Demographics and economic distortions support US housing prices and rents

The Major Challenge of Inadequate US Housing Supply

I came across a research report from Freddie Mac titled, The Major Challenge of Inadequate US Housing Supply, and wanted to pass along some of its findings. I think its analysis effectively illustrates the current issues and dilemmas that are plaguing the residential housing market in the United States. While my analysis will concentrate on the domestic residential market, I believe that these conclusions can apply to many areas around the globe.

Keep in mind that the burgeoning and growing distortions and factors affecting the housing market in the United States are without precedent. Thus, it is naive to simply look at the Case-Shiller indexes and conclude that prices are doomed to fall. My contention with most of the housing market analysis (especially in the alt-financial media) lies with their failure to properly recognize these secular changes and how they are affecting the equilibrium price levels in many areas of the nation. Moreover, many will cherry-pick their data to demonstrate a bearish case. Indeed, I do not see any viable long-term solutions on the horizon, and for most renters and prospective home buyers the case is bearish; for them.

Many prognosticators look to the stock prices of the home builders as well as the new and existing home sales numbers to make claims that show that prices movements will repeat the swoon of last decade.  They make the direct connection between these observations and the prices of our houses. Take a look at some of the numbers from last month’s Freddie Mac’s research.

After nearly a decade of low levels of building, new housing stock is well short of what is needed. This has supported rents and house prices. This trend will not reverse any time soon.

Despite the calls from policy makers on the local, state, and federal levels for more affordable housing, the situation grows more dire each year. The planning, build-out, environmental, and construction costs as well as the local zoning restrictions have permanently driven up the costs of home construction.

Home building costs encompass the cost of land and regulatory costs. Since 2010, the cost of land has averaged about 23 percent of total home building expenses. But in some markets like San Jose, Santa Ana, Oakland, and Los Angeles, land can cost upward of 70 percent of the cost of building a home.

Laws and regulations such as local zoning restrictions on lot sizes and building height and open space designations also increase the cost of building a home, in turn reducing the supply of new homes. Regulatory costs increased 29 percent between 2011 and 2016, the National Association of Home Builders (NAHB) estimates.

The Major Challenge of Inadequate US Housing Supply – Freddie Mac (December 5, 2018)

As home prices continue to escalate, the government responds by subsidizing the mortgage market, which just creates higher demand along every price point.

Moreover, existing homeowners tend not to support expansionary home building projects. The bottom line is that these economic distortions will make it increasingly difficult for demand and supply to find a long-term equilibrium. In a managed economy, supply is restricted and prices are continually moving higher. Thus, home builders find it profitable to restrict supply and only sell higher-priced homes.

370,000 additional new housing units are needed each year
In 2017, the United States added 1.25 million additional housing units (homes, apartments, and manufactured homes). Economists with Freddie Mac estimate that current demand is about 1.62 million housing units per year—370,000 units more than the current rate of supply

Freddie Mac estimates that 1.62 million units are needed annually to meet the housing demand: 1.1 million to accommodate household growth; 300,000 units to replace depreciated existing stock; 100,000 to meet the demand for second homes; and 120,000 units to provide enough vacant homes to maintain an efficient marketplace. While the true level of long-run housing demand is uncertain, even Freddie’s low estimate  of 1.30 million units per year exceeds the current rate of housing construction (1.25 million units in 2017). Although the Freddie Mac report did not display the data for 2018, it is similar to 2017’s numbers. Thus, the gap between supply and demand still persists.

The lack of new supply is causing rents to rise as well.

This graph shows the price/rent ratio (Jan. 2000 = 1.0). On a price/rent basis, the Case-Shiller National index is back to Feb. 2004 levels, and the Composite 20 index is back to Nov. 2003 levels.

Freddie Mac points out the three primary factors that are driving the need for housing construction: growing demand from a growing population; the need to replenish existing stock; and the need for vacant units in a well-functioning market.

As long as these marketplace distortions persist (and I do not see how they can reverse) The majority of the population will continue to be surprised how high home prices and rents climb over the long-term.

Rents nationwide have increased 79% since January 2000. Rents continue to increase and many will be permanently shut out of homeownership.

You and I know that the US Fed and the other central banks will have to embark on unconventional monetary policy programs soon in response to the growing economic problems. I do not see how the housing market will not be affected. If the Fed opens the spigots and works to lower interest rates across all points of the yield curve, house prices will receive support regardless of what happens to the economy; even if most can no longer afford to buy.

Despite the increasing percentage of the population who think house prices will correct soon and that it may be a poor time to buy and a good time to sell, I think many prospective homeowners could be surprised and shut out.

Look on the bright side; If you teach in San Francisco, you can sign up for government housing and massive rent subsidies. Of course, somebody bears the costs of these programs. The people who are the most adversely affected are those who do not qualify for subsidized rent and government housing. They are cast out into the open market to fight for the ever shrinking supply that resulted from the housing stock that was taken off the market and devoted to the subsidized programs.