In its annual "State of the Nation’s Housing" report released on June 6 even economists at the Joint Center for Housing Studies of Harvard University appear to be having a far more difficult time than usual discerning which way the wind will blow when it comes to the next turn in the “rocky road to recovery.”

The report concludes that the housing recovery will likely be led by improvements in the rental housing sector, but what happens next depends on how vigorously the economy can continue creating the new jobs needed to spark a pickup in household formations.

The longer-range housing outlook, the report says, hangs on the outcome of policy debates now raging over how the nation’s broken housing finance system should be put back together again.

“Implementation of the Financial Reform Act and decisions about what form government mortgage guarantees are to take will have a profound impact on the future cost and availability of mortgage credit,” according to the Joint Center.

The report points out that the housing market could turn quickly, but in the meantime tight mortgage underwriting requirements and lingering uncertainty over the direction of home prices dampened sales activity in this year’s disappointing first quarter and it is uncertain how quickly those constraints on home buying demand will be alleviated.

“The ingredients for a sustainable recovery may be coming together,” said Chris Herbert, the Joint Center’s research director, “but it is still not clear when home buyers will have the urgency to return to the market in sufficient numbers to lift the market in a meaningful way.”

Tougher Mortgage Qualifying Standards

Even before the dust settles on what qualifying standards future mortgage borrowers will need to meet, the aspirations of households to attain homeownership are coming up against some formidable obstacles in the current marketplace.

The Harvard report observes that low-downpayment mortgages, “a common means of entry for many moderate-income home buyers,” have largely evaporated outside of Federal Housing Administration-insured mortgage programs.

“Even there, though, the Obama Administration has tightened requirements and raised costs,” the report says.

“Many lenders originating low-downpayment loans have also imposed higher credit score screens than FHA,” it continues. “If the proposed 20% down requirement for qualified residential mortgages passes, low-downpayment lending without a federal guarantee may remain sharply curtailed.

“The combination of higher income, downpayment and credit score requirements in today’s broader mortgage market will prevent many borrowers from getting the loans today that they would have qualified for in the 1990s before the housing boom and bust.”

While it remains unclear where the impending reform of the housing finance system and the secondary mortgage market are headed, “regulators have signaled in their initial proposals that they are inclined to take a conservative approach to defining risky loans,” Harvard says.

The negative implications of tighter mortgage lending are compounded by the increasing dominance of minorities in household formations, the report suggests.

Making conservative assumptions on U.S. immigration, the study projects that minorities will account for seven out of 10 of the 11.8 million net new households expected in 2010-20.

Hispanics alone will contribute to nearly 40% of the increase in households, and by 2020 minorities will account for one-third of all U.S. households.

Affording housing will tend to be a stretch for this segment of the marketplace, which has lower average incomes and wealth than whites, placing downward pressure on homeownership rates, the report says.

And for that reason, decisions on key requirements for downpayments and credit score cutoffs will have “an especially important impact on the ability of tomorrow’s minority households to buy homes.”

Household Formations

The Joint Center has also become more downbeat about prospects for household formations in the aftermath of the Great Recession, which discouraged echo boomers born in 1986 and later — “the largest generation ever to reach their 20s” — from setting out on their own and which also brought growth in foreign-born households to a halt.

While estimates vary widely, the Current Population Survey from the Bureau of Labor Statistics shows household growth averaging about 500,000 annually in 2007-10 — half the 1.2 million average annual pace of 2000-7 and lower than the average of the decade of the 1990s when the smaller baby-bust generation was entering the housing market.

To match the 1.12 million annual average of the 2000s up to the downturn, “household formation rates must return to their 2007-9 average, and net migration must reach at least half of Census Bureau projections,” the report says.

If that occurs, Harvard economists calculate that the number of households under age 35 will grow to nearly 26.5 million in the next decade.

However, the impact of the massive echo-boomer generation on housing markets, and smaller homes in particular, is at this stage less predictable than the impact of aging baby boomers, some 3.8 million of whom will probably downsize their homes over the coming decade.

Headship rates of young adults were sliding even before the recession hit, according to the Joint Center, and that decline was accelerated by the downturn.

And it is now “unclear how much, if at all, headship rates among echo-boomer adults will recover as they age and the economy improves,” the report says.

Improving Rentals

Overall, “the state of the nation’s housing is sobering,” said Eric Belsky, managing director of the Joint Center.

“Total housing construction over the previous decade now barely exceeds the lowest level of any 10-year period in records dating back to 1974, but vacancies remain elevated because the recession has driven demand down so sharply.”

The news, however, is better and improving in the rental housing sector, driven by a 3.9 million increase in the number of renters from 2004 to 2010.

Even as demand was growing, “rental vacancy rates rose and rents stalled through 2009 as new additions to the supply and conversions of existing homes to rentals exceeded demand.

“The tide turned in 2010 as the rental vacancy rate fell from 10.6% in the first quarter to 9.4% in the last, the lowest quarterly rate posted since 2003.”

This trend has applied mounting upward pressure on rents after declines in 2009, and the rental rebound has now reached most metropolitan markets, with the exception of areas still suffering from an excess supply of for-sale units.

Of the metro areas covered, only Las Vegas; Fort Myers, Fla.; and Tucson, Ariz., saw rent declines in 2010.

NAHB and the National Housing Endowment are among the groups that provided support for the report.

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