Homebuilders won’t build what they can’t sell, and household formation isn’t so robust that builders must provide more to keep pace with demand.

Since 2012 the financial media chronicled the reflation of the old housing bubble but portrayed it falsely as a robust recovery based on strong fundamentals. Ordinarily, when prices rally in the market for any commodity, good, or service, the rally originates from resurgent demand that outstrips the available supply, and as a result, sellers and suppliers produce more to meet demand. Since 2012 when house prices bottomed, none of the usual signs of strong demand were present.

For example, consider that since the rally began, the housing market witnessed the following:

How do those facts equate to a strong rally based on fundamentals? Obviously, they don’t.

Given these unusual circumstances, it shouldn’t be surprising to find that new home construction less than 50% of normal.

And why is homebuilding so low despite an improving economy and several million more new jobs? Because despite the improvements, household formation less than 50% of normal, and apartment developers won’t create what they can’t rent, and homebuilders won’t build what they can’t sell.

By Monetary Watch | April 20, 2016

… If the jobs market is truly booming then those beneficiaries who should be feeling the (permanent) income effects should be causing another boom in construction. Builders would be crazy not to engage in tremendous new volume if there was all this pent up demand and steady if not steadily higher prices.

Throughout the so-called recovery, every few months some real estate hawker proclaims the market brims with pent-up demand about to be unleashed, certain to cause a flurry of sales.

It never materializes.

Yet, housing remains stuck in the bottom of the historical ranges while apartment construction is seemingly just stuck. U.S. housing starts fell more than expected in March and permits for future home construction hit a one-year low, suggesting some cooling in the housing market in line with signs of a sharp slowdown in economic growth in the first quarter… Last month’s drop in groundbreaking pointed to a moderation in housing market activity and mirrors other data such as business spending, trade and retail sales that have suggested economic growth stalled in the first quarter. Construction for single-family homes (is) nothing like what “should” be occurring if the economy were truly booming and there was a shortage of for-sale units. … Modest remains the key word in all of it. A true pre-bubble “boom” in housing used to be 1.1mm to 1.2mm units, more than 50% above the current level. So where the recent trend might still be positive, there is no indication of an overall rush of economic good fortune from those with new jobs and no place to live. It … reflects upon the true state of national income and wages of what the true labor market is likely far apart from the unemployment rate.

Look at the chart of home construction above. Resale prices have increased 50% or more over the last four years in many markets, yet come construction is still languishing at levels historically associated with deep recessions. This clearly demonstrates that the increase in home prices was not caused by resurgent demand.

Since the home ownership rate continued to plunge while prices went up, perhaps the apartment builders were taking up all the slack?

As it turns out, no. They were not.

Instead, on the multi-family side, construction remains around 400k (SAAR). The level of new permits in March dropped sharply to just 324k, the lowest level since the summer of 2013. Even last year when overall construction indicated a relatively better pace it was still at the lower end of historical ranges. … In other words, 400k is not a healthy pace in a “normal” economy but especially one that is now supposed to be “booming” in labor markets and at the same time of a persistent housing shortage as new labor entrants seek to unwind prior cohabitation arrangements.

The homeownership rate crashed, rents skyrocketed, but apartment construction never really took off. Developers built more apartments in 1966 than they did in 2016.

… Instead, we find home construction in all segments that remains rather subdued on its own terms, and quite noticeably so in relation to the supposed acceleration of recovery and growth. Despite what should be very favorable construction economics, construction instead continues to be positive but not significantly so. As with so many other accounts, it suggests an economy that never really took off where it “should” have and that it was only the huge crash and depression up to 2010 that accounts for even these small positives. More than five years after the crash and given population expansion (+14 million in the civilian non-institutional population since the start of 2011) there is no reason that housing construction should remain so tepid save actual economic circumstances.

So why is construction so much lower than the economic happy-talk suggests it should be?

Is it because the economy is not creating new jobs?

No. Although the recovery from the Great Recession hasn’t been spectacular, the economy created nearly 200,000 jobs a month for the last six years.

Is new home construction so low because new homes are not affordable? Logan Mohtashami believes this is the problem.

What’s up with the Home Builders? You may remember this statement from my 2015 Housing Prediction Article: “You get my drift: The bar for housing is so low that some housing bulls might try the predictable tactic of bellowing about exponential growth portending a miraculous recovery when all that is occurring is a bump up from a pitifully low base. I take a more measured (or perhaps jaundiced) view of what the future holds” … What happened? The pundits, economists and analysts (Ivy Zelman, Janet Yellen and others) all say the same thing: Housing is so affordable. But, if Housing is so affordable then why do we have this data line showing, with the lowest interest rate curve post WWII, we still have the worst demand for existing homes on record. And new homes are much more expensive.

While this argument is compelling, the main reason new home prices are so far above trend for income is due to mortgage rates hovering near record lows — the stimulus used to reflate the bubble. When normalized for payments rather than gross income, housing is affordable, even new housing. Therefore, I don’t believe the real reason for low construction volume is affordability.

If people are finding new jobs, and if house are affordable, why isn’t new home construction going crazy to keep up with demand?

Because for a variety of reasons, people are not forming new households, so the demand for new construction simply isn’t there.

The Great Recession wasn’t kind to the Millennial generation. The biggest challenge was a lousy job market for recent college graduates. Finishing college with a degree, large amounts of student loan debt, and bleak job prospects forced many young adults to move back home with their parents or take on roommates in a multi-bedroom apartment.

You can see this in the above chart. There was a big fall in household formation in 2008. In 2005, household formation peaked at 1.9 million. By 2008, that number was just over 400 million. It was less than a quarter of its previous high three years earlier. To put these numbers in perspective, the average from 1990 to 2005 was about 1.3 million. It averaged around 627,000 after the peak. In 2015, household formations were about 900,000 and housing starts were about 1.1 million.

The bottom line is that people are not forming new households. If people don’t form new households, neither apartment developers or homebuilders possess customers; no customers means no construction.

The bigger question here is whether or not this is a new cultural phenomenon or the result of a recession hangover. There is plenty of evidence that suggests the barriers are economic (by force) and not psychological (by choice).

However, the generation that grew up during the Great Depression were frugal throughout their lifetimes. Perhaps the Millennials will be the same. The lack of household formation will likely improve as Millennials age, get married, and start families, but we may see more non-traditional lifestyle choices with people living at home or with roommates for a very long time.

Demand may be pent-up, but it may remain pent-up for a very long time.

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