Homebuilders are not so happy anymore, according to their national trade association. After eight months with a majority of builders feeling positive, the pessimists have started to gain ground. (In addition to the attitude survey shown in the chart, January housing starts fell due to the bad weather.) Does this mean a bust for homebuilding and home prices in 2014?
Not so fast. Let’s look at the fundamentals of supply and demand. Last year, new housing completions totaled less than one million units (counting both single-family and multi-family construction and adding in manufacturing housing).
Our average need for new housing units is . . . what? Looking at population growth, we seem to need about 900,000 new units. That looks at the increase in population divided by the average household size. However, if we instead look at the estimated number of new households, we need almost 1.4 million new housing units. Why the difference? In the recession, adult children moved back in with their parents. So in 2009, we added just 400,000 net new households despite an additional 2.5 million people. (On average we live about 2.5 people per household.) Looking forward, if adult children move out from their parents, and singles with roommates get their own pads, then we need more housing than we’re building. On the other hand, if the adjustment is finished, then we don’t need so many houses.
Notice that I’m ignoring what housing analysts sometimes call “inventory,” which is those houses that are listed for sale. I don’t much care whether the house is formally on the market or not. There is supply, and there is demand. Bank-owned real estate may change the timing of the market’s reaction to supply-demand imbalance. Mortgage lending regulations may change the mix of demand between owned and rented housing. Fundamentally, though, the market is based on the total number of households and the number of housing units available.
Given the improvement in jobs (gradually but certainly improving), more younger people are likely to move out, either from their parents or from roommates. I’m inclined to think we need more like 1.2 million housing units this year and a like amount next year.
Today’s construction pace is too light, and homebuilders should be optimistic. However, this household formation rate is sufficiently flexible that the population-housing construction link does not work in every single year. Further, it makes a lot of difference to homebuilders whether people are buying single family homes or renting apartments, even if it doesn’t matter much to us economists.
Moreover, surveys of attitudes are likely to be much more variable than “hard” data, such as actual sales or construction. So long as the economy does not re-tank, then housing demand should continue to be firm.
As for the mix, rising incomes usually lead to a preference to buy rather than rent, but less the slightly less favorable mortgage lending environment will dampen that effect—but not eliminate it. Thus, I forecast moderate gains in home construction and mild price appreciation in 2014 and 2015.
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