How’s the housing market? That’s a pretty standard opening line for builders and real estate agents when they meet but not exactly a conversation starter for the average citizen. For the sizable share of the population that owns a home in the U.S., however, it’s a question that has more bearing on their lives today than normal.

 

Since the housing bubble and mortgage crisis that followed it in 2007-2008, the dynamics of the housing market have gone from steady to volatile. Now, a full decade after the phrase “subprime mortgage” entered our collective consciousness, the housing market is entering another volatile phase. This time around the problem is 180 degrees opposite that of 2007. Whereas easy mortgage money provided a way for more people to buy homes than could really afford them during the bubble, today’s dilemma is a tight supply. For homeowners, this condition is a happy one. Prices are rising faster than normal because there are more buyers than sellers. Instead of being upside down, like what happened in 2009 when home values plunged, homeowners are seeing their equity grow faster than expected.

 

After the heartburn of a decade ago, such market conditions hardly seem like bad news. And for sellers the conditions bring good fortune. But, like with most market imbalances, today’s conditions have a downside. Buyers are forced to make quick decisions about the home they want and many find themselves in a bidding war. Rapidly-rising prices are making it harder for first-time buyers and with interest rates rising – albeit only slightly for now – the pressure on first-time buyers won’t be easing.

 

There are two main issues creating the problem: fewer existing homes on the market and less new construction. These two things don’t usually coincide. In fact, tight supply of existing homes has always sparked more new construction. But there are a couple of factors limiting new construction, both hangovers from the mortgage crisis. There are fewer homebuilders and the obstacles to residential development are greater than ten years ago.

 

This interesting and contrary housing market is a national phenomenon and it is also a Pittsburgh phenomenon. The housing crisis of 2007-2008 largely bypassed Pittsburgh. While there was a slight increase in foreclosures – and a shakeup among the lenders that dabbled in subprime loans – there were none of the problems that other cities faced. Few people lost their homes. Home values stumbled slightly for a couple of years. But by 2010 home values were increasing again and, thanks to the Marcellus Shale boom, Pittsburgh’s housing market became healthier than it was before the Great Recession. Yet for the market’s health, new construction has not returned.

 

Seen from a number of perspectives, this tight supply issue isn’t a big deal. Circumstances will no doubt change to either increase supply or quell demand. In Pittsburgh, however, there are few indications that a significant change is on the horizon. For a city that is trying to attract younger skilled workers (and succeeding), an extended period of tight supply could impact one of Pittsburgh’s biggest advantages: its affordability.

The Housing Market: Just the Facts

An examination of the housing data for metropolitan Pittsburgh reveals a tale of two markets: one before 2008 and one after. From the early 1990s, when the housing market began to expand in response to Pittsburgh’s economic rebirth and the completion of several important infrastructure projects (think Parkway North), builders were consistently starting between 2,500 and 3,500 single-family detached homes. In fact, the average number of new homes started during the 1995-2007 period was just over 3,000 units. The same was true of single-family attached homes – mostly townhouses – which saw an average of 928 units built during that timeframe. For nearly 15 years there were more or less 4,000 new units of single-family new construction available for sale in the Pittsburgh market. That changed in 2008.

 

Like in most U.S. cities, the financial crisis altered the residential construction landscape in Pittsburgh. New home construction fell by almost 1,800 units per year from 2008 until 2013. Economic uncertainty impacted demand during the first couple of years following the crisis and tight lending standards for residential mortgages pinched demand for a few more years. A boom in apartments filled the demand as Pittsburgh’s economy saw double-digit job growth from 2010 through 2012 and the stage was set for a housing market lift-off. The market is still awaiting that lift-off.

 

During the nine years since the recession started, there has been an average of 1,920 new single-family detached homes started. The average for the last five – which covers the period in which Pittsburgh saw strong job growth – has been 1,962. Apartment construction tripled during this latter period, with an average of more than 2,600 units built each year; however, even as that market softened, new construction for sale has remained unchanged.

 

Logically, this unusual stagnation of the new construction market would be offset by a robust existing home sales market. That hasn’t happened. In point of fact, the opposite has occurred. For several reasons, existing home sales should be increasing rapidly but even a recent improvement in sales hasn’t changed the overall trend. There are fewer houses to sell, even though metropolitan Pittsburgh is a place people want to live.

 

“Pittsburgh consistently ranks in the top places to live and work in the U.S., with U.S. News and World Report ranking the city #11 in most affordable places to live in the U.S., ” said Ron Croushore, current president of West Penn Multi-List, Inc., and owner and CEO of Berkshire Hathaway HomeServices The Preferred Realty, Pittsburgh. “The relatively low cost of living in our area is very attractive, especially to first-time buyers.”

WHEN comparing January-March 2017 with the same time period in 2016:

  • Closed sales are up 4.25 percent (5,275 units in 2017 versus 5,060 in 2016).
  • Closed sales volume is up 7.03 percent ($881,584,375 in 2017 versus $823,707,280 in 2016).
  • Average sale price is up 2.66 percent ($167,125 in 2017 versus $162,788 in 2016).
  • New listings are up 2.20 percent (9,311 units in 2017 versus 9,111 in 2016).

 

West Penn Multi-List covers a 17-county service area – Allegheny, Armstrong, Beaver, Butler, Cambria, Clarion, Crawford, Fayette, Greene, Indiana, Jefferson, Lawrence, Mercer, Somerset, Venango, Washington and Westmoreland counties. Croushore’s assessment of the market describes its potential, not its reality.

 

That upbeat data may give heart to real estate agents but it belies the long-term trend. A recent comparison of Multi-List’s data for total listings as of April 30 shows the extent of the problem. The listings as of April 30, 2017 totaled over 23,000, a decline of more than 7,000 from the total of almost 31,000 homes on April 30, 2008.

 

“I just spent the morning in meetings trying to figure it out,” replies Howard “Hoddy” Hanna III, CEO of Howard Hanna Real Estate, in response to the question of why there aren’t more homes on the market. Hanna leads the region’s largest real estate agency – and the nation’s third-largest – and he offers three observations that can explain the supply problem.

 

“There is a lack of new construction so there is not the triggered sale of an existing home behind it. Second, people are staying put, which is hard for us to understand. We can see a price gap in listings from $150,000 to $400,000, which means fewer people are moving up. The third factor is that a lot of homes were bought by big private equity firms around the country. We haven’t seen those on the market,” Hanna summarizes.

 

The latter factor wasn’t as big a factor in Pittsburgh, but private equity funds and investment banks like Goldman Sachs did take three million homes off the market as rentals during the downturn. Hanna’s observation about the slowdown in new construction is quite relevant to Pittsburgh’s situation. The same is true nationally.

 

Between 2009 and 2016 there were 6.9 million units of new housing started, a number that is well below the average for the previous three decades. Allowing for 1.9 million units of housing that were either demolished, condemned or otherwise removed from the dwelling stock, the net number of homes available in the inventory for occupancy grew by five million from 2009 to 2016.

 

During the same period, however, population grew in the U.S. by 19.7 million people. Using the historical average of 2.5 persons per household, roughly 7.9 million households should have been formed in those years. That number is nearly three million units more than the net number of new homes in the inventory.

 

Pittsburgh has not seen the same level of population growth as the rest of the nation, which has prevented the supply issue from worsening. By the same token, the root cause of the housing dilemma – the lack of new development – is more pronounced in Pittsburgh.

 

 

The Drag on Development

The environment for residential development was drastically different in Pittsburgh compared to the rest of the U.S. in 2008. While many cities had tens of thousands of lots in the development pipeline, with little demand, when the mortgage crisis hit, Pittsburgh was already in a bit of a lot shortage. So when most cities saw prices for residential land collapse when this decade began, the opposite was occurring in Pittsburgh. Then a perfect storm of sorts made things worse.

 

Pittsburgh is an old city by U.S. standards, with little flat land available for development. That means the cost of developing lots is higher than other places. Land prices are also higher. The demographics of the stock of developers are typical for Pittsburgh. Developers are older than average. And the makeup of the homebuilders discourages development competition. Any of these factors would be a drag on development. Within the last five to ten years all of these factors combined to choke off new residential projects.

 

“Land prices are just outrageous if you’re looking at the desirable areas in the North Hills or along the I-79 corridor,” notes Mark Bozzone, owner of Bayberry Development. “A good deal of the money you make in land development is made on the price of the land. If you don’t make a good deal going in, the returns are much lower but the risk is still high.”

 

Land prices are a function of supply and demand, just like everything else. The maturity of the Pittsburgh market means that the supply of land in desirable locations is smaller. With the steeper topography of the remaining land, developers have to consider the higher cost of preparing the lots and extending utilities as part of that cost equation. Part of that perfect storm, however, is that demand from outside residential development is also impacting land prices. As developers might have been looking to acquire land to boost the lot inventory in 2009 or 2010, their biggest competition for properties was gas companies rather than other developers. This heightened competition pushed prices beyond what could be economically feasible for new home construction, even though the gas industry was only leasing a limited number of acres. The psychological impact on the sellers was almost universal.

 

“It only takes one sale and every other land owner thinks that’s their number too,” says Bozzone.

 

“The availability of all land is a problem,” echoes Bill Weaver, CEO of Weaver Homes. The Mars-based builder is also a developer of residential communities. One of the partners in Treesdale in the 1990s, Weaver develops a few lots for other builders, focusing on his own Epcot communities like Altmyer Farms and Bellevue Park. As a builder/developer, Weaver Homes has more flexibility with the return on investment, since creating lots also creates opportunity for profits on building houses. That doesn’t mean Weaver is jumping at opportunities that land developers won’t.

 

“Land for sale is very expensive and that’s discouraging people from developing. You just can’t make the numbers work,” he concludes.

 

For developers, the return on investment has to be high enough to justify the risk relative to other opportunities. Bozzone believes that returns from the stock market or commercial real estate have been easier to justify during the recovery. Given the time needed to develop and build out a typical housing community in Western PA, a project has to deliver returns of 25 to 40 percent. Those kinds of numbers just aren’t there for multi-builder custom communities right now, at least not without the kind of density or price point that isn’t feasible in Pittsburgh at the moment. That’s a big reason younger developers aren’t entering the market.

 

“If you talk to those [older] developers, what they were getting for their investment and the risk they took back then was way more,” asserts Mark Heinauer, president of Barrington Homes. “Now they can sit on their couch and make other investments that don’t have the risk or involve the work that development takes. Younger people don’t have the capital and financing is harder today.”

 

Economic feasibility is where the makeup of the builder stock in Pittsburgh comes into play. Until the Great Recession, the majority of the homes were built by custom builders that completed fifteen homes or fewer each year. Ron Croushore estimates that his firm sold houses for more than 100 custom builders at one time. Pittsburgh had only three or four builders that would build 50 homes or more per year and realistically only two or three true production-style builders. The size of the market discouraged the large national builders, which typically like to have potential for 1,000 homes, to enter the market. The fact that Ryan Homes, Maronda Homes and Heartland Homes were all based in Pittsburgh probably accounted for why those volume builders remained in Pittsburgh. Since the downturn ended, far fewer custom builders remain active in the market and the share of new construction delivered by the top three builders has jumped to 60 percent or more.

 

The dramatic shift in market share is another factor for developers – and lenders – to consider. If overall returns are lower because of higher costs, the risk of development can be managed by shortening the time of the investment. A 75-lot project developed for five custom builders may take five or six years to be absorbed. NVR or Maronda or Dan Ryan Builders may take those same lots down in two years or less. That dynamic is an incentive for developers, particularly those with aging ownership, to steer projects to those faster-selling builders, which are more attractive to lenders as well.

 

 

On the other side of the coin, these unusual market dynamics create an opportunity for builder/developers like Weaver Homes. Builder/developers can respond to smaller opportunities and are more self-reliant for absorption. In recent years, it’s been companies like this that have crept higher on the list of top builders in Pittsburgh. Among those builder/developers are Costa Custom Homebuilders, RWS Schuster Homes, Barrington Homes and newcomers, Charter Homes.

 

Rob Bowman, Charter Homes’ president, sees opportunity in the landscape in Pittsburgh as a builder/developer. The Lancaster-based builder doesn’t underestimate the challenges.

 

“If you’re in the development business and you survived the last fifteen years you have a new appreciation for what risk is,” Bowman chuckles. “If your frame of reference is pre-crash, I don’t think it’s ever going to be that easy again. It’s a tough business and it takes a lot of expertise; it’s a challenging financing environment; there’s nothing easy about the business. We gave up a long time ago thinking it would be the way it was. You can’t look back to go forward.”

 

“Once that frame of reference changes, I think there are interesting opportunities from two perspectives,” Bowman continues. “One is understanding where the land is and where you need to be in the marketplace is incredibly valuable. And if you do have the skill set and the resources to develop, it’s a good time to be able to do that.”

 

Barrington’s Heinauer sees development as a creative solution to the Pittsburgh market conditions that don’t favor custom builders. He notes that custom building in the U.S. has fallen from more than 40 percent of the market in 1992 to less than 21 percent today. With his two sons, Heinauer has formed MGD Capital and is looking at six projects in various stages of development. While MGD will develop for other builders – including Ryan Homes – its first project to get into construction is Woodland Trace, a 46-lot custom home community in Adams Township off Mars-Evans City Road.

 

“We’re developing for ourselves. One of the reasons I may be more comfortable doing it in the custom market is that I build the most homes in the custom market,” Heinauer observes. “I can draw down enough lots each year to build it out in five years and build in other communities too.”

 

With the formation of MGD Capital, Barrington Homes is able to broaden its services for its customers. As a developer, designer and builder, Barrington has more control over the entire process and the total cost of each home. Rob Bowman also believes understanding and controlling all the costs associated with development is the key to managing the opportunities for return on investment.

 

“It takes the same amount of effort to develop 20 lots as 200,” he says. “What you have to do is assess the return, not just dollars and cents but the time put into it. To do a 20-lot neighborhood it has to be a pretty amazing location to produce an extraordinary return.”

 

Charter saw Sewickley as such a location for its 53-unit Edgewood neighborhood and sees similar opportunities at its planned 58-lot Calvert Hill community in Moon Township. At the other end of the spectrum, Charter is developing a major community at the former Mayview Hospital site in South Fayette Township. The community, called Hastings, has 572 dwelling units and will be built around approximately 75,000 square feet of commercial development, offering residents access to retail and services within walking distance.

 

Well-managed companies like Weaver, Barrington, Costa and Charter have a clearer path to succeed today in an environment where custom building is in decline but even their success will not replace the 1,000 units of housing that seem to be missing from the new construction market in Pittsburgh. Data about both new construction and existing homes validates that the new construction market is constrained by supply problems rather than demand. The demand side of the equation is about to get bigger, if recent data becomes a trend.

Enter the Millennials (And Their Parents)

The problem with the supply/demand imbalance in Pittsburgh is that it could lead to an extended period of hyper-appreciation for housing prices that would erode one of the region’s biggest competitive advantages: affordable housing. For certain, prices would have to grow astronomically fast to become uncompetitive with San Francisco, New York, or Washington, DC. But even without posing a talent attraction threat, rising prices exacerbate a problem that already exists: it costs too much to build lower-priced housing.

 

All of the development challenges described above add costs to building a house before the foundation is poured. It’s pretty simple math. If the costs to buy and develop land come to $120,000 per lot, and the cost of construction is $125 per square foot for bare bones construction, it means that a 2,000 square foot home is going to run about $400,000 before the builder adds any profit. As homes get larger, the portion of the price that is the development cost gets smaller, meaning that the builder can be more profitable as homes get larger. That puts a lot of pressure on any development of homes that are in the sweet spot for first-time buyers and empty-nesters, which are the two largest groups of buyers.

 

“What we need are homes in the $300,000 to $350,000 range, which are hard to build in this market,” notes Hoddy Hanna.

 

Hanna’s concerns get to the heart of the demographic cause of the supply problem. Pittsburgh’s population is aging faster than all but a few cities in the U.S. At the same time, the median age of a Pittsburgh resident has plummeted to 32 years old. Because of that, the median age of an Allegheny County resident is declining too, falling while the median U.S. age is climbing. In other words, Pittsburgh’s population is growing younger than most cities too. This phenomenon was recently recognized by Forbes, which ranked Pittsburgh among the best places for young adults to live. The squeeze in the lower range of housing prices is impacted by both of these trends.

 

“The cost makes it hard for developers and builders to build cost-effectively. It’s hard to make new construction affordable for first-time buyers,” says Croushore, noting that Pittsburgh’s demographic make-up offers a solution. “We’re always hearing about Pittsburgh being older than anyplace but Dade County, Florida. Guess what? The houses those old people own will be the first-time buyers’ homes.”

 

“There’s very little product in that right-size house. That buyer usually wants new construction but there is relatively little of that product in the market,” explains Hanna. “We’ve seen the number of buyers under the age of 35 increase dramatically. Since the first of the year, 43 percent of our sales were first-time buyers. All of last year they were 29.5 percent.”

 

That trend is playing out in cities around the U.S. Adults between the ages of 20 and 35, the so-called Millennial generation, are the largest demographic cohort ever born. The leading edge of that younger generation came of age as the financial crisis roiled the economy and dominated the headlines. Many of these young adults watched the stress of that crisis first-hand. They saw family and friends lose homes. They found employment harder to secure after graduation. These conditions gave Millennials a sense of insecurity about home ownership that previous generations didn’t experience. Instead of seeing a home as their best investment, more Millennials saw it as their biggest risk. As it turns out, time changes those emotions.

 

As Millennial generation renters mature and come to understand their personal finances, there is a growing realization that the resources devoted to rent would better serve them as equity. Thirty-something Millennials are having babies now at a pace their parents did, meaning that the allures of a responsibility-free life don’t make sense for a nuclear family’s lifestyle. With interest rates still very low, Millennials are converting rent checks into mortgage payments with increasing frequency.

 

Consider the changes to American lifestyle that have occurred because of the demands of the Baby Boomers. For better or worse (and there has been plenty of worse), Boomers changed the way America sold everything. The American housing market was one of the areas that Boomers had their biggest impact. The number of second homes quintupled because Boomers demanded it and could pay for it. McMansions boomed. The size of the average home grew by 50 percent during the adulthood of the Baby Boomers. Now remember that the Millennials have even greater buying power.

 

For Pittsburgh’s housing market, the combination of a booming population under the age of 35 and growing Millennial home buying demand is a recipe for supply issues to become a supply crisis. If the trend continues, expect there to be opportunities for a housing boom of sorts in places like Bellevue, McKees Rocks or Sharpsburg. Expect also that communities with great school districts will see big increases in prices.

 

Therein lies the problem. Pittsburgh has shed its smoky steel town image and has become an attractive place to live and work for people all over the world. Part of that attraction is the affordability of its housing. Will its popularity ultimately ruin its affordability?

 

If all this sounds like doom-and-gloom, there is a certain amount of that bad news in the Pittsburgh housing market. There are definitely some structural problems that have to be fixed or to which the market must adjust. Here’s the good news: these are growth problems. Compare the Pittsburgh market to that of, say, Las Vegas in 2009, when there were ten homes on the market for every buyer looking. Home prices fell by as much as 70 percent. Perhaps first-time buyers will have to borrow more or for longer than they want or maybe an empty-nester will have to have a small mortgage or put more of their savings into their home as an investment. In both cases, the risk of experiencing the loss of value in a supply-constrained environment is almost nonexistent.

 

“Pittsburgh is steady. When the market went south in other markets, houses in Pittsburgh held their value,” reminds Croushore. “We weren’t selling houses that were under water. People have equity in their houses here.”

 

“Pittsburgh is steady. When the market went south in other markets, houses in Pittsburgh held their value,” reminds Croushore. “We weren’t selling houses that were under water. People have equity in their houses here.”

 

Should prices in Pittsburgh reach an affordability crisis level, the market will take corrective action that will establish a new equilibrium. Demand will have to increase quite a bit first, meaning that there will be an influx of people (and jobs) driving that demand. That’s good for the economy. Rising prices will make developing more lots more lucrative. More lots will relieve the pressure and stabilize prices.

 

The supply problem in Pittsburgh’s housing market is real. Perhaps some level of outside intervention – like a patient land development loan fund or subsidized urban affordable housing – will accelerate a solution to the problem. In the final analysis, however, it’s not the worst thing in the world to live in a city where the housing isn’t cheap. mg