Adam Deermount
Adam Deermount

It’s incredible how quickly things change. Just a few years ago, conventional wisdom was that it would take an eternity to work through the excess inventory created by the housing bust and subsequent foreclosure crisis. In reality, banks proved adept at managing their REO inventory, preventing the anticipated glut. Meanwhile, little new housing was built as financing dried up and builders pulled back in fear of competing with the anticipated bank REO liquidation. Fast forward to 2016 and the stark reality of a new sort of housing crisis: there simply aren’t enough units being built to satisfy household creation. The pivot has been as pronounced as it has been swift and it doesn’t appear as if things are about to change anytime soon. The Federal Government’s bi-annual report on housing inventory provides a rather bleak outlook, especially for entry level buyers and renters. ULI put together an excellent summary of the report here (emphasis mine):

“Newly released data and analysis illustrate a major obstacle to a fully healthy housing market in the United States: the nation is not building nearly enough new residential units. The serious shortage of new supply is bottling up housing demand and pushing home prices and apartment rents well beyond what a growing number of households can afford.

A biennial report from the federal government titled The Components of Inventory Change found that the nation’s housing stock increased by a net 270,000 units between 2011 and 2013—the slowest growth measured by the survey over the past decade, which included the worst years of the Great Recession. The report concluded: “Despite the gradually improving economy, there were large declines in both new construction and net additions to the housing stock during the 2011–2013 period compared to the 2007–2009 period.

A recent Freddie Mac commentary noted that the total number of housing starts … in 2015 was 30 percent below the historical average between 1970 and 2007. The National Association of Realtors estimates that the country’s supply of for-sale and rental units combined is 3 million units short of current demand.”

The most pressing issue here is that not only are we not producing enough units across the board but nearly nothing is being produced at the entry level in either for-sale or for-rent properties where units are most in need. Again, from ULI (emphasis mine):

A survey conducted by the National Association of Home Builders (NAHB) found that 59 percent of respondents said they could and would spend no more than $249,000 on a new home, but only 35 percent of new homes started in 2015 were at or below that limit. The online real estate service Trulia recently reported that the number of starter and trade-up homes available […] has plunged by more than 40 percent since 2012.

Yes, […] multifamily construction volume nearly doubled in 2012 compared with that seen in 2010, and increased another one-third from 2012 to 2014, according to a new study by the Research Institute for Housing America. […]

But most new apartments and single-family homes are aimed at the top of the market. […]. The average price of new homes for sale in 2015 was $351,000—a 40 percent increase from 2009.

What is driving the trend towards builders constructing a smaller number of higher priced units? A few factors to consider:

1- Post financial crisis, there wasn’t much of any mortgage financing available at the lower end of the market. So builders focused on more expensive price points where buyers were willing and able to obtain financing or buy with cash. Combine this with the higher margins often achieved on luxury units and you have a recipe for builders gravitating towards more expensive units. Availability of financing is improving but it has left certain markets 100% beholden to FHA limits.

2- Regulatory burden is soaring. A study from NAHB released earlier this year, found that regulatory fees for new construction jumped nearly 30% over the past 5 years. Builders need more expensive product to absorb the regulatory burden in order to make a profit.

3- People are staying longer in their entry level homes due to the lack of move up houses inventory which results is less infill availability driving up prices. If supply does not materialize to meet demand, yesterday’s entry level home becomes too expensive to be classified as entry level.

4- While the development financing market has shown some marginal signs of improvement, especially for developers with well located properties, for most, it still isn’t very good.

5- Land owners aren’t selling, at least not when it comes to their best lots. One would think that rising home prices would make this a land seller market. However, that isn’t currently the case as Bloomberg detailed recently. When asked for investment advice, Mark Twain once said: “Buy land, they’re not making it anymore.” Right now, owners of well-located land are heeding a variation of that advice in expectation (or, perhaps hope) of higher prices: don’t sell your land because you can only sell it once and it’s likely to be more valuable in the future. There is substantial gap between what builders are willing to pay and what landowners are willing to sell for, particularly in the best markets. Landowners will sell today but only if builders are willing to pay them for possible future inflation that may or may not happen. To complicate matters further, a lot of landowners bought during the brief run-up in 2013 thinking that the market was about to take off. It didn’t and now they are holding out in hope of higher prices down the road.

At some point, the laws of economics dictate that this has to change. We aren’t going to stop creating households and people can’t continue to pay an ever-larger percentage of their incomes towards housing costs without resulting in adverse economic consequences. Demographics are improving for household creation through at least 2024, meaning that the housing shortage will get worse as the deficit continues to widen unless we ramp up production in short order. Unfortunately, as you can see it’s not a problem that’s easily solved.

Adam Deermount, is co-founder of Landmark Capital Advisors in California and Landmark Links blogger.