[A] new type of thinking is essential if mankind is to survive and move toward higher levels.
Albert Einstein telegram reported in New York Times on May 25, 1946 in reference to atomic weapons and often inaccurately recited as “[p]roblems cannot be solved with the same mind set that created them”.
Although Einstein was concerned in 1946 with the thinking by humans about the creation and use of atomic weapons for which he urged $200,000 in research funding, his advocacy for new thinking is far more generally applicable. The daily news cycle, which now abides no rest for the media, declares daily clearly inconsistent and seemingly irreconcilable problems in the U.S. capitalistic housing market — a market that has created the highest standard of housing worldwide in our humble opinion.
Conundrum Part 1 : The Affordability Problem
Day-to-day market researchers and analysts report that housing is unaffordable. For-sale home prices and rents have been rising by double digits for two years. The median for-sale home price is near $390,000 down only recently from above $400,000. Mortgage interest rates settled just below 7% in the week ending September 30. The total cost of housing for the median home surpasses $3,000 per month (including taxes, insurance, utilities, and PMI, assuming a 10% downpayment).
Median income for one wage-earner in the U.S. hovers today around $57,000, which is $4,275 after taxes at the lowest (10%) income tax rate. Median household income in 2021 (the last year for which data is provided by the U.S. Census Bureau) was $70,784, down slightly from 2020. A prevailing rule-of-thumb is that a household should spend no more than 30% of its net income on all housing costs, although much higher ratios are allowed by government mortgage guaranty agencies. The median home monthly cost of $3,000 amounts to 70% of one wager-earner’s income and nearly 51% of median household income. A conundrum? A paradox? An intractable reality?
Academics, analysts, policymakers, and industry participants all easily see the affordability part of the conundrum. The most often urged solution is more housing. Increasing the supply should drive down the price, or so goes the supply-and-demand theory of economics.
Conundrum Part 2 : Housing Supply Is Decreasing
Freddie Mac research reported in 2018 that the U.S. housing supply was short by 2.5 million units. Other analyses quote a much higher number. Three years later, Freddie Mac reported that the housing deficit had increased by 52% to 3.8 million units, relying in part on vacancy rate data from the U.S. Census Bureau and assuming that a health housing market has a vacancy rate of 13%. At the end of June 2022, the vacancy rate reported by the Census Bureau was 5.6%.
The cited reasons for the shortage of housing are numerous, as reported by National Public Radio and many others. An non-exhaustive list of cited causes are:
- Lasting overhang from the 2007-2008 housing market decline, including a labor shortage;
- Increased investor participation as buyers in the single-family and townhome segments of the housing market;
- Municipal regulations and regulatory processes that limit density, increase land development cost, and slow the approval of new communities;
- Local resident opposition to increased housing density or affordable housing construction;
- Rising land cost;
- Scarcity of available land within reasonable commuting distance of employment;
- Inadequate investment in transportation infrastructure;
- Much more restrictive mortgage origination criteria as a result of the 2007-2012 default rate on subprime and no-doc loans;
- Higher construction costs particularly as a result of the Covid-19 pandemic and its impact on the supply chain for materials and as a result of consolidation among construction suppliers;
- Rapidly increasing interest rates on construction loans;
- Scarcity of financing for land acquisition and development also a direct result of the 2007 housing market collapse and default by land developers on acquisition and development loans.
The Pew Charitable Trust recently published an informative and balanced overview of the challenges to expansion of the U.S. housing supply. The report optimistically noted the issuance of one million building permits in the first seven months of 2022, basic math proves that number to be far from adequate. Unless the U.S. population stops growing immediately and children stop becoming adults, new household formation, which was historically low from 2010 to 2020, will absorb a substantial portion of new homes constructed.
According to the last decennial census, approximately 1.01 million new households were formed annually from 2010 to 2020. At the building-permit issuance rate cited by the Pew report from September 2022, annualized new building permits in 2022 will be approximately 1.7 million. Subtracting the absorption of those new homes by newly formed households leaves 700,000 new homes to close the 3.5 million gap in housing supply. In other words, at least five years.
Taking into consideration the actual trend of new building permits from January to August 2022, the outlook is even more bleak. According to the Census Bureau, the annualized new permits count for August was 1,542,000 — 13.5% below the 1,782,000 average from January to July and almost 13% below the prior year.
At the August annualized new permit rate, the country will wait more than 6.5 years to close the housing supply gap. Of course, rising interest rates and ongoing supply chain problems will bedevil the home construction industry and likely drive down the growth of housing supply while new households continue to form.
In Part 2 of this post, we will examine in more detail the factors affecting housing supply.
