Monday, June 11, 2007

Housing Fundamentals

Let me start by saying that I am not a housing economist; what follows is an analysis based on what I perceive to be common sense fundamentals. Please correct me if I am wrong.

House construction must be correlated with the formation of new households, particularly those consisting of more than one person. The chart below shows annual house starts and new households with two or more persons. From this perspective, the housing "bubble" can be at least partly explained by the unusual spikes in new households in 2001 and 2003, further boosted by record-low interest rates in the same period.

Data: Census Bureau

There are a few observations that can be made from the above chart:

a) Spikes in household formation, rising much above the median (754.000/yr), are rare. There have been only three in the past 45 years (1980, 2001, 2003). The unusual 2001-2003 sequence must have driven housing demand beyond normal and caused builders to become overly optimistic.
b) When the difference between housing starts and household formations widens too much, a significant correction follows, with starts dropping as low as 1 million units/yr. As of April 2007 starts were still running at 1.53 million units/yr.
c) Will household formations spike upwards again in the near future, thus driving housing demand anew? I am not a demographer, but logic argues against it.

I must conclude that, from a fundamental point of view, housing construction will continue to decline, particularly now that interest rates are also ramping up, creating affordability issues.


  1. I don't think new households drive the construction business. It's more like the other way round. If housing is too expensive relative to income you stay home with mom & dad for a few more years. If housing is affordable (i.e. price, low interest, sucker loans, etc.) you get a place of your own.
    Eventually speculation was the driving force behind the latest building boom (at least here in Miami). People that never intended to occupy the new housing after completion. They camped out on the street before pre-construction sales...why just flip one? It's the new economy. Downpayments are for sissies. Builders egged on by the mania went over board and created a huge oversupply. Now builders are unloading at lower prices putting specuvestors upside down in their "investments". They are left holding the bag...couldn't have happend to a nicer bunch of people. I hope they lose every penny and with it the ability to screw up other people's lives. Houses are for living. If you want to speculate, we have a thing called the stock market or Vegas.

  2. Yes, I think this time around the final days of the housing cycle most definitely involved rampant speculation. But as with all "speculations", the housing bubble was also based on a kernel of truth: there were a lot of newly formed households chasing a place to call home.

    For example, the dotcom mania was based on fundamental progress: technology improved and telecoms became very cheap. But that is one thing and IPO's priced at ridiculous valuations is quite another...


  3. Just anecdotally, I know of at least 3 single women in their late 20s and early 30s who bought a house/condo in the past 3 years. So I'm not sure that your assumption about new household creation based on 2 person situations is entirely accurate.

    Hoax Meister

  4. There will always be single people buying regular houses (the chart/correlation does not include condo apts.), but common sense dictates that they are a small minority.


  5. Hi,

    What is astounding with this mania is just the opposite to the previous one.

    The previous bubble was business-related, technology-driven, highly immaterial, sometimes down to nil...

    AMHA JUSTIFICATION FOR BUBBLES SHOULD NEVER BE SEARCHED FOR IN DEMAND. Since this is alas essentially a matter of perverse currency management. Financial conditions are the key.

    I do not qualify as an Austrian economist but well that's pretty obvious.

    When money is printed by the billions on a yearly basis, noone saves anymore. Saving become a stupid habit. Spending is the trick.

    Everyone looks for down-to-earth investment possibly with others' money. This "other" is the FED.

    In the end this is all about currency, inflation (the real one) and very bad financial habits.

    No more need for this housing over-extended building endeavour than for the Tulips in Netherlands in goold old days.

    You can of course include in the needs for housing the need for housing of those who entered the country to build the new homes...

    By the way those people will need funding. Call that subprime, I expect?


  6. Hai,Nice post...I like it...