Three things to keep in mind for 2017: the economy will grow at a slower rate, home prices will continue to rise, but more people will want to rent. This isn’t much different from 2016 but the risk of investing will be higher in some local markets.
The Federal Reserve believes the economy is “strong” and will do even better next year. My company, Local Market Monitor has been busy running the numbers and thinks this is pie-in-the-sky optimistic.
The US economy moves in tidal waves that ebb and flow for years at a time. This is especially true for jobs. After the 2008 recession, job creation built back to a peak of 2.3 percent in early 2015 and since then it’s receded to a 1.6 percent annual rate. Maybe another wave of growth will follow in 2017, but I doubt it. Some important stats say further slowing is more likely.
Job statistics tell us what the economy is likely to do, but they don’t tell us why. To better understand what will happen with jobs – and therefore with real estate – we need to look at the longer-term situation of American consumers, who drive the economy but can only spend money when they make money. Or when they borrow it.
The next slowdown will probably happen when consumers are up their eyeballs in the vast amount of debt they have taken on to pay for college.
Over the last ten years, student debt increased by a trillion (yes, trillion) dollars. When a business borrows, it may invest in something that will grow the economy; but when a student borrows to pay for something that has no more value than a high school diploma once did, it’s not an investment that will grow the economy – it’s just a transfer payment to their college, and a debt that keeps them from spending money on other things.
The unfortunate situation we seem to be in is that our economy can only grow modestly unless consumers borrow to spend – first it was homeowners, now it’s young adults. What will happen when all consumers have borrowed all they can?
Nationally, home prices bottomed out in 2012 and are up about 5 percent a year since then. But the local differences are stark. In the last three years, prices rose 30 percent in Southern California, yet just 5 percent in Alabama and Connecticut. Many local markets are still under-priced 25 percent or more. Not surprisingly, job and population growth account for much of the difference.
It’s easy to list growing markets where prices will continue to rise, but are the under-priced markets an investment opportunity? For that matter, what’s the best way to invest in markets that are already over-priced? The answer may lie in the rental question.
Buying Versus Renting
Buying, fixing up and then renting out single-family homes remains an attractive proposition. Right after the recession, bargain home prices were a big draw for such an investment, promising quick returns. But even with higher prices, the fundamental economics of renting will be favorable for years.
In 2005, 37 million American households were in rentals. In 2016 it was 44 million. Builders, however, have not kept pace – in the last five years just 2 million new rentals built although 4 million were needed. And there are good reasons to think this imbalance will continue.
The income of the average worker increased just 10 percent in the last five years – no better than inflation. More importantly, the income of the lower half of workers increased only 8 percent. Fewer people have the income to buy a home and more of them are already saddled with debt.
Slower job creation in 2017 – incomes for many people don’t match inflation – the debt of consumers goes even higher – more people need to rent – but builders aren’t building enough rentals.