Solving the Growing Home Ownership Gap

Andrew Nesbitt (MBA '16)

"Haven't we seen consistent job gains for several years? Hasn't the economy gotten better? Yes. Sort of."

"Haven't we seen consistent job gains for several years? Hasn't the economy gotten better? Yes. Sort of."

     There has been a lot of discussion recently about the growing gap in home ownership, now at a staggering 48-

year low in the United States. What's more, the average age of a first time home buyer is now 33 years, up from 30

just a generation ago in the early 1970s. One might expect ownership would rise in the years following the end of

The Great Recession. Yet this gap has only grown since 2009. Certainly part of this is due to the housing collapse of

the Great Recession, which still makes many younger generations view home buying as risky. However, new

regulations, as well as moving away from things like government CRA loans that encouraged reduced underwriting

standards, have helped mitigate this risk. So what else could it be? Haven't we seen consistent job gains for several

years? Hasn't the economy gotten better?

Yes. Sort of.

     Job-growth has allowed more young people to move out of, say, their parent’s home and into their

own residence. It has also allowed people who already rent to be able to afford a better place. But wage-

growth has actually been stagnant for well over a decade. This, along with rising rents, have made it very difficult

to afford the high initial down payment typically required to purchase a home.

     This drives even more demand into the rental market, thus creating a cycle of home ownership declines

and rental market increases. In fact, according to the Wall Street Journal, the number of Ownership Homes

dropped by 400,000, compared to an increase in Rental Homes of over 2 Million, in Q2

of 2015 alone. Another more peculiar, yet critical factor: mortgage rates remain historically low. So low, in fact,

that average mortgage payments across the 35 largest US metro-areas are exactly half of monthly rental rates

exactly. In some markets, such as Chicago and Philadelphia, the average rental rates are over-double the average

mortgage rates.

     The question then remains: can we avoid this perpetual rental cycle? Many real estate economists and

investors would say no. Investor incentive typically comes from being able to take advantage of trends like a

hot rental market, and they can do just that the way things are done now (i.e. investing in a residential

property, renting the units, and selling the property at the end of a 10-year holding period, all while extracting

the profitable equity).

     Indeed, this still may be the best approach for markets that are growing tremendously, such as Denver,

Portland, and Austin, which have seen record year-over-year rent increases. In fact, by using rental rates as

a valuation method, it's no wonder many multi-family homes have become so expensive to own. But for

slow growth, still desirable rental markets like Chicago and Minneapolis, there might be a solution:

  1. REITs, private equity funds, and other real estate investing firms could provide funding very early for the development or purchase of one or more new, large-scale multi-family properties (i.e. higher-end condos, apartments, or town-homes).

  2. These companies could then set up a centralized selling/loan office within these properties, similar to a leasing office. As soon as possible, they could then sell the units to normal, creditworthy people seeking to buy homes and live in them as tenants.

  3. These tenants would obtain the primary loan (e.g. 85% LTV) from a third party, such as a bank, to pay the real estate investing company--directly through the selling/loan office--for their home purchase. That amount would be refunded to the investing company's investors within the first year.

  4. For the remaining 15% of the value--what would normally be the prohibitively expensive down payment--the selling and loan office would originate a higher-interest, fully-amortizing mezzanine loan for the tenants. The loan term would, in general, be set to match the holding period, or planned maturity, of the real estate investors. Note that because the office would be on-site, it provides an easy and direct way to acquire potential home buyers and explain this option vs. renting to them.

  5. The office would also charge a selling fee (similar to a broker-dealer fee), as well as an origination fee for the mezzanine loan. These fees would then be split with the original investors to provide incentive to utilize this method.

     Some may view the fees and higher interest unfavorably, but again, right now average rental rates are double

the current mortgage rates. So monthly payments would still be less than current rental rates anyway, only

with this plan, the tenants own their homes and start building equity, all while not having the burden of a

massive down payment. And investors could achieve the same or better IRRs and cash-on-cash returns1, and

get their money back far earlier (the majority in the same year), while also reducing risk.

     Of course, this isn’t an all-or-nothing approach. A company could actually do a combination of the above (i.e.

renting some units while selling others), and simply adjust to achieve the desired returns/constraints for both

investors and would-be home owners. And, the benefits don't end there.

     For starters, slow-growth markets, such as Indianapolis, would be more attractive to would-be home-

buyers. Two, if the real estate investing companies expanded services to include things like internal debt

origination and sales for these types of properties on-site, this would likewise create new high-quality jobs. This is

especially because this type of transaction could and would happen much more frequently than a typical 10

year investment. Both of the above factors would help improve the economy in each respective city.

     Owning a home is one of the cornerstones of the American Dream, and a key aspect in helping the middle-

class build wealth and raise a family. Unfortunately, however, doing so only seems to be getting more and

more difficult. Hopefully, new approaches—whether it’s this one or another—will help to start reversing this

troubling and ongoing trend.