Groping Toward a Housing Recovery

Dennis Norman St LouisLast week I got to hear a presentation by Brendan Lowney of Economic Advisors, aptly titled “Groping Toward a Housing Recovery“, which I think is a perfect way of describing our current housing market, so perfect, I borrowed it for the title of this article. Mr. Lowney began his presentation with a very sobering statement, saying “it’s really hard to overestimate the severity of the downturn that we’re in. This is much worse than anything we saw in the ’70s or the early
’80s, if people remember, and it’s really akin in many ways to the Great Depression, and within the housing sector, it’s a very good analogy.”To back up his opening statement, Lowney referred to charts showing the GDP going back to the 1870 illustrating that the growth trend has been 3 percent and that our economy has always returned to the trend line, even during the Great Depression. He showed our economy is currently 5 percent where it should be and said this implies we need growth faster than 3 percent over the next couple of years before we see a reduction in unemployment and then it will still be at least 5 years before things return to normal. I want to focus on the housing market so I’m not going to go deeper on his comments about the overall economy.

Jobs and household formation critical for housing:

Lowney said reducing unemployment is critical for the housing market and that another critical factor for a housing recovery is household formation, which increases when people are employed and feel comfortable about their job situation. As jobs and housing formation increases, that will increase demand for housing and help absorb, as Lowney refers to it, the housing overhang. He explains that the housing overhang thwarts new home sales, because it’s hard for a new home builder to compete with the houses on the market, particularly those homes which are distressed sales. Lowney says that the current overhang is mostly a function of under demand rather than over supply.

Housing under demand vs over supply:

Lowney then took a stab at computing the amount of oversupply in the housing market, starting by explaining that a typical inventory of homes for sale is about 1.9 million single family homes and, based upon May’s data, there are currently about 3.2 million homes for sale, or about 1.6 million excess homes (the overhang). Lowney was quick to point out that there was more to consider when it came to computing the “overhang” and that this calculation didn’t take into account what many refer to as “shadow inventory”. He then used census data on the vacancy rate of housing units to show that the current vacancy rate is about 14.5 percent, up from a typical rate of 12.5 percent, which when factored in results in an excess supply of about 2.4 – 2.5 million housing units.

Florida alone has 20 percent of the excess supply:

Lowney’s data showed that a whopping amount (almost 20 percent) of the excess housing supply is in Florida alone, estimating 500,000 excess units in that state.

A bright future for new home sales- but be patient:

The good news is, it sounds like we have some good years ahead for new home construction and sales, the bad news is it’s probably not going to start until 2014 or 2015 according to Lowney. Mr. Lowney went through a very thorough, and well supported, explanation of what has happened historically with population growth, household formation and new home construction in the U.S. and how all this ties together. It was really quite fascinating and I learned a lot. In fact, in light of some of what I’ve learned you will see in the future my comments on new home starts compared to new home sales will change somewhat. But for now, let me give a quick recap of his points:

  • US population growth has averaged about 2.8 million people for the past 5 years
  • Normal household formation has been about 1.3 million new households in the US per year
    • The past two years have seen only 400,000 new households formed each year though- this is a result of people “doubling-up”, young adults not moving out of their parents homes and, to some extent, immigrants heading back to Mexico.
    • It is projected there will be only 600,000 new households formed this year
  • Typically there needs to be 2 new home starts for every one new home sold – this is due to the fact that some homes are not completed, many new homes are built for owners and never go on the market, as well as other issues.
  • Looking forward, as the economy gets better we are going to see a rush of newly formed households as a result of the severe downturn of them in the past two years.

Ending on a fairly optimistic note, Lowney said “more likely than not, we are going to get a rapid snap back in housing starts at some point.”

There was a Q&A period that followed…here are some of the better questions:

  • Q- In regard to the Fed’s recent policy to tighten lending standards, what role has this policy played with respect to the ongoing housing market turmoil and how do you expect the Fed’s policy to influence the market going
  • A- Okay, that’s a great question. We think it’s overrated.
  • Q- Buyers may need larger down payments 5%, 10%, even up to 20%- how is this going to affect a housing recovery?
  • A-I’ll point out if the down payment is at 20% or 10% of X, is what you need, and that X has come down—X being the house price… So those have come down in many areas like in Arizona, Florida, Sacramento. House prices have dropped by more than 50%, so to that extent you need less money. And we think there’s a private
    insurance market going to emerge… re-emerge, actually, and that’s going to facilitate many of these loans. But there is no doubt we’re going to need higher lend… Folks are going to need generally higher down payments than they did in the past. Another thing I want to point out is we expect the homeownership share is going to recover only very slowly.
  • Q-Do you see the future trend in housing moving more to multi-family than in the past?
  • A-We do see the multi-family share of housing increasing over the next 15 years or so. We think it’s going to be incremental kind of evolutionary change and it’s primarily going to be driven by demographics, by older folks moving into denser housing units. With respect to wood use, kind of the optimistic point that we would make is that multi-family home sizes are going to increase at a faster rate than single-family home sizes. In fact, single-family home sizes, they’ve actually been increasing recently, although you wouldn’t know that by reading the
    financial press. But the multi folk, a lot of folks are moving into multi-family homes and they want some of the same amenities and characteristics they had in their single-family homes. So they’re getting bigger, and this particularly has implications to the engineered wood segment.

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