Inside Financial Services

It’s Not Just Banks’ Inventory Overhang That Will Drive Housing Prices

The bears forget that pent-up household formation and the collapse in housing starts will play a key role, too

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At The Atlantic, Daniel Indiviglio is perhaps the last man in the country to become aware of banks’ looming inventory of foreclosed and soon-to-be-foreclosed homes. He’s gotten hold of a chart from Laurie Goodman of Amherst Securities, and is worried:

According to Goodman’s presentation, even though homes sold are only about 90,000 per month, inventory is growing by around 60,000 per month. So the homes sold each month would have to increase by two-thirds just to keep up with the growing inventory — not to begin to cut the 3.35 million homes in the shadows. To conjure up enough demand to meet 150,000 sales instead of just 90,000, home prices would almost certainly have to fall faster. [Emph. added]

Indiviglio is overreacting. First, while the inventory of homes owned (or soon to be owned) by banks has ballooned, other sources of housing supply have collapsed. The collapse will act to offset some of the banks’ overhang. The most obvious of these other sources is new homes. Since 2007, housing starts have plummeted. Last year, there were just 471,000 of them-the fewest since the Commerce Department started keeping records in 1959. By contrast, the typical run-rate of home starts in the 1990s and 2000s was more like 1.2 million per year. Since 2008, the homebuilding industry has trailed that rate by an aggregate of roughly 2.2 million units. That’s a lot of forgone supply. Take a look:

Meanwhile, incremental demand has evaporated too-but only for awhile. It will surely return with a bang. A bedrock fact in the homebuilding industry is that demand growth is driven by household formation. But thanks to the recession, there hasn’t been much of that lately. Just 357,000 households were formed last year, according to the Census Bureau, the fewest since 1947. It was the third year in a row that household formation came in well below its long-term, 1.2-million annual rate. By now, total pent-up formation comes to around 2.2 million households. Those people aren’t going to live with their parents forever.

Nor is net in-migration to the U.S. from other countries, which has been falling for years as the economy has slowed, apt to stay depressed indefinitely. As the economy and job prospects here improve, net immigration will rise-which will create further demand for housing.

You’ll get no argument from me that the banks’ shadow inventory constitutes a huge challenge to the housing market. Things won’t get back to normal until all those properties have worked their way through the system. But if you only look at banks’ housing inventory, shadow and otherwise, to figure out where prices are headed, and ignore other big shifts going on in the market, you’re apt to come up with too gloomy a conclusion. Rather, look at all the factors that are driving supply and demand. Housing starts and the rate of household formation are hugely important. Recent trends for both go a long way to offset the huge inventory of homes held by the banks.

What do you think? Let me know!

12 Responses to “It’s Not Just Banks’ Inventory Overhang That Will Drive Housing Prices”

  1. c smith

    “Those people aren’t going to live with their parents forever.”

    Maybe not, but another 3 to 5 YEARS is certainly in prospect, what with $25K in college debt and no prospect of a job paying anything near what it costs to afford a $200K home, let alone the 20% down payment. Household formation simply does not happen without an income and access to credit. Home prices are going lower, and housing starts won’t push above 500K for another 3 to 5 years.

  2. AGPS

    What about the financing side of a home purchase? I think Tom is right in identifying the significance decrease in both housing starts and family formation. However, I don’t see people being able to qualify for a mortgage, so while the amount of families who want to purchase a home should be increasing daily, their ability to finance a home is still not there. I believe until the lending standards are loosened to make the home mortgage more affordable to more families you won’t see an increase in demand. I am not suggesting we go back to where anybody who is warm and breathing can get a mortgage but standards have to be lessened so you don’t need a 700+ FICO and 20% down.

  3. Tom James

    Tom – In general, I agree with your points about the supply and demand for housing, and that Mr. Indiviglio is not providing or considering the whole picture. There are some wrinkles though:

    1) Over the long term – assuming stable average lot sizes and quality, which have long been the case and I don’t see any reason why this would change in the future – house price changes have been highly correlated with house square footage growth plus inflation (CPI). House square footage has long grown consistently with growth with real per capita GDP. Although I expect that to grow in the future, our demographics point to a dramatic increase in the dependency ratio (i.e. taking care of the baby boomers), whereas we’ve enjoyed the opposite for about 20-30 years. Smaller houses = lower prices

    1) Household formation growth is a function of population growth, of which immigration is an increasingly significant factor, and household size. Although the mean houslehold size has remained stable since 1970, that is likely to rise in the future as a greater percentage of the population is made up of the families of immigrants from Latin America where larger household size is part of the culture, and often an economic necessity. So although the US population will continue to grow at around 3 million annually, we will likely need fewer than 1.2 million homes to house that growth.

  4. bbernstein

    Couple that a reduction of housing stock per year of around 250k (floods, fire etc.) we might be closer to a turn than we realize. Maybe that’s why Warren Buffett is making capex into his construction companies.

  5. big al

    If new household formation was only 357K, but new home starts were 471K, then builders constructed 114K more houses that have potentially no buyers. How does this help to reduce the inventory glut?

    Housing inventories won’t go down until the economy recovers. And businesses create more jobs instead of hoarding cash and directing want little cash they do spendtoE-suitebonuses. Andt thatcouldbeadecadeaway.

  6. Donzo

    Morgan Stanley has a piece out saying we are shifting to a nation of house renters. One doubts this is too pronounced but at the margin it is clearly happening . Some big money is starting to come in to buy houses and play landlord

  7. S Clymer

    > As the economy and job prospects here improve

    That’s the key assumption. What if the following cause the economy to stagnate for another decade:

    + the most anti-growth policy climate in recent memory,
    + a looming fiscal and demographic crisis with no political solution
    + populist sentiment still strong among voters
    + no large productivity drivers on the horizon

    Who is to say that the economy won’t just continue to stagger along for a decade or more?

  8. Steve Williams - Cornerstone Advisors, Inc.

    Tom, I think this is a great counter point folks are missing. The oldest Gen Yers are now in their late 20s. Dude named Jared who love to play Xbox games have hot girlfriends named Ashley who wants to get married and get a house. Ashely won’t go for living at home and wants Jared to ask his parents for help buying a house. With affordability and rates very positive right now, the deal makes sense. Jared gets a hot, happy wife and Ashely gets to buy curtains for her dream home. Hopefully, our housing conditions improve with several million of these Gen Y move outs over time.

  9. alex

    Grim Reaper displays a commendable male, practical, sensible point of view. But most of the women I know, including wife and daughter, want to own their nest and raise their young in comfort and security as do all female animals and birds. I’m afraid we males are stuck.

  10. anonymous

    The big banks are dead meat that should have been allowed to fail. It takes over a week to transfer money between accounts in the same branch. They are issuing warning letters (such as if you use an online vendor, heavens, it must be suspicious because their fellow weasels won’t find work) and fees inconsistently and cluelessly all over again. Their average staff is at least twenty IQ points lower than they have any right to be. Don’t blame them entirely, they have been bludgeoned endlessly by regulators, they are clueless. They scurry about with mindless business trying to stay alive while pretending to work. Universal banking should only have been allowed if they started from scratch, not by merger. These guys are clueless as to how to integrate these things, because they have so many weird pieces which will never fit together. If you employ anyone who used to work at a big bank, you should get fired. They would drown you in penalties just because someone got sick and couldn’t pay – it is irrational how they think they will make it up in short term freak fees if they make you go under. Ibrahimic (not just Islamic) finance is the future – now they call it debt equity convertability.

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