Building a new
house generates a lot of economic activity.
Before a shovel breaks ground, architects, developers and banks get some
business. A realtor may take a commission. The physical substances of the house are cut
down in forests, quarried in gypsum mines etc.
From there, they're hauled to mills and factories, where workers
transform them from raw materials into finished goods. Once manufactured, transportation firms again
act as a middleman, delivering them to the construction site. When the building phase begins, well-paid
laborers and skilled tradesmen pour the foundation, erect the frame, run wire,
fit pipe, top it off with a roof, and so on.
Clearly, it's a major undertaking, and this isn't even an exhaustive
list.
A major reason for
the US economy's lackluster recovery is the stubborn lack of a rebound in
housing. While the economy went through
a Great Recession, the housing market has suffered a Great Depression. After a crazed period of overbuilding, the
housing bubble popped; housing starts have plummeted, as empty homes are slowly
filled. A look at historical housing starts
is striking. From 1959-2007, housing
starts averaged around 1.5 million per year, albeit on a cyclical basis. Until 2008, the number never fell
below 1 million. However, from
2008-2011, household starts averaged just 664 000 (starts) (1). Early indications suggest the number may be
around 750 000 or so for 2012, about half the historical rate.
Household formation
is mostly composed of two groups of people: immigrants and young people leaving
home. To a lesser extent, it also
includes people living with roommates, siblings and extended family that decide
to settle on their own, as well as divorcees, and a few other small
cohorts. Many immigrants continue to
dream about moving to the US, but few young people fantasize about living with their
parents forever (Warren Buffett has joked that "hormones" will heal
the housing bust). As the economy picks
up, and the jobs market recovers, pent-up demand - of both kinds - will be
released and homes will be built to accommodate it.
Once the excess
supply of homes is filled and the market is back in balance, housing starts
will match household formation over time.
A report from the Harvard Joint Center for Housing Studies projects that
2010-2020 household formation will likely average 1.18-1.38 million per year
(2). Whether it happens in a few weeks,
months or years, housing starts will nearly double from recent levels, and
create tremendous amounts of economic activity in the process. Though lower than past levels of household
formation, projections for the next decade remain 600 000-800 000 higher than starts
in recent years.
How much economic
activity will result as this gap closes?
Here's a crude, back-of-the-envelope estimate, designed not to be
precise, but to make a broad point.
Assuming housing starts that are 700 000 higher than in recent years,
and assuming a cost of $200 000 per house, $140 billion of additional economic
activity would be created per year, which would add nearly a full percentage
point to GDP. Keep in mind, this assumes
no multiplier effect at all, and ignores add-on purchases, such as new
furniture and yard equipment, that often coincide with new construction.
More aid will come
to the economy when real estate prices resume their rise (over the very
long-term, the price of real estate tends to rise at, or slightly ahead of, the
rate of inflation). Homeowners tend to
consume more as property values appreciate, a confidence-related phenomenon known
as the "wealth effect." One
estimate holds that for every dollar in increased wealth, consumers spend 6
extra cents (3). Given that consumer
spending accounts for 70% of US GDP, wealth’s effect on the economy is
considerable. And banks, which in recent
years have suffered heavy mortagage-related losses, will become more
profitable, prompting them to lend to consumers and businesses, and bolstering
the economy in the process. Banks, after
all, lend in proportion to their assets.
There's no
water-tight way to predict when the housing recovery will arrive, but
eventually it will, likely on a city-by-city basis. Though the housing bubble was national in
scope, real estate remains mostly a local market. When housing comes back in most major
markets, the US economy is likely to enter a strong, self-sustaining
recovery. A word of warning, though: shy
investors that take a wait-and-see approach may find that stocks have made most
of their gains by the time the long-awaited recovery appears.
Sources:
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