Retiring Baby Boomers are having a major impact on the construction and private lending industries.
Stop by a Sherwin-Williams store and you’ll see that gray is replacing beige as the go-to neutral color for interior decorating. This anecdote provides a platform for a plethora of bad puns, because the graying of the Baby Boomer population is having a major impact on the housing market.
The aging of Baby Boomers presents both an important opportunity and a series of challenges for real estate developers and the companies that finance them. The pattern of retiring workers selling the big family house and relocating to condos in Arizona or Florida is shifting. Over the past several decades, the number of retirees purchasing condos in multi-unit housing has been declining, according to Trulia. Some retirees are opting to rent, some want to “age in place,” and still others are looking to buy even larger houses. This, coupled with debt-laden Millennials holding off on purchasing, is upending a time-honored pattern of generational purchase activity. The good news is that this new dynamic is keeping the market humming.
Most Millennials and GenXers, like their parents before them, aspire to live in larger homes (excluding those folks attracted to tiny houses or hipster lofts). Their parents’ generation, however, is exhibiting an aspirational divide. While some in the over-54 category are upholding the honored tradition of downsizing and moving to warmer climates, other Baby Boomers are just as likely to buy a bigger home, even taking out a mortgage during retirement to buy it. This behavior is now as likely as downsizing to a condo in Florida. There are still other Boomers bucking tradition and deciding to rent, even though they could afford to buy. Now other factors including the shortage of available housing stocks in certain markets are coming into play.
Questions about when and where Boomers will retire—and what kind of houses they will buy—represent a complicated subject for economists making predictions on what’s in store for the housing market. Baby Boomers represent 31 percent of all homebuyers, second only to Millennials, who represent 35 percent. 53 percent of Boomers live in houses that are between 1,400 and 2,600 square feet, while a much smaller slice (12.5 percent) live in larger houses of 2,600 square feet or more, according to Trulia.
Will they trade up or down in size? Buy or rent? Those questions are complicated by the low inventory of housing stock that appears to be stalling home purchases across the country. Many analysts contend that the U.S. now faces an acute housing shortage: since 2012 the number of both starter homes and “trade-up” homes on the market have dropped by over 40 percent, according to Trulia.
Over the same period of time, price increases for higher-end premium homes have outpaced middle-tier homes, according to Trulia’s data. Today the median price of a premium home is $542,805, compared to a median for middle-tier homes of $267,845. That’s a significant impact for Boomers who were considering a move to a larger and more expensive home for retirement. As the price gap widens, it becomes more difficult for a buyer looking to trade up to justify and afford the price of a premium home. At the same time, the widening price gap may make it more difficult for retiring Boomers to find a buyer for their own existing homes.
FREDDIE MAC WEIGHS IN
The Federal Home Loan Mortgage Corporation, known as Freddie Mac, recently conducted a large survey of those over age 55 to investigate their housing perceptions and preferences. Among the homeowners who responded that they would consider moving, 12 percent believe their next home will be more expensive than their current one, while 37 percent believe it will be in the same price range.
About half of the respondents believe it will be less expensive. At the same time, 23 percent of homeowners say they would have to make major renovations in order to age in place in their current home.
In an interview with the trade magazine Mortgage News Daily, Freddie Mac’s Executive Vice President of Single- Family Business, Dave Lowman, pointed to the impact of Boomers on both the construction and finance industries.
“The decisions the nation’s Baby Boomers and other older homeowners make will have an enormous impact on the demand for housing and new mortgage credit for the foreseeable future,” Lowman said. “Whether they buy new homes or decide to refinance and renovate their current ones, the size of this generation and the fact that they hold close to two-thirds, approximately $8 trillion, of the nation’s home equity makes it very important that we watch what they do.”
The survey indicates that an estimated 6 million homeowners and nearly as many current renters may move again. Of those homeowners and renters who expect to move, more than 5 million say they are likely to rent by 2020.
CONDO DEVELOPERS DEVELOP NEW TRICKS
In the face of such currents, some premium condo developers are finding new ways to adapt. In Florida, they are focusing on retirees who can afford big houses but are interested in accepting much smaller spaces once the kids have left home – with the big caveat that the location must be cool and the amenities compelling. It’s a new approach to Baby Boomer downsizing that is becoming a lucrative niche. When they can find buyers for their homes, some retirees seem willing to give up traditional retirement homes for a hip urban lifestyle. Builders that traditionally focused on retiree housing are using such high-ticket condos to lure retirees to warmer climates.
Florida’s Kolter Group is known for diversified real estate developments and investments, with projects amounting to over $12 billion in value. At three Kolter condo developments—in Sarasota, St. Petersburg and north Palm Beach— condo units ranging from 1,800 to 2,400 square feet are priced from about $900,000 to $1.5 million, with penthouses priced at over $3 million.
For many Boomers who are potential buyers, there is some hesitation about the units because they are so much smaller than the houses they currently live in. “Our sales manager frequently gets the comment from the husband or the wife that they haven’t lived in something that small since their first house,” Bob Vail, president of Kolter’s Urban project, said in a recent article on Curbed.com. “But they still buy.”
What attracts them are the urban locations of the developments, in midsized cities with many nearby walk-able destinations like cafes, parks and shops, or “center ice,” as Vail puts it.
At 41 stories and 450 feet, ONE St. Petersburg is the tallest building in downtown St. Petersburg, with gorgeous views of the bay and the downtown area. It boasts a 5,000-square-foot fitness complex and many other amenities. Vue Sarasota Bay will feature a dog park on top of its parking garage. In North Palm Beach, The Water Club offers three towers of 22 floors each, with a full-service marina alongside. All three buildings, which are in varying stages of construction, have water views.
Kolter has bought into a new trend in interior design that’s attracting downsizing Baby Boomers. Its units feature open floor plans rather than walls marking out a living room, family room or dining room. Instead, the units have a central “great room” with very few or no hallways, high ceilings and floor-to-ceiling windows. So far, this design strategy appears to be effective. In Sarasota, the Vue project has eight units left to sell out of its 141, from a three-bedroom for $1.5 million to a four-bedroom penthouse listed for $3.4 million. The Water Club has closed deals for three-quarters of its 164 units in the first building. And ONE St. Petersburg, which broke ground in mid- January, has contracts for just under half of its units, according to Vail.
RENTING INSTEAD OF BUYING –A NEW TREND FOR BOOMERS?
When Boomers consider downsizing, purchasing a condo or another home is not the only option. Renting pricey apartments, particularly in attractive urban locations, is also a new trend for them. The number of renters who are age 65 or older will reach 12.2 million by 2030, more than double the level in 2010, according to research by the Urban Institute in Washington. While Millennials have driven demand for apartments in recent years, Baby Boomers represent the next wave, pushing up rents and spurring construction of increased multifamily housing units.
An article in the July 21, 2015 issue of Bloomberg interviewed some of the participants in the front lines of this trend:
“It’s a combination of their sheer size and that they’re entering the age range where they increasingly downsize,” said Jordan Rappaport, a senior economist at the Federal Reserve Bank of Kansas City. As a result, “it will put upward pressure on rents for all types,” he said.
Rappaport’s research reported that people ages 50 to 70 accounted for nearly all the net increase in multi-unit occupancy from 2000 to 2013. As members of the Boomer generation are now entering their 70s and downsizing, “multifamily home construction is likely to continue to grow at a healthy rate through the end of the decade,” he wrote in a report published last year.
With combined demand from Boomers and Millennials, vacancy rates for rental properties are already near 21-year lows. That pushed the national median rental price up 27 percent to $1,381 in 2015 as compared to $1,090 in 2012, based on data from the United States Census Bureau.
According to the U.S. Commerce Department, last year saw the largest increase in construction starts for multi-dwelling properties featuring five or more units since 1987. These multi-unit buildings represented over 40 percent of total housing starts, compared to about 16 percent of starts in June 2009 when the recent economic expansion commenced.
Real estate developers such as Lennar Corp., Bozzuto Group and Alliance Residential Company are undertaking multi-unit projects for multiple generations. Should the supply of rental properties fail to keep up with demand, however, it’s likely there will be conditions where younger workers are competing for housing with the burgeoning population of retirees, and other lower income retirees are going to struggle to find suitable rentals.
Lennar Corp., a Miami-based builder that traditionally focused on single-family home construction, formed a $1.1 billion joint venture that will develop multifamily communities in 25 major U.S. metropolitan markets, according to the Bloomberg report.
Alliance Residential is designing buildings with smaller, more affordable units on ground floors to attract Millennials, and with larger and more expensive apartments on upper levels to attract Boomers, as reported in Bloomberg. The larger units feature amenities like wine refrigerators and touch-button window screens to lure away Boomers who might ordinarily be attracted to new single-family housing.
At Bozzuto, which manages over 50,000 units in cities including Washington, Chicago and Atlanta, about 10 percent of up from 8 percent in 2012. The Maryland based company expects the share of Boomers to continue growing. “Something’s happening,” Tony Bozzuto, CEO of his family company, said in an interview with Bloomberg, adding that the company is looking to add rental properties catering to residents 55 and older.
OPPORTUNITIES FOR PRIVATE LENDERS
With all this new demand for the multi-unit housing market, both for sale and rentals, you might think lending conditions would be terrific for developers. After all, pressure on supply should axiomatically lead to higher valuations and improved margins, which should make banks comfortable with lending. However, the opposite is becoming the case. Commercial banks are getting more cautious with development projects because regulators are looking at the industry’s robust growth and worrying about a potential bubble. Federal officials are concerned about construction lending, according to a letter sent last December by three federal agencies that regulate banks, the Federal Reserve, the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation.
New regulations also limit how much construction risk commercial banks can put on their balance sheets. The Dodd-Frank Financial Reform and Consumer Financial Protection Act in the U.S. and “Basel III” banking standards were created years ago, and many of their provisions recently came into full effect. While the longevity of these new rules has come into question under a Trump presidency, currently these rules require banks to hold large capital reserves to cover potential losses on investments like commercial real estate loans. In many cases, smaller lenders simply move on to other types of lending with less stringent reserve requirements, like auto and student loans. In addition, construction lenders are worrying about rising costs of labor and land as the construction market stays frothy.
For private lenders, the upshot is that, in the short term, many new opportunities are going to emerge as some developers with solid plans for multi-unit projects struggle to obtain traditional financing. Banks offer construction loans with low interest rates that float 250 to 300 basis points over LIBOR, which is quite attractive. But if a commercial lender cannot get comfortable with a developer’s loan to value ratio, balance sheet, or other factor, a private lender can step in to save the day, while also earning a terrific premium by enabling the project to move forward.
Like all business practices, the key is to do your homework. Stay vigilant for new opportunities, while taking a systemic approach to analyzing the developer’s balance sheet and project plans. In addition, as the new administration settles in, it is anticipated that these stringent banking regulations will be relaxed so private lenders have to be ready to capitalize on the current framework and adapt to a changing one.
More and more good lending opportunities will be out there as the cohort of graying Baby Boomers transform the market and help drive new multi-unit construction starts for years to come. Private lenders have to be flexible and agile in order to capitalize on it.
This article was originally published in Private Lender Magazine. Check out the full magazine along with other great articles.