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Monday, June 02, 2008

Lawrence Lindsey on Housing: It's Only Going to Get Worse

by Calculated Risk on 6/02/2008 12:12:00 PM

From Lawrence Lindsey: Everything you always wanted to know about the housing crash, but were afraid to ask.. Lindsey covers a number of topics (hence the title), but here are some short excerpts on inventory and demand:

There are 129 million housing units in the United States, comprising owner-occupied, rented, and vacant units. Of these, 18.5 million are empty. This vacancy rate is 2.5 percentage points higher than it has been at any point in the half century the data have been tracked, translating into at least 3 million too many empty housing units in the country. This number, moreover, is rising. This is the most intractable part of the real estate bubble, for we cannot find a true bottom to home prices until this inventory of empty units starts to clear, and we cannot find a bottom to the mortgage finance market until home prices bottom out.
No question - there is a huge overhang of inventory in the U.S., but I think Lindsey's analysis overstates the problem. Here is my estimate:


Homeownership Vacancy Rate Click on graph for larger image in new window.

This graph shows the homeowner vacancy rate since 1956. A normal rate for recent years appears to be about 1.7%. There is some noise in the series, quarter to quarter, so perhaps the vacancy rate has stabilized in the 2.7% to 2.9% range.

This leaves the homeowner vacancy rate almost 1.2% above normal, and with approximately 75 million homeowner occupied homes; this gives about 900 thousand excess vacant homes.

Rental Vacancy Rate The rental vacancy rate increased to 10.1% in Q1 2008, from 9.6% in Q4. It's hard to define a "normal" rental vacancy rate based on the historical series, but we can probably expect the rate to trend back towards 8%. According to the Census Bureau there are 35.7 million rental units in the U.S. If the rental vacancy rate declined from 10.1% to 8%, there would be 2.1% X 35.7 million units or about 750,000 units absorbed.

This would suggest there are about 750 thousand excess rental units in the U.S. that need to be absorbed.

If we add this up: 750 thousand excess rental units, 900 thousand excess vacant homes, and 200 thousand excess new home inventory, this gives approximately 1.85 million excess housing units in the U.S. - very high, but well below Lindsey's estimate of 3 million units.

And Lindsey on demand:
The math of the housing market is fairly clear. Each year roughly half a million homes are destroyed to make better use of the land on which they sit. Population growth also helps whittle down inventory. The household formation years--ages 25 to 34--have 39.5 million people in them forming 19 million households, a group that creates demand for 1.8 to 1.9 million units each year. On the other hand, households pass from the scene later in life, and the homes they used to live in go onto the market. There are 11.6 million households of 65- to 74-year-olds and 9 million households of 75- to 84-year-olds. Their departure increases supply by around 1.1 million units per year. On net, therefore, demographic realities add about 850,000 units to demand on top of the half-million homes that are destroyed and removed from supply.

The home building industry is in a deep recession, with additional yearly new home supply cut in half since 2006. But homebuilders are still adding nearly a million units per year. The math is simple: Build a million, tear down half a million, form 850,000 households, and the country only whittles down its excess inventory by 350,000 units per year. This is one reason to expect a further drop in new home construction, but it will still take years to get our housing inventory back to normal. The economic, social, and financial damage over that time could be staggering.
It's important to understand that during a recession (or economic slowdown) fewer household are formed than normal, and also fewer housing units are demolished. Lindsey is estimating the demand for a normal economy (some people get confused by temporary changes in demand due to economic conditions, as opposed to the demand during more normal times).

Once again, I think Lindsey is a little too pessimistic. But this does illustrate the key problem for housing; it will take years to work off the current excess inventory.
Read on ... there is much more.