Housing Is Rebounding -- Just Not the Way You Think

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.

Why?

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.

Check back every Tuesday and Friday for Morgan Housel's columns on finance and economics.

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


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  • Report this Comment On September 11, 2012, at 1:08 PM, Darwood11 wrote:

    "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."

    Amen, brother!

    We live in interesting times, and in the aftermath of one of the most ridiculous periods in recent history. I wish I had written a book called "Homes $3,000,000" back in the "good old days" prior to 2006. A lot of people would have bought it.

    I do think that many people are missing the opportunity of a lifetime. The pendulum sometimes swings to extremes, and so it is today. Considering the short term memory of Americans, it's possible there will be another boom in a decade or so. "How quickly we forget,"

    Yes, housing is, unlike the stock market, a longer term phenomenon. Perhaps in this age of instant gratification, that is why it is in such disfavor.

    That, to me is a "green flag" as an investor. When so many are interested in "instant and immediate gratification" that provides so many opportunities for us tortoises.

    As an example, a 2-bedroom condo nearby was recently sold in an auction for about $69,000. It will rent for about $1,400 a month. This is an amazing price.

    As occurred in the 1970s when New York City was teetering on the verge of bankruptcy, I suspect that there will be a lot of fortunes made today, as occurred in the stock market in the period 2008-2009.

    My personal opinion is that the current situation is wonderful. First, it provides housing to those who need it for affordable prices. Financing is another matter, but as someone who 15 years ago lived in a $700 a month heated apartment so I could save for a home, I don't have much sympathy for the "instant reward" generations. Secondly, I am delighted that the speculators have moved on to other environs. Homes should never have become a bubble, and if it weren't for flawed government policies, incredible greed and avarice, it never would have been.

    Thank God for the reset!

  • Report this Comment On September 11, 2012, at 5:08 PM, hbofbyu wrote:

    I'm not sure there is any fool-proof way to prevent a bubble. I found this entertaining: http://www.businessinsider.com/most-ridiculous-bubbles-ever-...

  • Report this Comment On September 11, 2012, at 5:21 PM, RenegadeIAm wrote:

    This is what happens when government gets involved in pushing "affordable" housing to people who can't afford it.

    If it weren't for gov't sponsored Fannie and Freddie backing these worthless notes, NOBODY would have picked them up, and the taxpayer wouldn't be on the hook for paying it off.

    But government interference (guarantees) made them a sound investment.

    All of this so some people could get votes by promising that others could have "affordable" housing.

    Meanwhile EVERYONE suffers because the politicians decided they had to "do something" to get votes.

  • Report this Comment On September 11, 2012, at 5:22 PM, TMFMorgan wrote:

    <<If it weren't for gov't sponsored Fannie and Freddie backing these worthless notes, NOBODY would have picked them up, and the taxpayer wouldn't be on the hook for paying it off.>>

    If by "nobody" you mean the $1 trillion+ of subprime and mid-prime mortgages bought by the private securitization market, I fully agree.

  • Report this Comment On September 11, 2012, at 5:52 PM, xetn wrote:
  • Report this Comment On September 11, 2012, at 5:53 PM, Wade32ru wrote:

    Thanks Morgan. What's the total number of "shadow inventory", how much is being released per year, and how might that impact the 1.1MM household formations versus 612M housing starts? BTW - is the 1.1MM a NET figure - taking into account seniors that expire or move into care facilities?

  • Report this Comment On September 11, 2012, at 6:00 PM, TMFMorgan wrote:

    Wade,

    It's hard to say because, by definition, no one really knows what shadow inventory is. Here's a good summary of one calculation showing it recently fell to the lowest level in 4 years:

    http://www.calculatedriskblog.com/2012/06/corelogic-existing...

    As for new households, yes, that's net creations. I calculated it by the year-over-year change in total households, which is reported by the Census.

    Thanks for reading,

    Morgan

  • Report this Comment On September 11, 2012, at 6:03 PM, HalfWolf wrote:

    Ah but one man's greed & slippery words can often fog up another man's common sense

  • Report this Comment On September 11, 2012, at 8:59 PM, randallwaechter wrote:

    Have to disagree. Housing is a great investment - when done prudently - because of leverage. I can take $20,000 and buy a $100,000 property with a 30-year mortgage at 3.7% right now. Presuming the rental rate covers the mortgage payments, taxes, and other expenses (hence - the term "prudently"), it costs me nothing out of pocket to hold the property. Also presuming the value of the property rises in tandem with inflation (over the long-term) - say 2%, the property goes up in value by $2,000, on average, in the first year, giving me an unrealized gain of 10% on my initial investment. If my time horizon is 15 years plus, I stand to make as good, or better return as the stock market (historically), with much less price volatility (historically).

  • Report this Comment On September 11, 2012, at 11:11 PM, juanlascurain wrote:

    Jason, I believe your article hits a huge blind spot in the education programs of the US and heck, of every other country. We must provide people with basic financial education for people to plan and make their dreams come true and have a fulfilling life. For people to live without stressing for money issues. For people to have a financially independent retirement. Investing in financial literacy programs for people who already left the school system is also essential. I have been working on providing basic financial literacy to millions of people and would love to connect to people working on this subject. Thanks so much for your article.

  • Report this Comment On September 11, 2012, at 11:29 PM, GeoDG wrote:

    Randall - thanks for making that point. I think this article does a great disservice to individuals by not mentioning leverage. It obviously works in reverse, but your example shows how easy it is to get a 10% (or greater) return with 20% down simply due to leverage.

    GDG

  • Report this Comment On September 11, 2012, at 11:35 PM, juanlascurain wrote:

    Oops! Sorry, my previous comment was meant for another article...

  • Report this Comment On September 12, 2012, at 7:04 AM, TMFMorgan wrote:

    Randall,

    Don't forget taxes, insurance, upkeep, closing costs ... Those aren't minor fees. They can wipe out what looks like profit, even with high leverage.

    A leveraged investment makes sense if it returns more than the cost of capital. Real estate has historically returned about 2% a year. With a 5% mortgage, 1% taxes, 1% insurance, and 1% annual upkeep, the numbers don't work in many situations. Yes, you can live in the home, and there's huge value to that. But again, that's what's important: A home is a place to live, not a capital-appreciating asset. The housing bubble last decade came about when people forgot that.

  • Report this Comment On September 12, 2012, at 2:19 PM, Melaschasm wrote:

    This should be a good time to invest in real estate. With reasonable prices and rent, a landlord has a good chance of making a nice profit over the coming years. As is always true with real estate, location matters.

    With low interest rates, if you want to use leverage to invest in real estate, this is a particularly good time to buy.

    Just remember that the more leverage is used, the greater the chances of bankruptcy.

  • Report this Comment On September 12, 2012, at 3:17 PM, Turfscape wrote:

    >>This is what happens when government gets involved in pushing "affordable" housing to people who can't afford it.<<

    If you view the problem as a single-cause issue, you will not learn the real lesson. Did Government policy contribute? Yes. Did Government CAUSE the housing bubble and subsequent crash? No. Many groups were involved, both public and private.

  • Report this Comment On September 12, 2012, at 3:54 PM, feenix1944 wrote:

    Good article, Morgan. The construction stocks are the play for smart money. I've been quietly adding Armstrong World Industries on dips for some time now. They make (to name just two) floors and ceilings... no matter what sort of bells and whistles future homes have, I'm pretty confident they will have both of the above, plus, they periodically pay out a HUGE special dividend, and they're getting about due for another one in the not too distant future.

    Disclosure: I'm long AWI

  • Report this Comment On September 12, 2012, at 9:08 PM, nivekluap wrote:

    The house you live in is not an "investment"....mine isn't anyway. Nobody has ever paid me to live here. It keeps my family out of the weather, as a shelter should. Rental property, yes. Where you live, no.

    Stocks, that's where the money's at. Fool ON!

    KD

  • Report this Comment On September 13, 2012, at 1:18 PM, randallwaechter wrote:

    Morgan,

    You are the best writer at Motley Fool - love your work, but continue to (respectfully) disagree on this one.

    I understand that property taxes, closing costs, insurance, and annual maintenance must all be taken into account. Like any other investment, understanding market fundamentals and doing your due diligence is critical. Just like buying into stocks generally (as I did) in 2000-2001 was a bad idea because of valuations at the time, buying into US real estate now (or at least in the past couple of years) is/was a great idea because of current valuations + socioeconomic circumstances (i.e., lost of renters and few qualified buyers until credit histories are cleared).

    I personally know people who have bought in and are renting properties and the rental income covers ALL the expenses mentioned above and they are still left with a 7-8% net cash return. Add in 2% capital appreciation over the long-term as per inflation (I strongly agree with this point as you have made in the article) and 80% financing and they are currently achieving the equivalent of a 17-18% annual return (presuming they hold long enough). I say they are well positioned to beat the overall stock market over the next 10-20 years.

  • Report this Comment On September 13, 2012, at 1:21 PM, randallwaechter wrote:

    I should qualify, and maybe this is what you are really saying:

    A HOME is not a good investment, but a HOUSE can be an excellent investment, given the right circumstances.

    Does that sound about right?

  • Report this Comment On September 13, 2012, at 1:25 PM, TMFMorgan wrote:

    ^ Thanks. I enjoy respectful disagreements.

    Buying as an investment property you don't live in is a little different. As the article says, a home provides a place to live, and that has value. When you rent out that property you're turning that value into cash. And yes, you can earn good returns on that. No disagreement. The article is meant for those who look at their home as something to provide wealth *beyond* a place to live.

  • Report this Comment On September 13, 2012, at 3:39 PM, DS31 wrote:

    @randall,

    And one additional consideration is that it is not an equivalent comparison if you compare your real estate example above (with a leverage ratio of 5 to 1) against generic stock market returns which do not include any margin. That is not an "apples to apples" comparison.

    Although you can't lever up 5 to 1 in an investment account (margin requirements won't let you go that high), pretend for a moment that you could. If you have stock market returns of 10% with that kind of leverage, then your total return would be 50% (8% stock market returns would be a total of 40% and 6% returns would be 30%). This is the only way to make the situation comparable.

    But I do agree with you--Morgan is best writer at Motley Fool.

    Dan

  • Report this Comment On September 13, 2012, at 7:59 PM, randallwaechter wrote:

    Glad we're in agreement!

    And I do agree with the further point about leveraging 5:1 in the stock market, but that is a fairytale land of leprechauns and unicorns. And even if it weren't, the risk associated with even a 2:1 or 3:1 leveraged position is so high, compared to housing, that you better get a 24% or 30% return for all those sleepless nights. Remember, even if housing values go down for awhile, you still have a rental income to cover your expenses. As long as you bought in the right market (remember location, location, location!) and leave enough "cushion" for potentially reduced rental rates, you can wait out the drop. If you get a margin call in stocks, the game is over.

  • Report this Comment On September 14, 2012, at 12:05 AM, jlclayton wrote:

    Excellent commentary on an excellent article--thank you!

  • Report this Comment On September 14, 2012, at 12:11 PM, jrj90620 wrote:

    With unlimited population growth and unlimited inflation,housing prices should continue to inflate.This isn't that hard to figure.

  • Report this Comment On September 14, 2012, at 12:16 PM, TMFMorgan wrote:

    ^ At the rate of inflation, yes. Just not any more, which is what so many count on.

  • Report this Comment On September 16, 2012, at 12:08 PM, Edthedefender wrote:

    Q...why the assumption that household growth of 1.25 million per annum would support construction of 1.7 million units per year?

  • Report this Comment On September 16, 2012, at 12:12 PM, TMFMorgan wrote:

    ^ Every year a certain number of homes are torn down, lost in fires, floods, earthquakes, etc. So new home construction exceeds new household formations.

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