Make no mistake: Housing is recovering. It’s on an upswing. It’s likely sustainable, and I think it has a long way to run. But if you’re a homeowner, don’t get your hopes up. The recovery probably won’t affect you like you think.
Housing construction is rebounding, and there’s a decent chance it will double in the coming years (more on that in a second). But housing prices are another story altogether.
A little background here. A net average of 1.3 million American households were created every year from 2002 to 2007. During that time, an average of almost 2 million new homes were built annually. That, in a sense, was the housing bubble.
But the trend has been the other way around recently. According to the Census Bureau, 1.1 million new households were formed last year, but housing starts came in at 612,000. In other words, the gap between new households and new homes was nearly as distorted last year as it was during the bubble — just in the opposite direction.
As Stein’s Law reminds us, something that can’t go on forever, won’t. Zillow reports inventories of for-sale homes are down 20% nationwide in the last year. Supply will last five months at current sales rates, the lowest since 2005.
Homebuilders are finally starting to respond. New home construction is now running at an annual rate of 750,000 — up about a quarter from a year ago, and up two-thirds over 2010.
As for continued demand, here’s what Harvard’s Joint Center for Housing Studies predicts (emphasis mine):
Household growth will average about 1.48 million annually in 2010-20. Even if immigration falls to half the Census Bureau’s currently projected rate, household growth will still average about 1.25 million annually. This low-end estimate puts household growth in the next 10 years on par with the pace in 1995-2005, and should support average annual housing completions and manufactured home placements of well over 1.7 million units. The higher-end estimate would likely support production exceeding 1.9 million units per year on average over the coming decade.
Housing construction would need to more than double from current levels to fulfill those projections. And given low levels of supply — even with “shadow” inventory — that pent-up construction boom will probably need to happen sooner than some imagine.
The sway this could have on the overall economy is huge. Housing construction has historically been a major driver of growth. MIT economist William Wheaton estimates that housing starts roughly in line with the Harvard estimates above would add 0.7% to annual GDP growth. By comparison, housing subtracted an average of 0.5% from annual growth over the last five years. This is exactly why Warren Buffett predicts that, “We will come back big time on employment when residential construction comes back. You will be surprised, in my view, how fast employment changes when that happens.”
But there’s a big asterisk here: A rebound in housing construction doesn’t necessarily mean a rebound in housing prices.
Even after the housing bubble’s aftermath is cleared and behind us, home prices may not rise any faster than overall inflation for decades to come.
Because that’s what history tells us they do.
Yale economist Robert Shiller has the most complete set of nationwide housing prices that exists, dating back more than a century. His data show something unmistakable: From 1890 through around 1990, inflation-adjusted home prices were virtually unchanged:
Source: Robert Shiller.
Think about that. A full century where home prices went nowhere after inflation. Even when the country went through big construction booms that propelled economic growth, home prices typically never rose much faster than overall inflation.
To Shiller, this makes perfect sense. He told me in an interview last year:
[Homes are] just a manufactured good, and [construction] progress is always happening [that drives costs down]. On top of that progress, there’s the outmoding, the out-of-style factor. What kind of houses will they be building in 20 years? They may have lots of new amenities. They will be computerized or something in some way that we can’t anticipate now. So people won’t want these old homes.
Shiller once went back to the archives to see when people got this idea that their home should increase in value over time. Searching through newspapers dating from the late 1800s through the 1980s, he found little if any discussion about rising home prices. When the word “boom” was used in conjunction with housing, “it tended to refer to a boom in the construction industry,” he wrote. Making money on a home just wasn’t on people’s minds. “One expected to buy a home as part of normal living and didn’t think to worry about what would happen to the price of homes.” It wasn’t until the last two decades that the idea of homes increasing in value after inflation became mainstream.
Never forget that: The concept of a home as an investment (as opposed to a manufactured good and a place to live) is totally unique to recent times. And as millions have learned the hard way, it’s totally dubious.
Inflation-adjusted nationwide home prices are now back to about the same level they were at 50 years ago. There’s no reason to think the next 50 year will be any better. Or even as kind. “To me,” Shiller says, “the idea that buying a home is such a great idea is just wrong. They may very well decline for the next 30 years in real terms.” It’s happened before, and it could happen again.
So, two big things to think about in housing. Construction will almost certainly rise. That’s great, and it’ll help the economy out a lot. But if you’re counting on a big rise in home prices, take a long, hard look at history. It’s not on your side.
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By Morgan Housel | September 11, 2012