Home production falls as economy languishes

The nation's home builders, and some economists, saw October's slight increase in single-family construction permits as a positive sign, yet the housing industry remains concerned about a shortage in years to come.

In a study published this month, economists at the National Association of Home Builders said annual single-family-home production in 2008 and 2009 fell about one million units short of the housing that would be needed in a normal economy.

The economists, Robert Denk and Paul Emrath, suggested that "builders will have a lot of catching up to do as the economy improves and household formations return to trend levels."

Data from the National Association of Realtors show the United States needs to build 1.3 million to 1.7 million housing units annually to keep pace with yearly household formations averaging 1 million to 1.4 million, in addition to replacing the 300,000 obsolete dwellings that are razed each year.

Statistics published earlier this year by Freddie Mac, however, show that only 910,000 units were started in 2008 and 550,000 in 2009.

Freddie Mac had projected housing starts at 700,000, but the Commerce Department reported last week that the current annualized rate was well below that, at 575,000.

Housing economist Patrick Newport of IHS Global Insight in Lexington, Mass., believes that, in normal economic times, the number would be closer to 1.5 million.

"The key for housing going forward is employment growth," he said, because "new jobs will require new homes to be built nearby."

When job growth takes off, he said, the rate of household formation will pick up again. It has been extraordinarily low because the economic downturn has led to reduced immigration and doubling up of households - grown children moving back in with their parents, for example.

Increases in household formation will, then, reduce the housing glut, which will then stimulate new construction, Newport said.

If all this holds, housing starts will reach 604,000 this year (still below Freddie Mac's earlier projection), 783,000 in 2011, and 1.21 million in 2012, Newport projects.

But that still would be well below the level the Realtors' group says is necessary.

In fact, Denk and Emrath say, 2010 is "likely to add to the growing deficit of single-family homes by another one million units."

The "foreclosure overhang" is putting a lid on housing starts, said Joel L. Naroff of Naroff Economic Advisors in Holland, Bucks County.

He notes that residential construction is highly dependent on the same areas - the Southwest, California, and Florida - where the bulk of U.S. foreclosures are taking place, offering stiff price competition to new homes.

Even October's small increase in single-family building permits was interesting, Naroff said, "since builders don't generally go through the effort and expense to get a permit unless they have serious plans about turning them into homes."

"[What] we may be seeing is construction catching up with expectations," he said. "Permits exceeding starts hints at a pickup in construction over the next couple of months."

Indeed, Naroff said, the number of homes with permits but not started is at a historic low "as builders manage inventory very carefully."

Moody's Analytics chief economist Mark Zandi said earlier this year that the undersupply of the market could arrive by mid-2012. Construction would likely not have fully caught up to improved demand, and the market would tighten, he noted.

Denk and Emrath acknowledge that there was an excessive amount of single-family building from 2003 through 2005, but that the overbuilding largely ended by 2006 and the subsequent downturn was severe enough to more than offset those surpluses.

"Depressed levels of single-family housing production resulted in a cumulative deficit of 2.17 million units by 2009 and will likely grow to 3.28 million by the end of this year," Denk and Emrath said.

For a cumulative deficit in single-family production to persist, they said, a cumulative deficit in the number of households also must persist.

Historically, the United States averaged 1.2 million net new households per year between 1960 and 2005. Even without adjusting for population growth, household formations have run below that average consistently since 2005.

"It is also probably not surprising that household formations have stalled and remain depressed while the national unemployment rate is above 9 percent," Denk and Emrath said.