Friday, May 25, 2007

Home building in the US

With regard to the new home sales chart, I find it interesting that between 1971 and 1997, a period of 26 years where there was significant population growth in the US, the sales number stayed in a range between 400 on the low side and 800 on the high side. The number didn't break out permanently above 800 until 1998. Then the number stayed in a range between 800 and 1000 until the sharp increase around about the middle of 2003, a five year period. The striking thing about the current decline from the peak number of almost 1400 to approaching 800 is that this decline of almost 600k is larger in absolute numbers already than any of the dropoffs recorded in this chart.

It seems to me that during the 26 year time frame there were three factors that capped home affordability and therefore the peak levels of new home sales. In the 1970's general inflation was the culprit; first time homebuyers couldn't come up with enough down payment to buy because home prices were rising too fast and it didn't make sense for existing homeowners to try to move up because few could afford their current house and even with increased equity from the existing house a new house wouldn't be affordable due to the general inflation. In the 1980's the jack-up of interest rates to kill inflation also quashed the ability of pretty much anyone to get into a new home, and rates stayed relatively high so that as the economy recovered the volume of folks able to get into a home for the first time stayed capped. Then the post-Cold War defense cutbacks shrank incomes and limited the demand for new homes. Interest rate cuts by the Fed to counteract the early 1990's recession helped move sales rates up, but it wasn't until the inventory overhang from the housing bust in California was depleted and the internet economic boom kicked into gear around 1997 that demand for new houses reflected the population increases that had taken place during the span of the previous 26 years.

Also, from the chart it seems you could pinpoint when the mortgage industry decided to start pushing the teaser loans and no doc loans to about the middle of 2003. The increase in sales from the end of the recession to early 2003 could be attributed to the Fed's cuts in rates which made housing more affordable and hence increased sales, but then as the effect of that wore off and you see the downward spike in late 2002/early 2003; it makes sense that the industry would try to figure out how to keep the ball rolling and came up with the loan tweaking system.

In addition to the overhang of new and existing homes for sale that exists now that is driving the massive decrease in new home sales, there is another factor that will extend the length of the home building downturn. At some point the yield curve is going to return to a normal slope, which means that long term rates(including mortgage rates) will go up, and that will further cap the peak prices that homes will sell for. I am afraid that the US will experience a residential real estate market analogous to the experience of Japan after the peak of its bubble in 1989.

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