Reaching a floor in housing

By Christopher Swann
July 27, 2009

– Christopher Swann is a Reuters columnist. The views expressed are his own —

By Christopher Swann

NEW YORK, July 27 (Reuters) – Nestled in today’s otherwise heady home sales figures was a sobering message on prices. Homes were still fetching close to six percent less in June than they did just a month before, and 12 percent less than a year ago.

After three years of falling prices, homeowners are wondering when this will come to an end. “Don’t hold your breath” is the message from government forecasts. The “more adverse” forecast in the bank stress tests would have prices almost halving by end-2010 from their 2006 peak.

Yale economist Robert Shiller has even raised the more depressing example of Japan, where land prices in its major cities fell every single year for 15 years following the bursting of their bubble in 1991.

So will Americans have to wait until the Jonas Brothers develop laughter lines to see a revival in housing?

Despite the slump in prices, there are signs of hope. Indeed, the prospect of a repeat of Japan’s long-term decline in prices is extremely remote.

Economists are often tempted to treat housing too much like equities, undervaluing its role as a basic subsistence need. A look at the fundamentals of the housing market — population growth and construction costs — is at least modestly reassuring.

One source of comfort is demographic. Population growth has generally had a slippery relationship to house prices. A rising headcount does not automatically translate into extra demand for housing.

The rate of household formation — Census Bureau-speak for the number of people who need new accommodation — can fluctuate with the economic cycle. In depressed times, new graduates can move back in with their parents, couples can postpone a much desired divorce and immigration slows. The Census Bureau estimates that net levels of household formation — which normally fluctuates around 1.4 million a year — more than halved last year.

But this should soon rebound to more normal levels. In a recent paper MIT economics professor William Wheaton suggested that household creation should revive to at least 1 million a year by 2010. This is a far cry from Japan in the 1990s, when the number of households actually started to slide.

Assuming around 200,000 demolitions a year, Wheaton says, we will need about 1.25 million new units annually in coming years. With U.S. home-building at less than half this level, there is a giant shortfall.

“At this rate, the current excess inventory of units for sale or rent will be back below normal levels in 2011,” he argues. There are already signs that the market overhang is shrinking. At the existing rate of sales it would take 8.8 months to clear the unsold stock of homes, the lowest level since October 2007.

Another reason we may be near a bottom in housing is construction costs. If prices slump below construction costs, builders soon lay down their tools. Eventually shortages drive up prices again to the point where the builders’ strike ends.

Here again the United States is in a different position from Japan. At the height of Japan’s boom, the price of land accounted for as much as 80 percent of the cost of real estate. Even after more than a decade of falling prices it may still be 40 percent — creating scope for further declines.

This is not true in most areas of America. Harvard economist Edward Glaeser believes that in many areas, prices have already fallen close to the cost of construction in places like Phoenix and Atlanta. As inventories clear, this should help set a floor under prices.

Outside a handful of coastal cities, housing has never been the great investment that many Americans assume. Now it may be over a decade before house prices return to their 2006 level. But at least American homeowners are likely to escape the depressing fate of their Japanese counterparts. An end to house price falls is at least now faintly visible on the horizon.

For previous columns, Reuters customers can click on [SWANN/]
(Editing by Martin Langfield)

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