Home Prices Aren't Going Anywhere Until Hiring Improves

• Just 357,000 households were formed last year, a 60-year low.

• Household formation by those younger than 35 is down 600,000 since 2007.

• 180,000 new jobs per month would create 1.6 million new households by early 2012.

Washington has thrown billions at the housing slump over the past two years in an effort to support demand, keep people in their homes, and limit foreclosures.

However, the simple truth is that any meaningful recovery in housing must come through the labour markets. Stronger job growth will boost home demand, reducing inventories.

It will prevent defaults, thus limiting additions to inventory, and it will strengthen credit quality, facilitating lending. No mix of ad hoc housing policies can accomplish all that.

Improving job markets and income growth toward the end of last year are already having a positive impact on home demand, but the recovery has a long way to go. Sales of existing homes in December posted their fifth gain in the last six months, jumping 12.3 per cent from November, the National Association of Realtors said last week, but demand is still 2.9 per cent below December 2009. “The recovery will likely continue as job growth gains momentum and rising rents encourage more renters into ownership while exceptional affordability conditions remain,” said NAR chief economist Lawrence Yun.

The crucial role of the labour markets is most visible in the stunning decline during the recession in household formations. Last year only 357,000 new households were started, a record low going back more than 60 years. That pace is down sharply from 1.6 million in 2007 and from an average of 1.3 million per year from 2002 to 2007. The latest Census data put the total number of households at 117.5 million. If household formation had continued on its trend over the past two decades, the total last year would have been about 3.5 million more.


Photo: The Fiscal TImes

In the long run, the growth of new households mainly reflects population growth and demographics, but in the short run household formation is particularly sensitive to job-market and general economic conditions. The plunge in the willingness and ability of people to start a household, especially among college students, young graduates, and new immigrants, has been a heavy blow to home demand. It has also been a major deterrent to reducing the glut of home inventory, despite the nosedive in housing starts to record lows.

Poor economic conditions, including a 9.4 per cent unemployment rate, affected many of the basic supports under the growth of new households. Census data show that rates of immigration, marriage, and divorce, which are key drivers of household formation, have each dropped far below their trends of recent years. Population growth has slowed, but household formation has slowed much more, suggesting a new “doubling up” phenomenon, especially among younger adults choosing to share apartments and homes or to live with their parents. Over the past three years, Census numbers show that new households increased by 1.5 million, but the number headed by people aged 34 and under shrank by 600,000.

The sharp drop in household formation explains why the collapse in home construction has done little to reduce the supply of unsold homes. Housing starts, which stood at a 529,000 annual rate in December, fell to less than 600,000 units in both 2009 and 2010, from a peak of more than 2 million in 2005. About 250,000 homes need to be replaced each year due to fires, natural disasters, or old age. That replacement rate, plus less than 400,000 new households formed in 2009 and 2010 means that current demand is about sufficient to absorb the new construction, but is too weak to soak up the inventory of vacant or otherwise unsold homes.

The homeowner vacancy rate continued to hover at 2.5 per cent last year, well above the 1.7 to 1.8 per cent economists say is needed to stabilise prices, and the NAR said it would take 8.1 months to sell the December inventory, far above the more normal 4 to 5 months supply. Plus, even more inventory is lurking in the shadows as foreclosures continue to rise and banks put their repossessed properties back on the market.

Clearly, a faster pace of household formation is crucial to restoring the supply and demand balance so important for home prices. At the 2002-2007 trend of 1.3 million new households per year, plus replacement, underlying demand would be about 1.5 million per year. With housing starts below 600,000, one would expect inventories to shrink by about 900,000 homes per year. At those rates, the supply of unsold homes would have been significantly reduced by now.

All is not lost, however, as long as economists are right about faster job growth this year. Analysts at JPMorgan Chase say their models uniformly show that stronger job growth leads to faster growth of new households. Moreover, when the unemployment rate is unusually high, as it is now, it creates pent-up demand among people who would like to have their own home but are forced to double up. The analysts estimate that if payroll gains average 180,000 per month this year, household formation will accelerate sharply, to roughly 1.6 million by early 2012. “If these estimates are anywhere close to right, housing vacancies will recede noticeably over the coming year,” says JPMorgan economist Robert Mellman.

The problem: Even if job growth picks up on schedule, it’s a long way between here and there. One major risk, especially to prices, is the shadow inventory. In addition to the more than 4 million homes now on the market, more than 2 million homes are either in foreclosure, at least 90 days past due, or taken by the lender and not yet listed for sale. Also, credit standards, which are easing generally, remain tight for home loans, and with one in four homeowners underwater on their mortgage, the incentive to default and walk away remains high.

Past policy efforts will continue to nip around the edges of the housing slump, by reducing some of these risks. However, only stronger job markets and the confidence they instill can make people more willing and able to start a new household, which is crucial to restoring the balance between home supply and demand.

This post originally appeared at The Fiscal Times.

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