Why new home construction is slow, and will remain so for a long time

by fabiusmaximus

Summary: The refusal of housing construction to join the boom has baffled economists and investment experts. Demographic change explains much of this puzzle, and suggests that housing construction — a major driver of the post-WWII boom — will remain in the doldrums for several more decades.

Boom and bust of the housing market
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US Age Distribution-numbers

Numbers after 2010 are shown in red and blue bands to show the range of uncertainty. By Stephen Holzman.

This graph shows the raw force shaping the US national housing market (regional trends differ). The key buyers are those in 25-45 year rows: buying their first home, then moving to larger homes. Their numbers boomed after 1970 and stabilized after ~2006. Those older than 60 are sellers: downsizing from single-family houses to retirement homes, then into nursing homes, then into their graves. The number of oldsters began to boom after 2005 (when the first Boomers turned 60), and will stabilize at higher levels from 2050-2100.

The cresting of the Age Wave explains the failure of the US housing market to recover after the crash — and suggests that more pressure on housing construction lies ahead. For the first time since the 1930s there is a wave of net sellers to meet buyers, ending the multi-century boom of easy real estate profits for developers (many of the Founders and early Americans were real estate developers). It’s the answer to a puzzle that’s baffled many investors…

The puzzle

Number of New homes sold per capital (civilian non-institutional population)

New Homes sold per capita

In the sixth year of the recovery the number of new home sales per capita has climbed up to the 1963-2007 lows — and stalled there. The previous lows were during the 1982-83 recession, with housing crushed by years of severe recession plus doubled-digit interest rates. Years of the Fed’s zero interest rate policy (and record low commercial rates) have produced a small bounce in new homes.

This has baffled many economists and financial experts (e.g., Alhambra Partners, Lee Adler of Wall Street Examiner), whose models (based on history) tend to ignore or underestimate demographic effects. For several years after the bust we were told that the overbuilding in the bubble (net after homes torn down) would quickly be absorbed. But still housing remains stuck in low.

The “age wave” explains much of this. The Boomers’ buying boosted housing demand in their youth and middle age, as only new construction could meet their demand (their generation being so much larger than their parents’). In their elder years the boomers’ downsizing provides homes for the next generation to buy — reducing the need for new construction. If marriage and fertility rates continue to decline, boomer selling might create a surplus supply.

Large scale demographic trends change almost everything, as Japan has learned since 1989. As we will learn in the coming years. It is not too early to prepare.