New home sale figures for October, recently released, remain abysmally low at just 307,000 sales at an annual rate. They have fluctuated within only a narrow range over the past year, with no clear trend and no signs to be encouraged by. What is more interesting is the longer term context.
New home sales in the US fluctuate a good deal, but around a rising trend of 1.0% a year (calculated from a regression over the 1980 to 2010 data). They reached a fairly stable level of approximately 900,000 housing units a year between 1998 and 2001. But there was then a bubble between 2002 and 2006, reaching a peak of almost 1,300,000 in 2005, and then crashing to a bit over 300,000 in 2010 and 2011, where it now seems to have leveled off.
Only 300,000 new home sales a year is abysmal and a major drag on the economy. It is only one-third of the 900,000 level of the early part of the last decade, and less than one-quarter of the levels reached in the bubble years. But it should also be noted that people need homes, and that that need grows over time due to population growth. The trend 1.0% growth found in the data is consistent with this. And with new home construction now far below trend, it will be a significant spur to the economy if and when housing construction recovers. Brad DeLong has made a similar point in his blog a number of times. Here is one such post.
Keeping things simple and conservative, let’s assume that new home sales will, for the purposes here and over periods of time, on average equal the number of new homes constructed. All are eventually sold, with very few exceptions. And while there are figures available for new housing starts, these are consistently higher than sales for reasons that are not clear, but may reflect homes never completed. Using the 900,000 units sold a year between 1998 and 2001 as a reasonable norm, and for simplicity not even allow for a rising trend in this figure, one can calculate the excess over the bubble years 2002 to 2006 (the area in blue in the graph) and then the shortfall that has developed over 2007 to 2011 and continues (the area in red). Based on the figures underlying the graph, the excess during the bubble was 1.1 million units, while the shortfall in the subsequent bust through 2011 was 2.2 million units. There is therefore now a net shortfall in housing supply of 1.1 million, as the excess over 2002 to 2006 has been more than worked off. And as long as new home sales and construction remain at only 300,000 a year, that shortfall (relative to a 900,000 per year norm) will be growing by 600,000 housing units a year.
This suggests that a major pent-up demand for homes has built up. It has not been resolved due to continued problems in the housing market and especially in the housing finance market, with many mortgages underwater and hence do not move, mortgages that remain hard to get by potential new buyers, an overhang of houses not sold, and a foreclosure process that has not worked well. The market remains close to frozen.
But if these housing market problems could be resolved, so that construction could revert to its previous norms, the stimulus to the economy would be huge. Assuming simply a return to construction of 900,000 units a year (and hence ignoring what would likely be an overshooting of this for a few years to make up for the net shortfall of recent years), implies construction of an additional 600,000 units a year. At the average new home price of $221,800 in 2010, the aggregate value of such homes would be $133 billion per year. This is just short of 1% of GDP. Most of this would add to GDP as there is some, but only limited, “leakage” through some inputs that are imported (housing lumber, fuel for trucks, etc.).
But there will also be indirect multiplier effects, especially in the current depressed economy. A reasonable estimate of the multiplier on housing construction would be 2 to 3. A return of new home construction to previous levels would therefore add 2 to 3% of GDP. With actual GDP currently about 5% below potential GDP (estimate for end 2011 by the Congressional Budget Office, page 12), such an addition from housing construction would bring the economy about half-way back to where it needs to be. But this will not happen until the market for homes and for home mortgage financing begins to function reasonably well.