Are homebuilders producing enough homes?
Homebuilders produce the proper number of homes to match measurable demand.
Homebuilders only build houses if they can sell them. If homebuilders produce too many, they accumulate standing inventory, which they have to discount or incentivize in order to sell. If the problem persists, they lose money on the sales, and unless they want to go out of business, they stop building more homes. Homebuilders always produce the proper amount of houses to meet demand at any point in time.
However, demand derives from dollars. People’s desires or needs for housing doesn’t always equate to demand. Unless the people who want a home can produce the money necessary to obtain it, their desire creates no measurable demand.
During the housing bubble, demand was artificially boosted when lenders abandoned lending standards and allowed anyone with desire to create measurable demand. The gap between those who merely want and those who can actually afford to buy was eliminated, and as a result, homebuilders produced a great many homes.
Unfortunately, the demand of the housing bubble was not sustainable, and the gap between desire and demand grew significantly. Real measurable demand collapsed, and many of the houses produced during the mania were foreclosed and resold, so demand for new housing collapsed and slowly recovered.
The National Association of realtors recently completed a study claiming builders did not produce enough homes over the last few years. However, Pete Saunders, a Forbes contributor, disagrees. Despite their conflicting claims, they are both right.
Homebuilders did not produce enough homes to meet the needs caused by population growth, so the NAr is right, but homebuilders produced plenty of homes to meet the actual demand for what they could sell, so Pete Saunders is also right. The problem is that real, measurable demand concentrates in areas like the Bay Area of California where homebuilding is forbidden — at least in quantities that would match demand. If demand were not so concentrated, or if supply were not so constrained, homebuilders would produce more houses, and everyone would be satisfied.
While the homeownership rate tumbled in the wake of the great recession and millions of owners shifted to rentership, the total population and number of families continued to expand along with the need to house them.
Need and measurable demand are not synonymous.
Construction has been limited and focused on the upper-end of the market. Without an expansion of the total stock of homes, prices and rents will continue to rise at the expense of affordability.
In normal times the supply of homes for sale is driven by two sources: new construction and existing homes brought to the market for sale. In the aftermath of the great recession foreclosures and short sales emerged as an important channel for inventory but have receded. Negative equity and student debt now keep some owners from bringing existing stock to the market, but limited inventory also acts as a disincentive for some would-be sellers. As the market normalizes, the emphasis on traditional channels of inventory, new construction in particular, has grown.
The relationship between employment and construction can provide insights to the extent of the shortage. Historically, there is a strong relationship between new construction and the number of newly employed workers. From 1990 to 2002 the US averaged 1.2 for total permits (single family and multi-family), or 1 permit for every 1.2 new workers. For single family permits this employment-to-permits (EP) ratio was 1.6. Both of these ratios have been above their historic averages since 2012 and peaked in 2014. The total EP ratio fell from a high of 2.3 in 2014 to 2.0 in 2015 as strong single family permits growth outpaced steady improvements in new employment. The single-family EP ratio improved as well, from 3.7 to 3.4, but remains further from its long-term average.
This statistic demonstrates that the economy created many new jobs, but homebuilders did not respond by building as many homes as they ordinarily would in response to the new job growth. The remainder of the study examines the implications of the shortage. However, does this statistic alone really establish that homebuilders haven’t kept pace with real demand?
Pete Saunders, SEP 30, 2016
There are four reasons I can think of for why this represents some faulty logic on the part of NAR:
- New jobs simply aren’t providing the income necessary for home buying. One of the constant and consistent themes of the presidential campaign has been the slow growth of wages and its impact on the economy.
- Debt, particularly student debt, may play a significant role in delaying home purchases by younger potential buyers. Many young adults are leaving college with student debt that is equivalent to — or even more — than a mortgage, and are electing to pare down debt before making any future home buying decisions.
- Perhaps the 1.6 employment-to-permits ratio that NAR touts was an unsustainable historical anomaly. It’s likely no coincidence that the 1990-2002 period that NAR cites as the basis of the study is also one of the periods of greatest single-family home construction over the last 60-70 years, and provides an inflated sense of housing demand.
The 1990-2002 period was not the single greatest single-family home construction over the last 60-70 years. The housing mania years from 2002-2006 were much stronger. If the NAr would have used those years, their analysis would be suspect, but the period they chose is adequate to the task.
- Despite what NAR says, perhaps we still haven’t worked our way completely through the glut of housing produced in this nation, at least at the metro level.
This is true because far too many homes were produced in areas where people don’t want to live. For example, the Coachella Valley in Southern California is getting its first new subdivision in nearly a decade, while Irvine built several thousand new apartments and single-family homes over the last few years.
Yes, housing production hasn’t kept up with historical job growth levels. But it could be argued that, except in the hottest housing markets, it has kept pace in what’s an entirely new normal post-Great Recession.
This is a simple truth: homebuilding has kept up to the amount of measurable demand in every area where supply constraints allow. Only in a few coastal markets, mostly in California, does demand exceed supply, and this is alleviated by people substituting to other supply alternatives or other nearby locations.