Monday, December 8, 2008

When Will Housing Construction Resume?

Housing construction will resume when housing prices are anticipated to be at or above construction cost for the duration of time it takes to build a house.

OK, when will housing prices be anticipated to be at or above construction cost for the duration of time it takes to build a house? That will occur when the demand for housing is expected to exceed the current stock of housing. The U.S. stock of housing, measured in year 2000 prices, was $12.9 trillion at the beginning of this year. If demand continued to follow the trend of the 1990s (a period without a housing boom), the demand for housing at year 2000 prices would have been $12.6 trillion at the beginning of this year. In other words, we need a sustained demand increase of 3 percent in order for the houses we have to be worth construction cost.

During the 1990s, demand increased an average of 0.2% per month (2.4% per year). At that pace, demand would reach $12.9 trillion (today's housing stock) by April 2009. Below is a chart showing actual housing and 1990s trend housing. Notice from the chart that the trend exceeds this year's actual value before the beginning of 2010.



If demand returned to the 1990s trend, there a couple of reasons why housing construction could resume sooner than April 2009. First, some of the housing built during the 2000s boom may have been built in the wrong places, so the current housing stock is over-valued at year 2000 prices. Second, although in hindsight we can say that housing demand that was high enough to sustain boom time prices never materialized, housing demand might still have increased beyond the 1990s trend (that is, the housing boom was exaggerated but based on something real, wasn't it?). Third, houses are depreciating for the usual reasons, plus some additional neglect due to the foreclosure process.

Of course, we are in a recession and a financial crisis now, which may reduced demand below the 1990s trend. Also, the actual stock has not been frozen at $12.9 trillion because a bit of building has occured this year. I expect the size of this demand reduction and the contribution of year 2008 construction to be small, and therefore expect to see housing construction resume next summer, if not earlier.

EPILOGUE: WHEN WILL HOUSING PRICES RETURN TO BOOM LEVELS?
Boomtime housing prices were much above construction cost, and therefore much above where I expect them to be next summer. It will take either general inflation or another housing boom for housing prices to return to boom levels. I and some other economists have recommended some inflation, but if that recommendation is not followed and inflation rates continue in the 2-5%/year range, it will take a number of years for housing prices to return to what they were in 2005 or 2006.

5 comments:

Tino said...

I wonder if the unexpectedly strong defeat of the 2007 McCain-Kennedy Amnesty for illegal immigrants was part of the real shock to future housing demand.
The housing bubble happened largely in states with lots of illegal immigrants in general and Hispanics in particular, such as California, Florida, Nevada, Arizona. From my calculations using HMDA data 2004-2007 about 26% of aggregate subprime loans were taken by Hispanics, not a trivial amount.

Another possible real shock was the hike in the price of oil. To the extent that these houses were built in the suburbs and exurbs and commuting costs go up demand should go down.

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