Many housing optimists a year ago believed not only that the housing collapse was over, but also that a robust rebound was under way. Low mortgage rates and collapsed housing prices, not to mention the $8,000 federal tax credit for new home buyers and other initiatives, seemingly were going to kick-start housing activity nationwide.
Then a funny thing happened on the way to the housing recovery. The tax credits expired, home sales dried up, and prices resumed their declines from their 2006 peak. Excess inventories piled up due to overbuilding and mounting foreclosures. In the meantime, buying those lower-priced houses became more difficult as lenders, burned by the housing crash, tightened lending standards and increased down-payment requirements.
As a result, the housing sector not only has failed to bolster the weak economic recovery but is also likely to continue to struggle for years. And that's bad news for the economy, which has softened in recent months.
Excess inventories are the mortal enemy of housing prices. Lower prices are needed to unload surplus inventory, but in turn, lower prices bring forth more inventory from anxious sellers. The anxiety of house sellers and the reluctance of buyers are enhanced by the realization that house prices can fall – and are falling for the first time in 70 years.
Those excess inventories are huge. Historically, new and existing inventories listed for sale have averaged about 2.5 million. So that's the normal working inventory level, and anything above 2.5 million is excess. It's currently about 4 million, implying excess inventories of 1.5 million. But wait! There's more! As foreclosures keep mounting, a "shadow" inventory of as many as 500,000 additional homes will become visible as many more Americans choose to sell rather than endure further price declines.
This huge and growing surplus inventory of houses – at least 2 million above normal working levels – will probably depress prices considerably from here, perhaps another 20 percent over the next several years. That would bring the total decline in house prices from the April 2006 peak to 45 percent. My forecast may be optimistic, because declines tend to overshoot on the downside just as bubbles do on the upside.
Homeownership is becoming less attractive as many are realizing that it may be many years before house prices stop falling and stabilize, much less revive. Indeed, the homeownership rate nationally has fallen from its late 2009 peak of 69.2 percent to 66.4 percent in the first quarter of this year – precisely where it stood in late 1998.
As homeownership continues to lose its luster, rental apartments will gain. I'm a big believer in reversions to trends, and I expect the home-ownership rate to continue to decline to its earlier long-term trend of around 64 percent as people continue to separate their abodes from their investments and as the baby boomers age, retire, and downsize. That will mean about 4.5 million new renters in coming years. Apartment construction, which normally runs 300,000 per year, will be robust once surplus vacancies disappear.
Housing revival is normally a key component in rekindling robust growth in an economic recovery. But not this time. Its absence from the already-weak recovery highlights the lack of significant strength – such as in job creation, personal spending, and retail sales – in the sputtering economy.