The housing market improved significantly in building activity, sales, and prices in 2012. However, these indicators remain at depressed levels, not only in comparison to the housing bubble period in the mid-2000s, but also in comparison to
The housing market improved significantly in building activity, sales, and prices in 2012. However, these indicators remain at depressed levels, not only in comparison to the housing bubble period in the mid-2000s, but also in comparison to the more stable housing market of the mid- to late 1990s. Consider the following measures of housing activity:
These are just a few examples of housing market conditions that, while rebounding above recent crisis-induced levels, remain depressed. This begs two questions: 1) what is a “healthy” or “normal” U.S. housing market? and 2) how long will it take us to get there? While there are many aspects of a healthy market, this commentary focuses on sustainable levels of new production of housing units to meet future demand. We deem this sustainable level as representing normal housing production.
In Figure 1, we lay out our forecast of the normal level of housing supply required to meet the trend level of housing demand. Our forecast indicates that homebuilding will reach normal activity by 2016.
Figure 1: Demographic factors and historical trends suggest an annual average demand for nearly 1.8 million new housing units in the second half of the decade.
Source: Fannie Mae Economic and Strategic Research
Housing Demand Growth
The central determinant in forecasting the normal level of housing production is to derive future housing demand. We forecast a trend level of demand during the second half of the decade of 1.76 million units per year, which derives from three major components1:
1) Household Growth: Household formations are the largest component of incremental demand for housing units. Annual household formation—the number of net new households generated each year—slowed from nearly 1.4 million during the first half of the 2000s to less than half a million during the housing bust. We expect an average of slightly below 1.4 million net new household formations each year from 2015 through 2020. To derive our household projections, we apply our forecast of headship rates—the rates at which population in various age groups form into households—to the Census Bureau’s population projections. Our projections are based on the Census Bureau’s 2012 National Population projections released last December in which the Census Bureau significantly downgraded its outlook for population growth in coming decades, largely due to more moderate immigration projections. Had we used the Census Bureau’s more optimistic 2008 population projections, our projected annual household increase would have been roughly 1.5 million, other things remaining equal (see Figure 2).
Figure 2: A downgrade in Census Bureau population projections leads to a softer forecast of trend household formation.
Source: Census Bureau, Fannie Mae Economics and Strategic Research
2) Change in Vacancies: Growth in vacant housing units is the second component of new housing demand forecast. Additional vacant housing units are required in a growing housing market to satisfy new demand for vacation and second homes, as well as to accommodate movement and ensure smooth functioning of the market. Based on our household forecast, and the historical relationship between households and vacancies, we expect annual growth in vacant units to reach approximately 160,000 units during the second half of this decade.
3) Net Removals: The final component of new housing demand, net removals of housing units from the stock, comprises multiple distinct flows including demolition of obsolescent housing; losses due to natural disasters, fires, and similar events; combinations or subdivisions of existing housing units; and conversions of structures to and from residential use. We calculate net removals using a residual method that subtracts the change in the housing stock between decennial censuses from total housing production. Based on this approach, we expect annual net removals to account for approximately 230,000 units of new housing demand by the second half of this decade.
New Housing Production
During the mid-2000s housing bubble, residential construction outpaced fundamental demand for housing, creating an excess supply of housing units. In the aftermath of the bubble, new construction fell more than new housing demand, resulting in absorption of some of the excess supply. By the second half of the decade, we expect the excess supply to be worked off and to return to an environment where new housing demand and housing production are aligned. After three straight years of averaging roughly 600,000 units, housing starts rebounded to 780,000 