In this episode of The REconomy Podcast™ from First American, Chief Economist Mark Fleming and Deputy Chief Economist Odeta Kushi continue the REconomy “Summer School” series, breaking down the fundamental drivers and benefits of homeownership and explaining how these dynamics are playing out in today’s housing market.

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Listen to the REconomy Podcast™ Episode 93:

“Renters as non-homeowners gain no wealth benefit as home prices rise, that wealth all accrues to their landlords. Homeownership, even for the lowest quintile of income earners, helps to facilitate additional non-housing savings. Over time, assuming their wages rise, the fixed payment for shelter becomes a lower burden. And, therefore, homeowners can save in other ways that renters cannot.”  – Mark Fleming, chief economist at First American

Transcript:

Odeta Kushi - Hello and welcome to episode 93 of The REconomy Podcast and our second session of the Summer School series, where we discuss economic issues that impact real estate, housing and affordability. I'm Odeta Kushi, deputy chief economist at First American and here with me is Mark Fleming, chief economist at First American.

Mark Fleming - Hi, Odeta. That's right. And well done with the tongue twister of S's  - second session of the Summer School series. 

Odeta Kushi - We did it. 

Mark Fleming - We did it. I think the second session warrants a pop quiz. Don't you? Too early?

Odeta Kushi - No, I think it's a little too soon for prizes. You may scare off some of the students and then they'll just drop the course altogether.

Mark Fleming - I'm just channeling the professorial thing that I never was, you know, but that's a good point. We don't want that. Maybe the pop quizzes will be aimed at the long-time REconomy listeners instead.

Odeta Kushi - Okay, I think that's a little bit more fair. And today's topic is not only an important one, but it's timely given that we just wrapped up national homeownership month in June and we're publishing this episode around July 4.

Mark Fleming - I see what you're doing there. We must be talking about something near and dear to both of our hearts. And that is one of the main tenants of the American dream, homeownership.

Odeta Kushi - Correct and a plus to you. Beyond the fundamental financial considerations, we'll explore the connections between lifestyle factors that shape the desire for homeownership. We'll also explore the costs and benefits of owning your own home.

Mark Fleming - So you said beyond the financial considerations and, unlike many economists might like to think, I take it we are starting with the financial considerations, but there might be others.

Odeta Kushi - That is right, we're just going to get the math out of the way, so here we go. When making the financial decision to own or rent, you calculate the net-present value of owning versus renting.

Mark Fleming - Well, whoa, hold on now. Net-present value, I am not doing the econ-splaining for this one.

Odeta Kushi - All right, fine, fine. Here are the basics of calculating the net-present value of owning a home. First, calculate the initial costs of owning. So, this will include the down payment and closing costs, and, of course if you're not getting a mortgage, then this includes the sale price of the home. Then you estimate the ongoing costs, so your monthly mortgage payment, property taxes, homeowner's insurance, maintenance, repair costs, HOA fees, etc. I just said that in one breath. All right, now don't forget to consider the tax implications, such as deductions for mortgage interest and property taxes and potential capital gain implications when you sell.

Mark Fleming - There's more, there's still more?

Odeta Kushi - There's more. Then you calculate the expected value of the home at the end of the analysis period, accounting for appreciation or depreciation, then use a discount rate to calculate the present value of all future cash flows, both costs and proceeds from the eventual sale.

Mark Fleming - Oh boy listeners, if any of you are like me, I was lost at first calculate, but expected value, discount rate? Where are we going with this, Odeta?

Odeta Kushi - And I'm not even done because then we have to compare that to the present value of renting, which will vary slightly because you have to calculate the rental costs, such as monthly rent and renter's insurance, and estimate costs, such as possible rent increases over time, and then consider the potential investment returns from investing the difference between owning and renting. And then, finally, using that same discount rate as in the previous scenario to calculate the present value of all future rental payments and the potential growth of investments. Then you simply subtract the present value of owning from the present value of renting. And a positive net-present value indicates that buying is financially preferable. Voila. Simple.

Mark Fleming - Yes, so simple that I wonder if the pop quiz should be, can you do it all in one breath? All you need to do is perfectly predict everything from your tenure length, and real estate market trends, interest rates and investment market conditions.

Odeta Kushi - Easy peasy. Right? Like I said, it's simple.

Mark Fleming - Honestly, I really don't think anyone, even economists are doing this.

Odeta Kushi - And rightfully so. It's very difficult and unless you are a perfectly rational economic robot, this is not how people make the decision to buy or continue renting. Because buying a home is not simply an investment decision. It is a lifestyle decision.

Mark Fleming - Not how one does it, indeed. And, for our listeners, not to keep them hanging on this, in fact, our analysis has found that the primary demographic drivers of the tenure choice decision that is to rent or to buy is getting married and having children. Also being older and more educated helps and increases your likelihood of becoming a homeowner.

Odeta Kushi - Right, so a change in lifestyle, such as getting married, starting a family or the desire to settle down in one location can all be highly correlated with the decision to buy a home. Sometimes we call these lifestyle decisions, the five Ds of life events, diapers, diplomas, divorce, downsizing and death. 

Mark Fleming - Even sorted in time event order.

Odeta Kushi - That's right, well, we think. 

Mark Fleming - We think. 

Odeta Kushi - And, you know, just like the decision to rent can be a lifestyle decision, right? You just moved to a new city, you don't want to deal with the hassle of taking care of a home. I do miss that part, by the way. Or you simply don't see yourself living in that place for very long. Exactly.

Mark Fleming - Exactly. And yes, I've certainly had days when I've considered how nice it would be if I didn't have to worry about maintenance and repairs, like the freak hailstorm we had here in the D.C. area a few months ago. 

Odeta Kushi - Yes, I do recall that that can be one of the drawbacks to homeownership. But we digress. Once you've made the decision to consider buying, then you figure out how much you can afford to buy.

Mark Fleming - Yes, much better and simple decision to buy driven by one or more of the D's, then how much one can buy dependent on mortgage rates, your income and other financial considerations, such as your savings, how much debt you have relative to your income, credit worthiness, and, of course, house prices, not to mention the inventory of homes available for sale in the neighborhood or neighborhoods that you're interested in. After all, as we've said before, you can't buy, even if you can afford it, what's not for sale.

Odeta Kushi - These factors are very important. So, let's take this from theory to applied. How are we seeing these dynamics play out today? 

Mark Fleming - Well, today, millennials, the largest generation to date, are aging into their 30s. And additionally, millennials have higher educational attainment and that's translating into higher earning power. Remember, both of those are strong determinants of homeownership.

Odeta Kushi - Yet, the homeownership rate for millennials lags behind their generational predecessors at age 30. The millennial homeownership rate is approximately six percentage points lower than that of their generational predecessors, Generation X, at the same age of 30. Now, that's largely because millennials have prioritized their education, which takes time and money and have delayed marriage and family formation, which, as we already mentioned, are motivators for, and correlated with, homeownership. Previous generations made these lifestyle choices in their 20s. Millennials are making them in their early- to mid-30s. As evidence of this trend, the homeownership rate gap between the 40-year-old millennial and the 40-year-old Gen Xer is significantly narrower, at just two percentage points.

Mark Fleming - And it should also be noted that, as of 2022, more than half of all millennial households were homeowners, which is great news. Still leaves many more young households who want to make that same transition though.

Odeta Kushi - That's right. But to tie it back to the financial consideration, in the short-term high mortgage rates and reduced affordability may lead them to delay homeownership.

Mark Fleming -Yes, just like the record-low mortgage rates pulled forward some demand over the pandemic.

Odeta Kushi - Although that came with its own challenges, namely one of the most competitive markets in history.

Mark Fleming - So very true. But the financial environments can change again. In the short run, reduced affordability and limited supply may lead interested buyers to delay, but not necessarily forgo all together, their transition into homeownership.

Odeta Kushi - All right, and since we've mentioned that it's currently an affordability-constrained environment, we have to ask the question, just how constrained?

Mark Fleming - I love this question. It gets asked all the time, and we have a really cool way of looking at it. According to our recently released First-Time Home Buyer Outlook Report. Nationally, housing affordability has declined compared with a one year ago. No surprise there, especially for potential first-time home buyers. The median renter, who can also be considered the median first-time home buyer, could afford 29% of all homes for sale nationally in the first quarter of this year. This share is down from 34% a year ago, and 45% from the same quarter and 2022. So pretty dramatic.

Odeta Kushi - That's right. And this decline is in part due to an increase in mortgage rates. We know that the 30-year, fixed mortgage rate averaged 6.75% in the first quarter of 2024. That's an increase over the average mortgage rate in the first quarter of 2023. We also know that median house prices increased over the same period, further contributing to a decline in affordability. 

Mark Fleming - And since real estate is, as the adage always says, local. The affordability picture is worse in some markets than others. You can check out the latest First-Time Home Buyer Outlook Report blog post, which we will link to in the transcript. But the bottom line is that it is a challenging market for potential first-time home buyers. 

Odeta Kushi - But, as we said previously, financial conditions can change. In fact, the Federal Reserve has signaled a rate cut this year, which may indirectly result in a decline in mortgage rates. Additionally, our First American Data & Analytics House Price Index has shown five straight months of annual deceleration. And, perhaps most importantly, inventory has been on the rise. More housing supply not only exerts downward pressure on prices, but it gives potential buyers more choice. Despite the challenges, there's a glimmer of hope on the horizon for potential home buyers.

Mark Fleming - Indeed, we will take all the good news we can get at this point. Now, assuming, as all economists are inclined to do, that a potential home buyer has bought that home. What homeownership benefits can they expect? 

Odeta Kushi - Well, it's often stated that homeownership is a primary driver of wealth creation. But how so? Well, homeownership requires buyers to first save for a down payment. And, as a homeowner, you also build equity every month, the equity being the amount of money a homeowner can get if they sell their home, minus the debt the homeowner owes on it. Each month, the mortgage payment acts like a forced savings plan by reducing the amount owed on the home. The monthly mortgage payment also increases equity, a benefit that renters do not have. Renters can only build similar wealth if they invest an equal amount to the initial down payment and invest in an amount equal to the principal a homeowner pays off each month, not to mention the value of the home changes over time, usually increasing over the long run. Homeowners build equity wealth over time simply by being the asset owner, as homeowners move for a new job, or for a larger home, or for access to better schools for their kids. The equity they have accumulated goes with them. 

Mark Fleming - That's a great point. It's a forced savings plan. And you can take it with you. Renters as non-homeowners gain no wealth benefit as home prices rise, that wealth all accrues to their landlords. Homeownership, even for the lowest quintile of income earners, helps to facilitate additional non-housing savings. Over time, assuming their wages rise, the fixed payment for shelter becomes a lower burden. And, therefore, homeowners can save in other ways that renters cannot.

Odeta Kushi - So, let's put some numbers to this. For listeners who have been here from the beginning, these may sound familiar. For families that owned a home, the median net housing value, which we define as the value of a home minus the home-secured debt increased 44% between 2019 and 2022 from about $139,000 to just over $200,000. The increase was the largest on record over the history of the modern Survey of Consumer Finances. Mortgage - that was pretty much unchanged between that same time period, about 42% of families in both 2019 and 2022 had debt secured by their primary residence and the median amount of home-secured debt decreased by less than 1% in 2022.

Mark Fleming - Now maybe it's time for that pop quiz. One of these statistics that we've talked about before, the median homeowner in 2022, had how much household wealth relative to the wealth of the median renter?

Odeta Kushi - I've got Jeopardy music playing in my head. Give me a second to think about it. All right. Well, if you said 38 times, you would be correct.

Mark Fleming - And we'll give you the statistically significant margin of error. So, if you said 40, we'll give you that as correct as well.

Odeta Kushi - Yes, we are indeed very generous graders. Now, the data shows us that median wealth was $396,000 for homeowners compared to approximately $10,000 for renters. And here's another important finding - the majority of homeowner wealth comes from housing for every income category except for the very top earners. The lower the income of a homeowner and household, the greater the share of its wealth coming from homeownership. This pattern has remained consistent over the last three decades.

Mark Fleming - Wealthier households tend to have more diversification in their assets, they own more in financial assets like stocks and bonds, mutual funds and retirement accounts. They also tend to own more non-financial assets that aren't residential property, for example, a stake in a business or non-residential real estate.

Odeta Kushi - The difference in the composition of wealth means that fluctuations, of course, in home prices will have a much bigger impact on the wealth of lower income families and those that have a mix of other assets. But, unlike other types of assets, like stocks or business equity, housing is a relatively safe asset that historically has steadily appreciated. All right, well, I think we've covered quite a bit in this episode. And we didn't even touch some of the non-financial benefits of homeownership, right. Stability, security community, all of these other factors.

Mark Fleming - So, like what color you want to paint the walls of the house. 

Odeta Kushi - Yeah, you get some choice in that creative freedom. Right, but I think we've covered quite a bit, so we'll stop there. This concludes the second episode of The REconomy Summer School series. Please join us for the next episode, where our Senior Commercial Economist Xander Snyder will be joining us to talk commercial real estate. And, as always, if you can't wait, you can follow us on X. It's @OdetaKushi for me and @MFlemingEcon for Mark. Until next time.

Thank you for listening, and we hope you enjoyed this episode of The REconomy Podcast from First American. We're pleased to offer you even more economic content at firstam.com/economics. This episode is copyright 2024 by First American Financial Corporation. All rights reserved.

This transcript has been edited for clarity.