Bulls are beside themselves about the recent housing recovery in house prices: It’s off to the races again!
This is a happy theory, but the trouble with it that the fundamental problem in the housing market is still getting worse, not better. To wit: In the bubble years, we just built too damn many houses.
This overbuilding has led to record vacancy rates, both in rentals and in rentals plus owner-occupied (not) housing. This situation is not getting better. On the contrary, it is getting worse.
This chart from Calculated Risk tells the story. The red line is vacancies. The blue line is housing starts. Calculated Risk wisely observes that housing starts will not return to normal until we need more houses. And we won’t need more houses until vacancy rates start to drop.
Now, the National Association of Realtors (and others) have made huge noise about the recovery in Existing Home Sales. This recovery is largely due to falling house prices, falling mortgage rates, and the home-buyer tax credit (which pulled demand forward). Importantly, however, just because houses are trading does not mean that they are being filled.
Part of the issue here is that the home-buyer tax credit, et al, have encouraged some renters to buy instead of rent. When they choose to do this, they move into an owner-occupied house but vacate a rental. So the vacancy rate stays the same. The only things that will help the vacancy rate are:
- New household formation
- A surge in second-home buying (any day now)
Calculated Risk also notes the important connection between residential investment and the performance of the economy as a whole. In short, residential investment is a leading indicator. Without a pickup in residential investment–which includes housing starts–it’s hard to envision a strong recovery in the economy. And it’s hard to envision a strong recovery in residential investment until we work off some of this excess housing supply.
Here’s Calculated Risk’s excellent summary of the housing situation and its likely impact on the economy:
After reading some of the commentary regarding the housing starts report this morning, it might be useful to reiterate these three points:
Residential investment is the best leading indicator for the economy.
Residential investment will not recover rapidly because of the large overhang of existing vacant housing units.
Existing home sales are largely irrelevant for the economy...
This morning several commentators suggested that housing starts were depressed in October because of the expiration of the tax credit (new home buyers had to close by Nov 30th to get the tax credit), and also because of the weather. Probably. But the key point is that housing starts will not increase rapidly because of the large overhang of existing vacant housing units (see 2nd graph here). And that suggests that the economy will not recover quickly either.
Another key point is that existing home sales are largely irrelevant for the economy. This is an important point to remember next week when the NAR announces that existing home sales surged to 5.8 million units or so in October (seasonally adjusted annual rate). Some reporters and analysts will jump on the existing home sales report as evidence of a housing recovery. Others will point to it as showing that the first-time home buyer tax credit is helping the economy.
Both points are wrong.
The only contribution from existing home sales to the economy are some commissions and fees. That is good news for real estate agents and mortgage brokers, but not for the overall economy.
The good news is the level of inventory for new and existing homes is declining. The bad news is the inventory of rental units is at record levels – as is the combined inventory of vacant single family homes and rental units. Residential investment will not increase significantly until this overhang is reduced.
The key to reducing the overall inventory is new household formation (encouraging renters to become owners accomplishes nothing in reducing the overall housing inventory). And the key to new household formation is jobs. And usually the best leading indicator for jobs is residential investment. Somewhat of a circular trap.
And that suggests the recovery will be sluggish and unemployment will stay high for some time. More from Calculated Risk:
Quarterly Housing Starts And New Home Sales
Housing Starts Decline Sharply In October
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