The answer may surprise you, as the decline of new home building may soon neutralize the bubble's overbuilding -- if it hasn't already
You might think the question posed in the headline above sounds crazy. Aren't foreclosures very high and thousands of distressed properties hitting the market each day? Didn't residential construction go bonkers during the housing bubble in an epic overbuilding binge? The answers to these questions are: sort of, but it's complicated. After the bubble popped, home construction fell to historic lows and stayed there. As a result, we may be on the verge a housing shortage in the U.S., which would actually be very good news for the economic recovery.
Construction Boomed, But Not For Multi-Family Homes
The prospect of a coming construction boom has been addressed by a few economics writers this week. Ryan Avent at Free Exchange considers the possibility that we're running into a shortage of housing. Residential construction has been very low for the past few years. Moreover, the rate of household formation has declined due to the tough economy. This happened for two central reasons: more jobless young adults are remaining in their parents' home and some people struggling with unemployment have moved in with relatives or friends. He provides this chart as pretty clear evidence of household formation slowing:
Karl Smith, an economist and guest-blogger here at The Atlantic this week, agrees. He asserts that the housing bubble wasn't so much a boom for all residential construction, but for single-family home construction. If you look at the data for homes completed from the Census Bureau, you can see his point quite clearly:
We'll get to the implications of this a little later. But for now, you can see from this chart that overall home building did, indeed, boom during the bubble. Multi-family home building, however, remained pretty consistent between 250,000 and 300,000 structures per year throughout the bubble and declined in late-2009. Single-family building, on the other hand, grew to a rate of about one million homes per year in the mid-1990s to peak close to the rate of two million per year in early 2006. Then, of course, construction plummeted.
Is There a Shortage?
The question, then, is whether the very low levels of building we've seen sine the bubble popped have begun to neutralize the boom we saw during the bubble. One way to determine this would be to average the number of new homes built over a ten-year period, and see how that stacks up to historical experience. Of course, population growth also matters, since it's the central reason for the need for new housing. Here's what you find if you gather up that data (population below is civilian, non-institutional):
Let's start with the first row. This shows all new residential construction completed, single- and multi-family, over three 10-year periods. The most recent period had 875,000 more homes built then the previous one. But it had 138,000 fewer than the decade before that. If you take population growth into account, then you can see that the past decade was in the middle of the range of new population added per housing unit for the prior two decades. So if there's still some excess capacity in the market, there doesn't appear to be much.
The Rise of Renting
From all of this, we can conclude a few things. First, before long, residential construction will have to rise. Although vacancies are high currently, household formation should experience a boom as the economy adds jobs. With it, those vacancies will decline and new homes will be necessary to accommodate the growing population.
Moreover, both reasons for the decline in the rate of household formation indicate a need for more rentals. Young adults who are finally able to move out of their parents' homes will mostly rent first. They'll have short credit histories, relatively low wages, and little savings for a down payment. That combination that doesn't usually spell mortgage approval when underwriting is strict. And those who are living with relatives or friends because they have been unemployed for an extended period will also likely need to rent at first. They might have experienced financial troubles affecting their credit histories, their new wages will often be lower than what they earned before being laid off, and they may have little savings for a down payment if they needed to rely on that money when unemployed. Additionally, all of those millions of Americans who defaulted on their mortgages will have no choice but to rent for quite a while. Banks certainly won't give them a new mortgage for at least several years.
Now add this into the fact that multi-family construction remained constant during the boom, while single-family construction rose. This could translate into a coming mismatch between the types of housing units available and the specific housing demand that will rise. For the reasons just described, going forward the home ownership rate should fall to and remain at or even below its historical norm, while renting becomes more common. This implies two outcomes. Some single-family homes will need to be converted to rentals and additional multi-family structures need to be built.
A Coming Construction Boom?
So what are the economic implications? It depends on the timing. At this point, home building isn't doing much to help the recovery -- it's very, very anemic. But this analysis implies that it will have to rebound before too long and in a big way. But in order to do so, household formation will have to accelerate. And for that to happen, we'll have to see more job growth.
The big question, of course, is: how long will this take? Even once hiring rises, quite a few home vacancies have to be filled. But if too few of them are rentals and those owning those vacant units (largely banks and investors) won't rent them, then new construction will have to follow sooner. If they can be easily converted to rentals, however, then we might see a construction rebound take a little longer. But if residential construction remains at its current very low rate in the near- to medium-term, once home building does rise again, it may do so quite strongly. When the economy is again running near full strength, we'll probably have a noticeable residential housing shortage on our hands.
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