In this episode of The REconomy Podcast™ from First American, Chief Economist Mark Fleming and Deputy Chief Economist Odeta Kushi examine the history of homebuilding and the dynamics that have fueled our chronic housing supply crisis and explain the daunting challenges homebuilders face in trying to meet the demand for housing.

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Listen to the REconomy Podcast™ Episode 101:

“We know that builders have tried to respond to the housing shortage, but they have faced ongoing supply-side challenges stemming from skilled labor and lot shortages, lending issues, rising material costs and regulatory barriers that have made it difficult to deliver more homes.” – Odeta Kushi, deputy chief economist at First American

Transcript:

Odeta Kushi - Hello and welcome to episode 101 of The REconomy Podcast, where we discuss economic issues that impact real estate, housing and affordability. I am Odeta Kushi, deputy chief economist at First American, and here with me is Mark Fleming, chief economist at First American. Hey, Mark, you know, we spend so much time talking about the rate lock-in effect and how it's keeping homeowners from selling, and that's fair, because it's a real concern in today's market. But today, I want us to answer the question, if you can't buy an existing home, why not just build one?

Mark Fleming - Hi, Odeta, episode 101. Here we go. So, does that mean today we're laying the foundation for understanding the home-building market, brick by brick. 

Odeta Kushi - Indeed, we will frame the conversation around the new-home market and how builders are faring in today's environment. And, of course, we'll ask the question: while builders are raising the roof, can buyers afford to keep up? We will also apparently be engaging in a pun competition, and for those keeping score, it's currently tied at two to two.

Mark Fleming - This is going to be a tight competition. I'm sure I know how competitive you are. 

Odeta Kushi - Yeah, it's on. 

Mark Fleming - But enough with our puns. Okay, not really. Let's start hammering out the details. Three to two, me. 

Odeta Kushi - Alright, alright. Really, we got to get to it now. And I want to start with a historical overview. Let's look at how much homebuilding has been done in the past relative to present. We were able to use historical U.S. Census Bureau data to compute the number of total housing starts per 1,000 households all the way back to 1920 and we found some pretty interesting trends.

Mark Fleming - That's right. Starting from the very beginning, the average number of housing units constructed per year increased from 449,000 in 1921 to an average of 833,000 between 1922 and 1928. That's almost doubling of the rate of home building. This was the building boom of the 1920s, caused in part by a booming economy. And then in the late 1920s to mid-1930s building declined, obviously because of the Great Depression. In fact, in 1933, housing starts per 1,000 households was just three. That's right. Three, a series low in the entire history of the data we're about to talk about.

Odeta Kushi - Wow, three starts per 1,000 households. That's very low. But, you know, by the late 1930s, we were building again anywhere from 500,000 to 700,000 units a year, which equated to 15-to-20 units per 1,000 households. Then, there was a massive building boom in the post-World War 2, 1940s and 1950s. In fact, building peaked at 1.9 million units in 1950, or 44 units per 1,000 households. We have never built at this rate since.

Mark Fleming - Yes, the 1940s and 50s, spurred by the GI Bill, which guaranteed home loans with no money down. This is essentially when we built many of the suburbs that we know today around our major metropolitan areas, allowing millions of veterans to buy homes and move out to those newly built suburbs.

Odeta Kushi - That's right. And then we had the Federal Highway Act of 1956, which authorized the construction of 41,000 miles of new interstate highways, making cities more accessible to suburbanites. So, the percentage of American households who owned their homes increased from 44% in 1945 all the way to 62% by 1960.

Mark Fleming - That is a big increase, because generally, the homeownership rate does not move around very much. In fact, it has stayed between 62% and a peak of 69% ever since. And arguably that 69% homeownership rate that was reached at the peak of the housing bubble, that was anomalous. Currently, the homeownership rate is 65%, really not that far from the 62% back in 1960.

Odeta Kushi - Now, speaking of the housing bubble and subsequently the Global Financial Crisis.

Mark Fleming - Wait, wait, hold on, you can't possibly be skipping the '80s. I know we're on to our next 100 episodes, but I have a plan.

Odeta Kushi - Well, I mean, it wasn't particularly exciting.

Mark Fleming - What? The decade of big hair, neon everything, Back to the Future, and mix tapes. You do know what a mix tape is, right?

Odeta Kushi - I think I've seen like a picture in the history museum, maybe.

Mark Fleming - In a history museum. Oh, geez, for those listeners out there, do you miss your dual cassette deck and turntable? The ‘80s were totally rad. 

Odeta Kushi - Well, I meant nothing particularly exciting in the number of housing starts per 1,000 households, but yeah, tell us how you really feel.

Mark Fleming - Oh yes, that in the 1980s we were building about 18 units per 1,000 households on average. There was a dip in 1982, which is around when the housing market was struggling from those really high interest rates we've talked about in the past. But, even in that dip, we were building about 13 units per 1,000 households. 

Odeta Kushi - And then, from the mid '80s through the mid-2000s we were building on average, 15 to 16 units per 1,000 households. At the trough of the Global Financial Crisis correction from 2009 to 2011, we were building five units per 1,000 households, close to the Great Depression historical low. And currently, we're only building about 10 per 1,000 households. That's about the same as in 1991.

Mark Fleming - So it becomes clear, we have not built like we did post-World War 2 -- 40 housing units per 1,000 -- or anywhere close to that in many decades. So, based on some of these earlier numbers, it seems we have been significantly under building, at least since the trough of the Global Financial Crisis.

Odeta Kushi - That's right. And there's a lot of different ways to measure the extent of underbuilding. I mean, the example we just gave could be considered a flow-stock analysis, right. With housing starts being the flow variable -- how much we're building -- and the number of households being the stock variable. But, even when we do a flow analysis, we find that we've been underbuilding for over a decade. No wonder the housing market feels like it's been hammered by low supply. 

Mark Fleming - Oh, now we're back tied at three to three.

Odeta Kushi - I did nail that one. Didn't I? Four to three. Okay, moving right along. The average estimate of the nation's under supply is approximately 3 million units. When we look all across the industry estimates, it's right about 3 million. And the flow analysis I just mentioned measures the housing deficit by comparing new household formation, both rental and owned, to total new housing units completed and added to the housing stock, accounting for the replacement of a small fraction of the old stock for obsolescence. And, based on this analysis, we find that we have been under building since 2009.

Mark Fleming - Now, currently, there are approximately 1.5 million units of housing under construction, that's including apartments and homes. And, if all of those units proverbially came to market ready to sell or lease in the proverbial tomorrow, and there was no new household formation, no second home sales and no destruction of homes, then that's still only half of what's needed to meet that consensus shortage number. 

Odeta Kushi - Of course, we know the supply shortage isn't static because households will continue to form. Consider that between 2019 and 2022, annual household growth was 2.1 million per year, according to American Community Survey data. That's well above average household growth between 2017 and 2019 of approximately 1.3 million households per year. But, even assuming a more modest pace of household formation next year of 1 million, at least that many new homes must be built just to keep pace with potential demand. And, we have other ways of measuring the shortage as well. But, no matter the methodology, we always come to the conclusion that we've underbuilt in this country relative to demand for many years.

Mark Fleming - Okay? Econ shocker here. Look no further than our house price data. House prices are at the intersection of that supply and demand dynamic and, according to our First American Data & Analytics House Price Index, house prices have recently reached a new record high in September. Super simple, right? Well, actually not so easy, because of the five L's.

Odeta Kushi - Yep. And despite some recent pickup in both new- and existing-home inventory, we know that total inventory of existing and new homes for sale relative to the number of households, or what we like to call inventory turnover, has historically been about 2.5 percent, or 250 per 10,000 homes. Recently, that number was a mere 130 per 10,000 homes, up slightly from earlier this year, but still far from sufficient. So, I guess, to my earlier question, why don't we just build more homes? What did you say? The five L's?

Mark Fleming - The five L's -- labor, lots, legal issues, lumber and lending. These are ongoing challenges that builders have been facing that make it more difficult and costlier to build new homes.

Odeta Kushi - Ah, yes, we did touch on this in a previous episode in 2021. So, we know that builders have tried to respond to the housing shortage, but they have faced ongoing supply-side challenges stemming from skilled labor and lot shortages, lending issues, rising material costs and regulatory barriers that have made it difficult to deliver more homes.

Mark Fleming - And now builders are facing a market where consumers are struggling with diminishing affordability due to higher mortgage rates.

Odeta Kushi - That's right, so let's expand on some of these L's, starting with labor. Building a home, as we know, does not readily lend itself to outsourcing and automation. Homebuilding still requires manual labor as a key input into the production process, so you need more hammers at work to build more homes. The chronic labor shortage in construction has been a challenge for many years. And, despite positive gains in residential building, construction and remodeling jobs, more is needed. Many construction workers are aging out and retiring from the workforce and, at the same time, the industry is struggling to attract younger generations to careers in the trades. A recent analysis estimated that for every five people that retire, the industry is bringing in approximately two new workers. And, according to estimates from the most recent Homebuilders Institute Construction Labor Market Report, the required amount of construction workers needed per year is over 700,000 for the period between 2024 to 2026. This estimate represents the need for an additional 2.2 million adjusted net hires for the industry.

Mark Fleming - Listeners, if you're interested, check out the transcript, because there are lots of hyperlinks to all of these statistics that we're mentioning in this podcast today. Andon building materials, inputs to residential construction costs remain nearly 30% higher than pre-pandemic. Now, lumber prices have come down from their really high levels of 2021 and 2022, but other building materials, such as gypsum and drywall costs, remain above pre-pandemic levels. 

Odeta Kushi - And, on the financing side, according to NAHB's survey on AD&C financing, the availability of financing continued to tighten in the second quarter of this year and became even more expensive for most types of loans. So, for example, loans for land acquisition increased from about 11% to just over 12%, the highest these rates have been since NAHB started tracking interest rates in 2018.

Mark Fleming - And then there's all the regulatory costs. Another study from NAHB shows that regulations imposed by all levels of government account for almost $94,000, or 24% of the current average sale price of $397,000, of a new single-family home. That's from a 2021 study, and it showed that those costs were up 11% from 2016. I expect if it were refreshed, those numbers would be even higher.

Odeta Kushi - Yeah, and if you think about it, that doesn't even account for the rising material costs that end up showing in that final price of the home. So rising material costs, rising regulatory costs, chronic shortage of skilled labor, higher financing costs, these must get passed on to the consumer, right? 

Mark Fleming - Well, some of these costs definitely do, and buyers are already facing affordability challenges in today's market, but builders have also been addressing that affordability crunch by building smaller homes. According to a second quarter 2024 Census data, the estimated median square footage of a new single-family home was the smallest since 2010. Builders' adaptation to the needs of affordability-constrained buyers are working for now. About 40% of single-family home sales by builders have been made to first-time home buyers so far in 2024. By comparison, in 2016, that share was only 19%.

Odeta Kushi - Wow. So, despite all the challenges we've discussed, builders have had an advantage in today's market. Consider that existing homes have historically made up nearly 90% of the overall for-sale housing inventory. In 2024, that share has decreased to just over 70%. So the new-home market has gained market share since 2020 because of two primary factors -- the volume of new single-family homes for sale has increased and existing-home inventory has been very constrained. The collapse of existing-home supply is largely a result of the golden handcuffs of low mortgage rates, as about 84% of mortgaged homes have a mortgage rate below 6% and are financially disincentivized from selling their home in the current mortgage rate environment. We also know that builders can offer incentives, something that an existing homeowner is unlikely to do. So those are mortgage rate buy downs or even price cuts to entice buyers off the sidelines. According to an analysis from NAHB, 32% of home builders cut prices in September by an average of 5%, and 6% of builders use some form of sales incentive. So, when there are few suitable existing homes for sale, a new home with a rate buy down can be an attractive alternative. 

Mark Fleming - That's right. The long-term housing shortage coupled with a lack of existing-home inventory and builders ability to offer incentives will certainly help buoy new single-family home construction this year and into next. See how I constructed a bullish case for new homes next year.

Odeta Kushi - Way to even out the score at four to four in the final minute.

Mark Fleming - Yes, and love how this episode was full of so many concrete facts. Five to four.

Odeta Kushi - All right, I think we better end here before it gets any worse. So, to wrap up our conversation today, the housing shortage is real and contributing to the affordability challenges faced by potential buyers. Today, builders are trying to bridge the gap that is needed between supply and demand, but they face their own set of hurdles. Easing mortgage rates in 2025 should help with affordability constraints and financing costs. And the chronic shortage of existing homes should continue to make a new home a good option. Well, that's it for today. We hope this episode cemented some new ideas for you. Five to five. I'm a sore loser. And, thank you all for joining us on this episode of The REconomy Podcast. If you have an economics-related question you'd like us to feature in the future, you can email us at economics@firstam.com. And, as always, if you can't wait for the next episode, you can follow us on X. It's @OdetaKushi for me and @MFlemingEcon for Mark. Until next time.

Thank you for listening, and we hope you enjoyed this episode of The REconomy Podcast from First American. We're pleased to offer you even more economic content at firstam.com/economics. This episode is copyright 2024 by First American Financial Corporation. All rights reserved.

This transcript has been edited for clarity.