Rise in home prices largely due to rise of millennials

The U.S. housing market has enjoyed a strong surge in home prices since 2011. Nominal home prices, measured by the S&P CoreLogic Case-Shiller Home Price Index, are over 50 percent above the trough as of January.

While the economy has seen moderate growth and the job market has tightened, rising home prices have far exceeded both income growth and inflation during this period, which have grown by 20 percent and nine percent, respectively.

{mosads}Homes have become more expensive against both income and other consumer goods. The January data shows that home price growth is accelerating, not slowing. But the last housing cycle has made economists more skeptical when home price and income growth diverge.

One expression of that skepticism is the forecasted slowdown in home price growth, which most economists forecast. I will make the case that today’s housing market is very different from the last cycle, and that home price growth will continue to be strong and could even accelerate.

My optimism for strong home price growth over the next few years is based on two factors driving the housing market: strong first-time homebuyer demand and a sluggish housing supply. As a result, the housing recovery has seen larger increases in price than in sales.

The kind of homebuyers active in today’s market gives important clues about the market dynamic. Research by Genworth Mortgage Insurance shows that home sales to first-time homebuyers have grown by 40 percent between 2014 and 2017.

To put that in perspective, it represents over 80 percent of the increase in total home sales over the past three years. In this sense, the tight housing inventory and accelerating home price growth are largely driven by first-time homebuyers on the demand side.

That strong demand is the result of millennials aging into homeownership. Millennials started to leave colleges and enter the labor force in 2011, so they are beginning to gain a more solid financial footing. Employment for people between the ages of 25 and 34 years has grown by four million since 2011, the largest growth period in 30 years.

Millennials are also beginning to have children. Birth rates among women aged 30 to 34 — considered a strong precursor to homeownership — have surpassed their pre-recession peak.

So not only are millennials the largest generation in history, they are also reaching a critical stage of their lifecycle when their housing preference is changing from rent to own. The millennials are competing among themselves to become homeowners, and that leads to higher home prices.  

On the supply side, the homebuilding industry has seen a slow recovery. The number of new single-family homes started has expanded, but at around 900,000 units, it has remained historically low. The focus of the industry has shifted to higher price points, allowing it to thrive in a smaller market.

Since 2011, the share of new homes priced over $300,000 has increased from 28 percent to 56 percent. Growth in new home sales continued to be concentrated in this price segment. In 2017, new home sales priced above $300,000 grew by 15 percent while sales of new homes priced below $300,000 fell by one percent.

Since housing market demand is largely driven by first-time homebuyers, the lack of homes priced below $300,000 has created a seller’s market at the lower end. Home prices at the lower end have out-performed the overall market.

The S&P CoreLogic Case-Shiller Home Price Index tracks home prices in 17 cities by price tier. Among these 17 cities, home prices in the low-price tier grew by an average of 10.6 percent over the past 12 months, while prices for the entire market grew by 6.8 percent.

The housing market today is fundamentally different from the last cycle. The last cycle had been driven by investors and speculators on the demand side and very high levels of production on the supply side.

The demand today is coming from young homeowners looking to start families, which should continue based on strong demographics and the release of pent-up demand. Housing supply has not been adequate in the recovery thus far and will likely remain so.

That means the same dynamics should continue in 2018, with growing demand mostly translating into rapid home price gains.

Tian Liu is the chief economist at Genworth Mortgage Insurance, responsible for tracking U.S. and regional economic trends.