Why a Stronger Housing Sector Isn’t Boosting the U.S. Economy That Much
Construction of single-family homes, which packs an outsize economic punch, has stalled as new households rent and building costs have risen
By Kris Hudson And Nick Timiraos
A house under construction in Livermore, Calif., in August. New construction of single-family homes is stuck near levels hit during the early 1990s recession. Photo: David Paul Morris/Bloomberg News
The U.S. housing market dragged the economy into a deep recession nearly eight years ago.
Could it now insulate the domestic expansion during a fragile period of global growth?
Recent numbers look promising, but several obstacles—including shifts in where young households want to live, their capacity to take on debt and rising costs for home builders—suggest the sector won’t soon offer breakout growth.
First, the good news: New foreclosures have dropped to precrisis levels and sales of previously owned homes—the bulk of the market—have climbed to the pace of the early 2000s. Rising housing prices have made homeowners feel better about spending on their homes.
The problem: Housing still isn’t contributing much to overall economic growth because new construction of single-family homes, which packs an outsize economic punch, is stuck near levels hit during the early 1990s recession.
Initially, construction collapsed due to falling demand. Now, it faces a second headwind: Supply constraints have emerged as more people want to live in cities and construction costs have risen, while demand remains stubbornly weak at the entry level.
The forces hindering home building matter a lot. New single-family homes give the economy a bigger boost than existing-home sales or the construction of new apartments, which is booming as more people rent. The National Association of Home Builders estimates that building a single-family home supports three full-time jobs for a year in construction and ancillary services. In comparison, it estimates that construction of a condo or apartment unit supports one full-time job.
During the past year, single-family construction added up to just 1% of gross domestic product, roughly half the contribution during the 1990s. Even though new-home sales are running more than 20% ahead of last year’s pace, that pace is still well below almost every year of the 1990s.
Contracted sales of newly built, single-family homes accounted for 16% of the annual unit volume of all single-family home sales in the 1990s, on average. Last year, that ratio was 9.2%.
With homes for sale in short supply, price gains are outstripping income growth. Inflationary pressures are modest throughout the economy, save housing. The consumer-price index’s measure of core inflation, which excludes the volatile food and energy categories, is up 1.8% over the past year.
It would be half that if shelter costs were excluded.
So if prices are rising, and resales thriving, why does home construction remain so weak?
First, blame soft entry-level demand. New-home sales are more closely tied to household formation than existing home sales, which depend more on churn. To support new construction, the total number of households generally needs to expand, increasing the pool of potential buyers.
“Demand has been exceptionally low in aggregate because household-formation rates have been unusually low,” said Brad Hunter, chief economist for construction research firm Metrostudy.
While household formation is picking up, most of those new households are renters. The boost in rental households explains why the homeownership rate has fallen to a 48-year low. Rental vacancy rates, meanwhile, are at their lowest level in 30 years.
Households also need to qualify for a mortgage. Before the bust, builders relied on no-money-down programs to put new buyers into homes. Now, those programs are gone. Even though lending standards aren’t as tight as commonly assumed, perceptions of tight credit can also dissuade would-be buyers from looking.
Meantime, living preferences have shifted. In the past, builders put up entry-level homes in far-flung suburbs where land is cheapest, but many buyers today aren’t willing to commute to get a better deal.
Instead, many are opting for apartments closer to where they work and socialize, places that also happen to be more crowded and where land is more expensive. Home building is low because “the places where people want to live are not that buildable,” said Hui Shan, an economist at Goldman Sachs.
Rising supply bottlenecks magnify the demand problem if builders don’t see a reason to reliably produce starter homes. For example, PulteGroup Inc., which builds in 29 states, often must sell three to four move-up homes each month in a given community to meet its desired return on capital. To build less-expensive starter homes, that hurdle is six to eight sales a month, because profit margins are lower. Many builders and analysts say demand for starter homes isn’t that robust yet.
Labor costs have increased because many construction workers left the industry after the bust.
Ms. Shan ran an analysis on nationwide data that found just 54% of a sample of 637 construction workers from 2007 were still in the industry by 2013. Related industries such as city permitting and inspection also have struggled to rebuild their ranks.
Even more daunting: Builders’ largest raw material—land—shot up in price. To the extent there’s a substantial gap between prices of new and existing homes, “that’s land prices,” said John Burns, who runs a builder consulting firm in Irvine, Calif. “If these guys could build homes at $220,000, they’d be doing that. They can’t. Their costs are too high.”
In recent years, policy makers have focused on boosting demand by maintaining low interest rates and easing credit standards. Some industry analysts say other approaches will need to focus on supply bottlenecks by, for example, improving the permitting process.
“We are on the cusp of a serious housing shortage,” said Aaron Edelheit, an investor who earlier this year sold his company that had amassed some 2,500 rental homes in Atlanta beginning in 2009.
“Everyone keeps focusing on rates or qualifying for loans. They need to pay attention to supply.”
The good news is that, with construction still low, housing has plenty of room to run. But if incomes don’t rise, higher housing costs will continue to squeeze budgets and slow new household formation.
In that regard, housing’s recovery looks more like a long-distance race than a sprint.
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