Lovallo: Millennials are better financed than previous generations

Key Concepts

• 50-year mortgage
• 30-year mortgage (standard in the US)
• 15-year mortgage
• Home prices
• Buying power
• Interest paid over loan term
• Equity building
• Average home buyer age (56 years old)
• Average new home buyer age (38 years old)
• First-time home buyer age (closer to 40)
• Millennials
• Renting vs. Buying
• Stock market investment
• American Dream
• Home builders
• Mortgage buy-downs
• Incentive loads
• Profitability and margins
• Global Financial Crisis (GFC) trough levels
• Consumer confidence
• KB Home, LAR, Meritage, Py, Toll Brothers (home builder stocks)

50-Year Mortgage Proposal and its Implications

The discussion begins with the recent news of a potential 50-year mortgage, contrasting it with the current standard 30-year mortgage and the less common 15-year option in the US.

• Financial Impact: Running the numbers on a 50-year mortgage suggests a monthly saving of approximately $120 and an increase in buying power by about 5%, equating to roughly $20,000.
• Drawbacks:
  • Longevity of Loan: The average first-time home buyer is 40 years old, meaning many would likely pass away before the mortgage matures.
  • Increased Interest: A 50-year mortgage doubles the amount of interest paid over the loan's term compared to a 30-year mortgage.
  • Equity Building: This extended term makes building equity more challenging.
• Overall Effect on Home Prices: While intended to make homes more affordable on a month-to-month basis, a 50-year mortgage would ultimately increase the overall cost of a home over time.

Shifting Demographics in Homeownership

The conversation then shifts to the aging demographic of home buyers, citing research from the National Association of Realtors.

• Average Home Buyer Age: The average home buyer is now 56 years old.
• Average New Home Buyer Age: The average new home buyer is 38 years old.
• Historical Context: Both these figures are considerably elevated compared to historical averages.
• Implications for Market: This trend raises questions about the feasibility of paying off a mortgage by retirement age, even for first-time buyers who are now closer to 40.

Analysis of the Modern Home Buyer and Market Dynamics

The discussion explores the characteristics of today's buyers, particularly millennials, and how their financial behaviors and life choices impact the housing market.

• Millennial Buyer Profile:
  • Delayed Life Events: Millennials are often delaying marriage, child-rearing, and other life events that typically necessitate larger living spaces.
  • Better Financing: This generation is described as being better financed, having spent more time in the workforce.
  • Motivation: These delayed life events can make them highly motivated buyers when they do occur.
• Renting vs. Buying Debate:
  • Cost-Effectiveness of Renting: Research suggests it is currently cheaper to rent than to buy, which could diminish the motivation to purchase a home.
  • Alternative Investments: Many individuals are investing in the stock market or other avenues rather than solely focusing on homeownership.
• Evolving "American Dream": While there was speculation that millennials would be a "renting generation," the sentiment is that the desire for homeownership, including the traditional elements like a backyard and a "white picket fence," remains strong as they reach key life stages.

Home Builders' Strategies and Market Outlook

The role of home builders in the current market, particularly their use of mortgage buy-downs, is highlighted.

• Mortgage Buy-downs: Home builders are offering mortgage buy-downs more extensively than ever before.
• Sustainability of Buy-downs:
  • Demand Generation: Buy-downs are a critical driver of demand.
  • Profitability: Builders are maintaining profitability and margins above Global Financial Crisis (GFC) trough levels, even with incentive loads that can be as high as 9-10% of the home's sale price (three times the normal incentive amount).
  • Efficiency: Builders have achieved significant efficiencies in their build processes to offset these costs.
• Market Outlook:
  • Continued Demand: The speaker believes buy-downs will continue to drive demand until consumer confidence and the broader market improve.
  • Positive Signs: There are positive indicators heading into the next year that suggest market improvement.
• Investment Recommendations: The speaker has a "buy" rating on several home builders, including KB Home, LAR, Meritage, Py, and Toll Brothers, viewing the setup for the next year as decidedly positive.

Conclusion

The discussion concludes that while a 50-year mortgage offers short-term affordability, it comes with significant long-term costs and challenges to equity building. The aging demographic of home buyers and the current cost-effectiveness of renting present complexities. However, the resilience and strategic use of mortgage buy-downs by home builders, coupled with their operational efficiencies, suggest a positive outlook for the home builder sector heading into the next year, with specific companies identified as strong investment opportunities.