiment for August should show little change with the potential for marginal improvement. The ISM manufacturing index for September should also show slight improvement. 

| Thought of the week |

The United States accounts for roughly 29% of the world’s net wealth but only roughly 4% of the world’s population.