Recent Data on Home Prices and New Home Sales: Still Far To Go

Case - Shiller Home Price Index, 10-city composite, January 1987 to April 2012

US new home sales, 1980 to May 2012, annual data

A pair of new reports on housing released yesterday and today have sparked positive reports on conditions in the housing market.  Both indicate that conditions have improved.  But comparisons to the recent past can be misleading as conditions have been so miserable.  It is important to look at the data also in a long-term context.  This blog post updates two which were posted on this site last December (here and here).

Yes, compared to the recent past, conditions have improved.  But viewed over a longer term context, one cannot yet say that the changes are significant.  The recent data might ultimately turn out to have marked a turning point.  But it is too early to say that.  Plus there is far to go before one can say there has been a meaningful recovery from the downturn in US housing that started in early 2006 when the housing bubble burst.

The top graph shows the Case-Shiller 10-City Composite home price index for the period from 1980 to April 2012, where the April figures were released this morning.  The Case-Shiller numbers are three month moving averages (so the “April” numbers represent an average over February, March, and April in their raw data).  The index is calculated by looking at changes over time of individual home prices, comparing the price of the home when it was sold to the price when it was purchased.  There is also a broader 20-City Composite Index, but this index only goes back to 2000.

The Case-Shiller numbers indicate an uptick in prices in recent months.  But the upticks are small, with monthly increases of just 0.7% in April and also in March, no change in February, and negative before.  Compared to a year ago, the index was 2.2% lower.

But all these changes are small compared to the fall of one-third in prices from the peak of the housing bubble in early 2006 to now.  Prices were plummeting in 2007 and 2008, and then finally stabilized within a few months of Obama taking office.  But there has not been a significant change since then.  Nor is it necessarily likely that there will be a significant change anytime soon.  As one can see in the diagram, average home prices were fairly flat for almost a decade, from late 1988 to late 1997.

The New Home Sales figures, released yesterday by the Census Bureau, were somewhat more positive.  Estimated new home sales in May reached 369,000 at an annualized rate.  This was almost 20% higher than the 308,000 figure for May 2011.  The January to May, 2012, average pace of new home sales was 352,800, which was 17% above the 300,400 pace of new home sales over January to May 2011 (with all figures at annual rates).

These increases are more encouraging.  But they are still small compared to the pace of new home sales that reached close to 1.3 million in 2005 at the peak of the housing bubble, as seen in the graph above.  The high rate of new home construction and sales during the bubble was clearly excessive.  As was discussed in the earlier blog post, annual sales of about 900,000 a year in the US right now might be considered roughly what is needed, on average, given the US population and its growth.  Sales at a pace of 369,000 units a year is still far below this.  An increase of 17% over the pace of 300,400 in the January to May 2011 period is good, but sales would need to almost triple (an increase of 200%) to reach 900,000 a year.

Over time, one should expect home building to recover to this roughly 900,000 level.  When this happens, it will serve as a significant spur to the economy.  And it might well start soon.  Taking the 900,000 figure as a rough benchmark, there was excess home construction during the bubble years of the Bush administration from 2002 to 2006.  This is shown as the area in blue in the figure above.  The excess during this period (i.e. the excess over the 900,000 benchmark) totaled 1.1 million housing units between 2002 and 2006.  Construction and sales then plummeted as the bubble burst.  With the continued depressed state of the economy, new home demand has remained low, and the cumulative shortfall from 2007 to now (calculated again relative to a 900,000 home unit per year pace as the “normal” demand) has come to 2.5 million units as of May 2012.  There is therefore now a net shortfall in housing units of 2.5 million minus the 1.1 million previous excess, for a net of 1.4 million units.  And at the current rate of 369,000 units per year (at annualized rates), the net shortfall is growing at a rate of 900,000 – 369,000 = 531,000 units per year, or about 44,000 units per month.

All this is consistent with recent published reports (see this Census Bureau report, or this Washington Post article based on it, from June 20) on how households are “doubling up” in record numbers, particularly with adult children in their 20s continuing to live with their parents.  The Census Bureau estimates that the number of doubled up households increased by 2.0 million between 2007 and 2010, with the number of “additional” adults (over and above the household head and his or her spouse or partner, and excluding students) in such households increasing by 3.8 million over this period.

Many of these additional adults will seek their own homes as soon as they can.  This will happen when the economy improves, and the home purchases will then in turn serve to spur further improvement in the economy.  When this happens, the impact on growth will be significant.  A rough calculation in the previous blog post suggested that new home construction and sales returning to a pace of 900,000 per year would add about 1% of GDP, or 2% of GDP assuming a multiplier of two.  The Congressional Budget Office estimates that GDP is about 5% below potential, so such growth in new housing construction could act to make up a significant share of the gap.

This pent up housing demand could therefore act as a significant spur to the economy once the process starts.  This serves to underscore again how important it is to end the fiscal drag that is holding back the economy, and instead allow fiscal growth such as that which acted as a significant spur to the economy during the Reagan years (as was discussed in this earlier post on this blog).  Once growth starts, the recovery of housing construction and sales to a more normal level will act to reinforce the recovery.

It is, however, premature to claim that the recent housing data provides an indication that this recovery is underway.  While positive, the changes are still too small, when seen in the longer term context, to bear much weight in drawing such a conclusion.

New Home Sales Remain Abysmal, But The Potential Should Be Recognized

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.