The Next Hot Housing Market: Starter Homes

Millennials are buying homes, steering builders toward lower price points

First-time buyers are rushing to buy homes after a decade on the sidelines, promising to kick a housing market already flush with luxury sales into higher gear.

Tracking home sales to a particular age group is hard, but a series of data points form a mosaic of a generation of young people ready to buy: The number of new-owner households was double the number of new-renter households in the first quarter of this year, the share of first-time buyers is creeping back toward the historical average, and mortgages for first-timers are on the rise.

“They’re crawling out of their parents’ basements, they’re forming households and they’re looking to buy,” said Doug Bauer, chief executive of home builder Tri Pointe Group Inc., which operates in eight states.

In a shift, new households are overwhelmingly choosing to buy rather than rent. Some 854,000 new-owner households were formed during the first three months of the year, more than double the 365,000 new-renter households formed during the period, according to Census Bureau data. It was the first time in a decade there were more new buyers than renters, according to an analysis by home-tracker Trulia.

Home builders are beginning to shift their focus away from luxury homes and toward homes at lower price points to cater to this burgeoning millennial clientele. Demographers generally define millennials as people born between roughly 1980 and 2000.

In the first quarter of this year, 31% of the speculative homes built by major builders were smaller than 2,250 square feet, indicating they were in the starter-home range, according to housing research firm Zelman & Associates. That is up from 27% a year ago and 24% in the first quarter of 2015.

“There’s an increasing confidence level in that part of the market,” said Gregg Nelson, co-founder of California home builder Trumark Cos. “The recovery is finally starting to take hold in a broader way.”

The shift reflects a reversal of a pattern that has driven the five-year housing-market expansion.

Up until now the luxury market has soared, while the more affordable end of the market has struggled. Tough lending standards, slow wage growth, growing student-debt obligations and a newfound fear of home ownership have combined to crimp demand among millennials in particular.

Now, the return of first- time buyers is allaying fears that millennials might eschew homeownership permanently. But it also provides an infusion of new demand while housing supply is tight and home price growth is significantly outstripping wage gains.

The return of first-time buyers is accelerating. In all they have accounted for 42% of buyers this year, up from 38% in 2015 and 31% at the lowest point during the recent housing cycle in 2011, according to Fannie Mae, which defines first-time buyers as anyone who hasn’t owned a home in the past three years.

While economists and builders said lending standards have started to ease, getting a mortgage remains challenging for young buyers with shorter credit histories and, in many cases, student debt. Mortgage rates are also expected to rise further this year, posing an added challenge. Rates for a 30-year fixed-rate mortgage have risen to 4.05%, up from about 3.5% in November, according to Freddie Mac.

In Orange County, Calif., Trumark’s Mr. Nelson said he has been selling entry-level homes at nearly double the rate of his higher-end ones.

He is even gaining confidence to build homes in more far-flung locations. The company is about to begin construction on a 114-home project in the Inland Empire east of Los Angeles and another development in Manteca, Calif., about 80 miles east of San Francisco. Both areas were hard-hit during the housing crash and were among the slowest to recover.

Builders largely avoided the exurbs after the bubble burst in 2006. But because land there is cheaper, they can build lower-end homes more profitably.

“Most builders really preferred to stick straight down the fairway, right at the corner of Main and Main. They were afraid to go back into the rough where they built a lot of homes in the prior cycle,” said Alan Ratner, senior homebuilding analyst at Zelman.

Outside Las Vegas, Tri Pointe has introduced a new home design that is specifically targeted to millennial buyers, featuring indoor-out- door patios and deck spaces, as well as a separate downstairs bedroom-and-bathroom suite that could be rented out to a housemate. Mr. Bauer said the homes, geared toward first-time buyers, have been selling more rapidly than pricier homes.

Joey Liu, a 28-year-old technology worker, purchased his first home in San Jose, Calif., earlier this year. He said it is more expensive than renting but that he is getting to the stage in life where it was time to buy.

“A lot of friends of mine bought a home so I started thinking maybe it was time to buy a home and stop paying rent,” said Mr. Liu, who settled on a three-bedroom townhouse for $690,000. He plans to rent out a room to help with the expenses.

Builders say their return to the starter-home market shouldn’t invite comparisons to the fevered construction of the mid-2000s.

“One of the misconceptions is that, here we go again, this is another 2005, 2006 where all these builders are going to build hundreds of thousands of homes. We’re not going crazy,” said Brent Anderson, vice president of investor relations at Scottsdale, Ariz.-based Meritage Homes Corp. Mr. Anderson said that last year the company was building four to five speculative homes per community and is now up to 6.4 on average.

Building executives said one challenge is that many people are buying first homes later in life, meaning they have higher incomes and greater expectations molded by years of living in luxury downtown rentals. Such buyers also appear wary of driving farther out to get more space.

Article From Wall Street Joral
By  Laura Kusisto and  Chris Kirkham
Updated May 11, 2017 8:09 p.m. ET