U.S. housing activity is gaining traction, with home sales and construction touching multi-year highs. Average existing home prices have finally returned to their 2006 peak, though remain about 15% below after adjusting for inflation. The recovery has been broadly based, with sales and prices posting healthy annual advances in all major regions.



A strengthening U.S. job market and rising household formation should extend the recovery. Mortgage rates remain historically low. Leading indicators, including pending home sales, home purchase intentions, buyer traffic, builder sentiment and permit demand, all point to further improvement in the months ahead. Demographic trends are supportive, with the large millennial cohort moving into its prime homebuying years.



Yet the recovery continues to face a critical headwind — the lack of a discernible pickup in first-time buyer activity. The first-time buyer share of existing home sales has been stuck around 30% since 2012, well below the typical 40% level. Still tight credit conditions, weak wage growth and rising student debt loads remain a hurdle for many potential buyers.



Declining affordability also poses a challenge, with house price increases consistently outstripping income gains. The National Association of Realtors affordability benchmark for first-time buyers has deteriorated roughly 15% since 2012, though it remains above its long-term average. Affordability could be further constrained next year if mortgage rates drift higher.



At the same time, a number of factors are restricting the supply of entry-level homes. These include the conversion of foreclosed properties to rentals in recent years, and an ongoing, albeit declining, pool of negative or near-negative equity households which are more limited in their ability to move or finance a new mortgage. About 12% of mortgage holders are either ‘underwater’ or have less than 5% equity, with the highest concentration for homes valued at less than $200,000.



Rising new construction is not adding notably to the inventory of more affordable homes for sale, as builders continue to target high-income buyers. The average size of recently completed single-family dwellings climbed to a record 2,700 square feet in the second quarter. Meanwhile, tougher financing rules in recent years have contributed to a record low level of condominium starts, an affordable entry point for many first-time buyers.



A growing share of new construction has been geared to the rental market, primarily high-end units. Fully one-third of U.S. housing starts over the past year have been rental units — the highest share on record. Builders’ growing preference for purpose-built apartments mirrors strong rental demand, falling vacancy rates, rising rents, and increased investor interest.



The U.S. rental boom, while initially driven by a wave of property foreclosures following the 2006 housing bust, is showing no signs of letting up. The overwhelming majority of the roughly 1.6 million new U.S. households formed over the past year have chosen to rent, not buy. Many will likely eventually make the transition to homeownership, but this could take some time. While the greater propensity of Americans to rent is likely being driven primarily by financial constraints, it may also reflect lifestyle considerations, including a growing preference for urban living.



Generating a larger pool of first-time buyers is becoming increasingly important to sustaining the momentum in the U.S. housing sector as demand from investors slows. Individual investors have accounted for less than 15% of existing home sales this year, compared with 20-25% in the aftermath of the housing bust. Investor purchases are expected to remain moderate alongside a shrinking pool of distressed properties.



The number of international buyers of U.S. real estate also has declined, as steady house price increases and a strong U.S. dollar erode their purchasing power. U.S. home purchases by buyers from Canada, the U.K. and Mexico posted double-digit declines in the twelve months through March. Chinese buyers have been a notable exception, with continuing strong U.S. property acquisitions supported by a relatively strong yuan. Foreign buyers — resident and non-resident — account for about 4% of U.S. existing home sales, and about 8% of the dollar volume of sales.

