Housing May Be So Much Closer to the Bottom Than You Think

Last month, Yale economist and housing expert Robert Shiller told me that we should be prepared for the possibility that home prices could decline in real (inflation-adjusted) terms for several decades. It's happened before, and it will probably happen again.

But there's an important distinction to make here. Housing prices could stay flat or decline, but housing construction increasingly looks like it's not only near a bottom, but ready to snap back. That's important, because housing construction tends to be a big driver of economic growth. From 2003 to 2006, construction accounted for over a quarter of all economic growth. Since 2008, it's dragged economic growth down by over 9%.

A few things to keep in mind: The housing bubble that caused the mess we're in wasn't brought about just by inflated prices, but by a massive overbuild. Because prices were so high and credit so easy to come by, homebuilders had a huge incentive to build as many homes as they could. The result was epic: From 2001 to 2006, 11 million homes were built in the United States, but only 8 million new households were formed.

To compensate for that binge, new home construction utterly fell off a cliff in recent years:

Source: Federal Reserve.

That drop in housing construction is a big part of why the economy has been so slow. It's not just construction jobs that get whacked when housing dries up. Everyone from mortgage brokers to Home Depot staff to furniture salesman suffer as well. And as all those workers get laid off and stop spending money, the pain moves down the economic ladder. It's an ugly cycle.

But there's evidence that it's starting to turn around.

Rental prices on apartments are rising briskly, and rental vacancies have dropped like a rock to the lowest level in over a decade. Apartment rental rates in several metropolitan areas are rising at double-digit rates, and nationwide are expected to rise between 4.5% and 5.5% this year. When I signed a lease on my current home of Seattle in 2009, I felt like I could negotiate nearly anything I wanted. When I renewed a few months ago, I could barely get a word in -- it was "take it or leave it." The rental vacancy rate, which was as high as 8% in 2009, is now just 5.2%, according to housing data firm Reis. Even when the economy was booming, the vacancy rate stood at or near 6%.

As more young households that had been discouraged from owning a home suddenly become even more discouraged from renting an apartment -- and as developers receive the demand to build more apartments -- construction should rise.

And it looks like it already is rising. While 2011 saw the lowest level of housing starts since the Census Bureau began collecting data in the 1950s, the numbers are bouncing back ever so slowly. After bottoming at an annual rate of 480,000 in 2009, housing starts have now rebounded to around 660,000, and are expected to total over 700,000 this year.

The numbers have to eventually rebound -- and sharply. Housing construction is at the lowest level it's been in a half-century, but even that figure doesn't show how depressed the industry is. When you adjust housing starts for population growth, you get a better understanding of how abandoned the industry has become:

Sources: Federal Reserve and author's calculations.

Keep an eye on the y-axis. Since 1959, housing starts divided by U.S. population has averaged around 0.006. Today, it's 0.002. Think of it that way, and it's not a stretch to think that housing construction could eventually rebound threefold, maybe more.

The question is: When? And while it's impossible to predict this stuff with any precision (if at all), I have a feeling we're closer to the bottom than some assume. Between housing starts being unsustainably low, low vacancies pointing to pressure in the rental market, and housing numbers already starting to perk up, it looks like the tide has turned.

Several things could pull the market back into decline. There's still a large number of homes waiting to be sold either by banks holding foreclosed properties or by homeowners waiting for a better price to sell. If this number -- called shadow inventory -- is larger than we expect, the market could face another leg down. And if unemployment rises or the economy slips back into recession, that too could send the industry back down.

But I think the most likely outcome is that housing will make a noticeable turn within the next year or two. That could be great for the economy, and great for companies like KB Home (NYSE: KBH  ) , MDC Holdings (NYSE: MDC  ) , and Meritage Homes (NYSE: MTH  ) -- all three of which I've given a green thumbs-up to in my CAPS account.

Disagree? Tell me why in the comments section below.

Fool contributor Morgan Housel doesn't own shares in any of the companies mentioned in this article. Follow him on Twitter @TMFHousel. Motley Fool newsletter services have recommended buying shares of Meritage Homes. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (12) | Recommend This Article (27)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On January 23, 2012, at 3:54 PM, ETFsRule wrote:

    I think we've hit the bottom already. Housing vacancies are down to pre-2006 levels. Hopefully they will keep dropping a little more, to around 2%.

    The home ownership rate has already dropped to pre-1998 levels, and seems to be levelling off around 66%.

    http://www.census.gov/hhes/www/housing/hvs/qtr311/files/q311...

  • Report this Comment On January 23, 2012, at 4:30 PM, snipe15 wrote:

    Maybe I'm missing something, but during the "boom", we only barely crossed the average of 0.006 housing starts/population. Compared to the catastrophic effects that had on our economy now, the mid 70s effects of double the housing starts look tame. I guess this was the credit freeze? Trying to wrap my head around this one.

  • Report this Comment On January 23, 2012, at 4:59 PM, sailrmac wrote:

    You're assuming that becasue .06 was an average over a certain time period that we would eventually revert to that mean. This could be true or possibly it's not.

    It is also possible that the number people per household (boomerang kids, kids leaving the nest later, multi-generation households) has not only gone up but will stay that way. It is also possible that the % of people who choose to rent has not only gone up but will stay that way (baby boomers renting apartment in cities, 20 something's waiting to become 30 somethings before they buy, families having kids later, etc.).

    Graphically your .06 average horizontal line could just as easily be seen as a downward slopping one.

  • Report this Comment On January 23, 2012, at 6:41 PM, Hawmps wrote:

    Perhaps the housing market is not over-built, but rather under-demolished?

  • Report this Comment On January 23, 2012, at 9:29 PM, subrot0 wrote:

    Housing or whatever markets that are being analyzed will have to wait until the elections. Just about every major market will wait to see who comes into power.

  • Report this Comment On January 23, 2012, at 10:10 PM, TurbulentTime wrote:

    If I am not wrong, houses on the market (including new homes and homes for resales) are in the millions. I remember reading somewhere in some .gov website, the new home sales in 2010 was around 315,000 homes. And all homes sales were well below 500,000 in that same year. If we take that and multiply by 5 years, we arrive at 2.5 millions home will be sold (plus or minus) in the next 5 years, and we have millions of home out there for sale, and said to have millions more from the remainder list of bank repossessed homes. Am I missing something here? Would love to have someone point me to the right direction.

  • Report this Comment On January 23, 2012, at 10:17 PM, jaykay767 wrote:

    Disagree - Sorry have to respectfully disagree here.

    In this crisis, there was/is a fundamental change that has occured. the concept of dream house or any house for that matter has disappeared. so most of them are sharing rentals or on rentals & they will NOT return to individual houses even if the economy improves. People have realised the value of Cash & they will hold on to it for the rest of their lives instead of buying expensive houses on mortgages. so a few rich folks will buy many of the houses & rent them as they have always done. the middle class/poor will never buy them in this life time. so housing sector will languish for the next 2 decades. People should sell the houses on rallies & move into rentals.

    Go for a rental that is less than 10% of your monthly salary, living expenses of max 20% salary, 40% into treasury bonds, rest 20% into gold/silver (buy on a monthly basis & average your investments), 10% into stocks assuming a salary level of 36000 per year post taxes !!. your treasury bonds will be the emergency fund etc.. In 5 yrs, you will be financially independant !!.

  • Report this Comment On January 23, 2012, at 11:05 PM, srvfan100 wrote:

    Rent for less than 10% of income? On what planet?

    As a landlord I can tell you that none of my tenants would come in at that,maybe a couple at 20% more like 30%+. There Is no place they can move for 10 or less around here.

    Housing won't move until after the election and can't move much without the return of higher paying jobs,and who knows when that will happen.

    The real trick will be keeping the mortgage rates rock bottom low or house prices won't move at all.

    Problem is thats how they slow inflation, raising rates.

    Raise rates to say 7-8 to control inflation over the next couple years and that will keep prices down.

  • Report this Comment On January 23, 2012, at 11:06 PM, moneyman35 wrote:

    Close to the bottom or far from the bottom. Does it really matter if its not going to go up???

  • Report this Comment On January 24, 2012, at 12:23 AM, MichaelDSimms wrote:

    Prices have stopped falling it seems. But a real housing recovery won't happen until job hiring increases. We have at least another year or 2 or 3 to go, I would imagine. Decades is a bit of an overstatement.

  • Report this Comment On January 24, 2012, at 4:20 AM, saunafool wrote:

    I think the point of the article is not that housing construction needs to revert to a mean of 0006 or that it even will in the next few months.

    Rather, the point is that construction is at a historic low, has been there for a long time, and there only needs to be a small uptick to generate a significant recovery.

    Think about it this way. If housing "recovers" to a rate of 0.003, that is a 50% increase in activity. That creates probably hundreds of thousands of jobs and more economic activity.

    Second, rents are higher and housing prices have fallen substantially from the bubble top. Can they continue to decline? Yes, but at this point with interest rates at record lows, the rent vs. buy math looks much more favorable for housing.

    And people will continue to buy houses. When couples start having kids, they will want a yard and good schools and all the other stereotypical crap. I never wanted any of it until I had a 2-year-old bouncing off the walls of our apartment.

    Finally, when housing appears to have bottomed and is no longer "taboo" the purchase rate will rise significantly, and the huge inventory of houses on the markets will be soaked up in a reasonable amount of time. Again, it doesn't need to happen overnight. The months of unsold supply trend just needs to start heading downward and eventually it becomes a self-feeding cycle as optimism returns.

    I'm going to CAPS and giving all the homebuilders green thumbs right now.

  • Report this Comment On January 24, 2012, at 7:57 AM, tancred77 wrote:

    Dunno if anyone else has particularly noticed, but top and bottom channels for the housing starts/population trend shown above are plainly in very a steady, long-term decline.

    My guess is this reflects the demographics of boomers passing through their economic life cycle, which is now entering the retirement phase, less income, and therefore reduced housing requirements. Another long-term surge in housing construction may develop, but it doesn't look like new highs are remotely likely, best case.

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