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Housing cools but shortage persists

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The US Census Bureau reported that new residential housing was started at an annual rate of 1.549 million in May, a whopping 14.4% drop from April and 3.5% below the rate of starts. under construction in May 2021. The sudden cooling was attributed to both rapid price appreciation and a sharp rise in mortgage rates making affordability out of reach for many buyers.

Single-family home prices have risen nearly 20% in 2021, driven by strong demand and exacerbated by critical shortages of materials and labor in the wake of the pandemic. But the housing crisis is not simply an artifact of Covid’s supply chain disruption or improving consumer debt profile and savings rates. The housing shortage in the United States has accumulated for almost four decades and the market is still suffering from the hangover from the financial collapse of 2006.

The fact is, homebuilding in the United States simply hasn’t kept pace with population growth since the 1980s. April housing starts of 1.8 million units at an annual rate we are just back to 1998 levels of new home construction and are well behind the annual rate of 2.5 million in the early 1970s. of the same period. And even if the Fed’s ongoing rate hikes are dampening demand for now, the long-term imbalance will still take many years to resolve.

While many remember the early 2000s as a period of excess in the residential real estate market, the fact is that new housing construction was just beginning to pick up to meet population growth before the trough does not collapse. It was not overbuilding per se, but a confluence of factors related to how the building expansion was financed that led to the catastrophic collapse that nearly destroyed the entire US economy. Since then, the lingering changes resulting from the crash have continued to hamper a full recovery in new construction.

The factors that led to the crash of 2006 are legion, including misguided government policy, the rise of non-bank lending, the securitization of mortgage loans, including subprime loans with lax underwriting, regulatory loopholes, as well as the greed and deceit of mortgage originators. An estimated $14 trillion in American wealth was destroyed and the average family suffered a 39% drop in net worth. Several mortgage and securitization reforms were passed in the wake of the carnage, making it harder to get a home loan but also pushing some potential buyers out of the market.

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The carnage suffered by homebuilders during the crash is perhaps the most significant factor in the under-construction of residential units. Prior to the Great Recession, the direct and indirect impact of residential construction and sales accounted for 15-20% of US GDP. Following the ensuing slump in 2007-2009, more than half of all homebuilders left the industry due to financial difficulties or bankruptcy. Nearly a quarter of all mortgages in the United States have gone underwater, leading millions of homeowners to mail their keys to the bank. Millions of skilled construction workers have left their trades to seek other employment, creating a skills gap that has yet to be filled. Many builders are now attesting that the pandemic has only exacerbated an already acute shortage of skilled labour.

The mix of new construction complicates the general underconstruction of housing. The new supply of entry-level housing is particularly constrained. The share of new single-family units under 1,400 square feet is only about 10% of all homes, compared to about one-third of all homes in the 1970s, leaving many first-time buyers shut out of the market.

Local zoning laws in many communities favor single-family homes and severely limit the permitting of multi-family units, even when local market demand prefers them over single-family homes. Meanwhile, the regulatory burden on contractors has grown exponentially over the past generation and, according to the National Home Builders Association, accounts for 25% of the cost of an average home. This makes entry-level housing construction essentially unprofitable.

The magnitude of the construction deficit can be seen in the accompanying graph which shows the ratio of new housing starts to population level since the early 1970s. The graph shows the general downward trend in the number of houses started per 1,000 inhabitants and points out that construction has not yet fully recovered from the crash of 2006.

A National Association of Realtors report in 2021 notes that on average, new homes per year since 2001 have averaged about 1.25 million compared to 1.5 million from 1968 to 2000, creating an estimated shortfall of 5 .5 to 6.8 million dwellings. The report states that “the scale of underconstruction and the existing gap between supply and demand are enormous…and will require a major national commitment to build more housing of all types.”

The current cooling in demand may provide some relief to allow strained supply chains to normalize and produce more skilled workers. But the larger issue is complex, involving governments at all levels to rethink lending, zoning and regulatory policies to allow the market to respond appropriately.

Christopher A. Hopkins, CFA