Inside the Inventory Gap

The supply of single-family homes for sale has been lean since 2012, and housing economists say it is likely to remain so for another two years.


Mortgage Banking

October 2015

By Robert Stowe England


A persistent shortage of homes for sale has defined the housing market for more than three years, according government and industry market data. In July, for example, the supply of existing homes for sale at the current sales pace was 4.8 months, while it was 5.2 months for new homes, according to the U.S. Census Bureau.


“When you look at the aggregate numbers, either for new or existing homes, certainly inventories are fairly tight at the national level,” says Mike Fratantoni, chief economist for the Mortgage Bankers Association (MBA). “Typically you expect about six months of supply to result in a balanced market, where it’s not really a buyer’s or a seller’s market,” he says. If it’s less than six months’ supply, it is a seller’s market, he adds.


A surge in household formation that has outstripped the supply of homes for sale is one key factor behind the inventory shortage on a national level, according to Fratantoni.


The inventory shortfall has also pushed the national median home price above its prior peak. In June 2015, the median home price for existing homes across the United States was $237,700--up 6.6 percent from June of the prior year, according to the National Association of Realtors® (NAR), Chicago. Nine years earlier, in June 2006, the median home price peaked at $230,900. In Jul 2015, the median slipped to $234,000, still above the prior peak.


The evidence of an inventory shortage is even more compelling in some especially tight supply markets such as Denver, Seattle and the San Francisco Bay Area, “where the inventory supply is measured in weeks, not months, and there are dozens of bids coming in above list price,” Fratantoni says.


In these markets, the shortage is driven by geographical constraints such as cities located alongside the ocean, rivers or bays--or hampered by heavy regulatory constraints that slow the pace at which permits can be obtained to build new housing.


The combination of low inventories and higher prices represents a “major issue at the moment” for the housing market, according to NAR Chief Economist Lawrence Yun. Potential buyers are showing more interest in the housing market, notes Yun. However, without more inventory to meet the expected future demand, rising house prices “could choke off demand,” he says. “It could begin to halt some of the housing recovery we have seen so far,” he adds.


Varying indicators of supply


The conventional measure of housing inventory--the number of months of supply of available homes at current sales levels--captures both the depth and the duration of the inventory shortage. Housing inventory soared when demand collapsed after the housing bubble burst. But the inventory trends played out differently for the new-home and existing-home sectors of the housing market.


For new homes, the inventory peaked at 12.2 months of supply in January 2009, according to the U.S. Census Bureau. That was higher than the prior peak of 11.6 months in April 1980.


By October 2011, new-home inventory had fallen to 5.7 months and it has remained below six months’ supply since then, except for the single month of July 2014, when inventory stood at 6.1 percent.


For existing homes, the supply of homes for sale began to fall in 2008 and bottomed at 6.5 months in November 2009, according to the U.S. Census Bureau. Inventory then rose sharply, hitting 11.9 months in July 2010 before beginning a steady slide to 5.5 months in September 2012. Supply has remained below six months’ supply since then, hitting a low of 4.3 months in January 2013.


The inventory shortage is more pronounced if measured against the overall increase in housing stock rather than as the number of months of supply based on current sales activity, according to Frank Nothaft, chief economist at Irvine, California-based CoreLogic, a data and analytics company.


The market is mired in a stretch of “extraordinarily lean inventory in terms of the number of homes on the market for sale,” he says. Based on a new quarterly metric of homes for sale he has developed for CoreLogic, Nothaft contends that there has not been a period of lean inventory that has lasted as long as the current one since 1983.


To create the new metric, Nothaft combines and standardizes the data from both the U.S. Census Bureau and the National Association of Realtors for existing- and new-home sales and then divides it by the total occupied housing stock in a given quarter.


This approach allows better comparisons over time because it adjusts for the growth in housing stock and does not fluctuate with home sales activity, according to Nothaft.


“What we observed is that the most recent three-year period from 2012 through today is the longest stretch of very lean inventory for sale in the housing market over the last three decades across the U.S.,” he says. The inventory of homes for sale stood at 2.11 percent of housing stock in the third quarter of 2015.


Nothaft’s CoreLogic method of calculating the inventory shortage reveals a starker contrast against historic trends than the standard measure of the number of months of supply based on current sales.


By CoreLogic’s metric, housing inventory peaked at 4.02 percent of total housing stock in the third quarter of 2007. The share of homes for sale fell to a 32-year low of 1.85 percent in the fourth quarter of 2012. It remained below 2.2 percent from the third quarter of 2012 through the second quarter of 2015--three full years so far.


By contrast, the longest period of very low inventory before the current one lasted 2.5 years from the third quarter of 1993 through the first quarter of 1995.


Furthermore, Nothaft points out, the current shortage is likely to continue another two years before the market comes into balance--making the current period of lean inventory even more of a historic anomaly.


The shortage skews toward low-priced homes


Inventory is, in fact, the tightest on the lower range of the house-price spectrum, where it is most needed to meet demand, while there is a much better supply of higher-priced homes for sale, according Eric Fox, vice president of statistical and economic modeling at Veros Real Estate Solutions, Santa Ana, California.


Veros divides markets into three price segments: low, moderate and high. “There are lots of people clamoring to get their first home. There are lots of investors who want to purchase in those markets,” says Fox.


On the high end, however, the opposite is true: few investors and more sluggish demand.


“For a typical market, it is not uncommon to see the lower price tier have only two months of supply while the upper price tier has eight months’ supply,” explains Fox.


Meanwhile the overall supply is about five months in the middle price tier for the market, which he considers a balanced market. Veros, unlike most other observers, believes that when markets have four to six months’ supply, they do not have a shortage--and that 6 percent represents a pretty “sluggish” market.


The trends in home-price tiers can mean that prices can rise 8 percent to 10 percent a year for the lowest price tier at the same time in the same market home prices can fall 5 percent for the higher-priced properties.


“That’s a trend we’ve really noticed since the recovery began in 2008 and 2009,” says Fox.


Role of new-home construction


NAR’s Yun believes that the lack of new-home inventory is one of the key reasons why there is not enough supply of homes for sale.


“The cause of the lack of inventory is the accumulation of home builders having stepped out of the market for multiple years,” says Yun.


“If one goes back to 2007 and looks all the way to today, the construction of owner-occupant homes is still at very depressed levels,” he says.


Thus, he argues, many years of lower production of new homes is causing the current shortage of homes in the market. “Single-family home and condo constructions needs to rise 50 percent from current levels to get us back to normal [historical levels of] activity,” says Yun. “That’s how far behind we are in the construction of owner-occupied housing.”


Doug Duncan, chief economist at Fannie Mae, also sees the shortage of newly built single-family homes for sale as a key source of the current inventory shortfall.


“There are just over 200,000 new single-family homes for sale,” Duncan says. By comparison, there has been an average of 325,000 new homes for sale over the period between 1970 and 2004. “So you can see we’re way below the number of actual houses for sale,” he adds.


Duncan also points out that the 2.24 million existing homes for sale is not far from the average from 2000 to 2005. “The actual number is reasonable, but we have had population and household growth since then,” Duncan adds, and that is why inventory at current levels represents a shortage.


The fact that overall demand remains 25 percent below its 2005 peak has helped prevent current inventory shortages from being even worse, according to Yun.


“The demand is not going like gangbusters. It’s just coming around. It’s the lack of supply that is pushing up prices,” he says.


If demand continues to rise without more new supply coming online, it could continue to push up prices, which, in turn, would push down demand because more potential buyers would not be able to afford a home purchase.


Yun sees a link between the number of existing homes for sale and the number of new homes being built. “If we don’t have new-home construction, some of the existing homeowners cannot trade into those new homes. Therefore if they cannot trade up, they cannot release their existing home into the market,” Yun explains.


Role of existing homes


David Crowe, chief economist at the National Association of Home Builders, Washington, D.C., takes issue with the notion that the lack of new single-family home construction is behind inventory shortages in the housing market.


“I think we have a shortage of existing homes for sale. I’m not as clear that we have a shortage of new homes,” Crowe says.


He points to the fact that the new-home inventory has surged significantly from its low of 143,000 homes in July 2012 to 218,000 homes in July 2015.


By comparison, there were 2,080,000 single-family existing homes for sale in 2012. Now there are 2,240,000 for sale, Crowe notes.


“So the inventory of single-family existing homes hasn’t budged very much since basically the bottom in 2012, while the inventory of new homes has risen substantially,” says Crowe. “We are putting more new homes on the market while owners of existing homes are not doing much about putting their homes on the market.”


There are several reasons why homeowners are not moving currently whereas otherwise they might, according to Crowe.


Some do not have sufficient equity to sell their homes and make a move without bringing money to the closing table. Or if there is equity in the home, it is not enough to make a down payment on the next home.


Some have refinanced their homes and have very low mortgage rates, and do not want to give them up. They are opting not to move because they would have higher house payments, explains Crowe.


Some homeowners may have enough equity to sell but household income has fallen and “their personal economic situation is still uncertain,” Crowe says.


Finally, some homeowners might not want to sell because they think they might not be able to qualify for a mortgage, as mortgage standards are much tighter than they were, according to Crowe.


The issue of negative equity


The number of homeowners with negative equity still remains quite high at 5 million, according to the Joint Center for Housing Studies at Harvard University, Cambridge, Massachusetts.


“If they sold, they would have to bring a check to the closing table because they wouldn’t be able to sell the house for enough to pay off the mortgage,” says Dan McCue, senior research associate at the Joint Center for Housing Studies.


An even larger group of 15 million homeowners have low levels of equity in their homes. Thus, McCue agrees with Crowe that one of the key challenges for this group of homeowners is they would not be able to sell their homes and have enough money for a down payment on another one.


Moody’s Analytics, New York, estimates there are between 6.5 million and 7 million homeowners under water--more than the 5 million estimated by the Joint Center for Housing Studies. That makes it difficult for homeowners to sell their homes--especially because the tax break for short selling has not been renewed, which means homeowners could face a large tax bill if they sell their homes at a loss, according to Mark Zandi, chief economist at Moody’s Analytics.


“I also think many prospective home sellers are reluctant to sell their home for a price that’s below what they remember back in the bubble,” Zandi says.


Even though median home prices overall have risen to pre-recession levels, there are many places where prices remain 5 percent to 10 percent lower than their peak, according to Zandi.


Are builders building enough?


NAHB’s Crowe disagrees with those who say builders are not building enough new homes. On the contrary, he adds--builders are constructing new homes at a pace to meet actual demand.


“Builders aren’t going to build a house if they can’t sell it,” says Crowe. The primary customer for a new home is an existing-home customer, he explains. “The chicken-and-the-egg [cycle of cause and effect] starts with somebody selling their existing home. If they are not selling the existing home, then the demand for new homes is lower,” he adds.


Crowe does see a key constraint in the shortage of buildable lots that could limit the pace at which builders could gear up to meet demand. The development of a subdivision takes several years and even longer in environmentally sensitive areas, he points out.


“Three or four years ago, when the process of developing a lot that would be available today should have begun, it didn’t; mostly because financing wasn’t available,” says Crowe.


The process was also delayed because builders felt more uncertain about the future. As a result, they did not start down the road toward creating buildable lots that would be needed today.


Critics say builders are only building more expensive homes and not the affordable homes that would expand supply for first-time buyers. Crowe points out, however, that first-time homeowners are less likely than owners of existing homes to be in the market for a new home.


The share of the new home market represented by first-time homebuyers has fallen off significantly from historical trends, typically due to a lack of credit, according to Crowe. When credit is tight, it adversely affects younger people just starting out.


Crowe also points out that if a builder can find lots, he or she has to pay more for them than in the past. Builders cannot make their expected return on investment if they try to build an inexpensive home on an expensive lot, he explains.


Builders are building homes to meet current market demand from buyers, according to Crowe. “And the market right now is for people who have sold their home and have a lot of equity or enough equity to move forward. So they tend to be those people in a better financial situation,” adds Crowe.


Constraints on construction


New-home construction faces both broad national constraints as well as local constraints that can intensify the national trends, according to Fannie Mae’s Duncan. Generally, inventory can be tight when there is both a strong local economy with good job growth combined with constraints on available land.


Duncan points to the San Jose, California, area as the classic example of how these factors can inhibit the creation of new supply. “There’s a strong tech sector and you have the Pacific Ocean on one side” limiting available land, Duncan says. This has created a situation where the current level of homes for sale in the San Jose area is one-third of what it should be to have a market balanced between buyers and sellers.


On the other hand, there can be places where strong employment growth does not face land constraints and, thus, does not result in a shortage of new homes.


“Texas has had strong employment growth and land there is not as expensive as it is in California,” Duncan says. “Builders are not constrained by oceans and earthquakes and, as a result, supply is more normal in that environment,” he adds.


There is another key difference between the two states: California has a more stringent set of regulatory restrictions on development than Texas. For California, that limits the ability of builders to bring to market an expanded supply of new homes at a price more buyers can afford.


New-home construction is facing another constraint: a shortage of skilled construction workers, according to Duncan.


“If you look at real wage rates in the construction space, they are actually higher than they were at the peak of the boom. What that tells you is the market is signaling for labor,” he says.


The market, however, is not providing the needed construction workers. Duncan points to four long years of very little construction activity as the contributing cause of the current skilled-labor shortage. “It’s not the case that people are going to sit by the phone for four years waiting for it to ring. They do something else,” Duncan says.


Some very skilled older workers have moved into retirement and are not willing to return to the labor force. In addition, some immigrants who worked in the construction industry returned to their home countries, Duncan adds.


According to a July 2015 survey of national business economic trends by the National Federation of Independent Business (NFIB), headquartered in Washington, D.D., 21 percent of small businesses involved in construction say that a shortage of qualified labor is their No. 1 problem. That compares with 3 percent who reported that as their No. 1 concern during the worst of the recession in 2009.


But in terms of regulatory constraints, the state of California’s hurdles are significant. Duncan offers a hypothetical example of a California builder with 2,000 lots trying to obtain the necessary permits to build homes in the new development. The builder has probably been to more than a dozen public hearings over a period of three years and is still not permitted to start construction, he says.


“Think about the carrying cost of the land, regulatory compliance costs to meet the permitting requirements, and add in to that mix the fact the builder could not get the labor,” Duncan says.


That means that when the lots are finally approved, the builder will be compelled to build more expensive homes to earn the rate of return sufficient to attract investors to fund the new real estate development. “That means there will be less new supply coming in at lower price points, where the supply is the tightest,” Duncan says.


In some markets there will be no new homes at lower price levels.


Duncan is also evaluating the role that new regulatory constraints on acquisition, development and construction (ADC) lending by banks are playing in the shortage of new homes. The constraints, some argue, are driven by the Dodd-Frank Wall Street Reform and Consumer Protection Act and new Basel III capital rules, which require banks to hold significantly higher capital levels to back ADC loans.


Smaller local banks in the past lent to local developers and helped expand the supply of local housing. This does not appear to be happening currently on the scale that it did in the past. Partly this is because banks find it less profitable, given the capital they have to hold against the loans and the fact that bank examiners frown on this type of commercial lending.


Without funding, smaller developers are not responding to higher home prices to bring new homes to market, according to this argument. “Large and public builders and developers have lots and have capital, and may be using the lack of competition to manage the pace at which they bring properties to market and maintain large profits,” says Duncan. “This is rational on their part but may be enhanced by regulatory restrictions.”


Millennials and Gen X’ers


Current overall home sales activity has, in fact, lagged because of the absence of a robust role for first-time homebuyers in this cycle. In the past, first-time homebuyers have typically made up 40 percent or more of the market. In June, however, the share of existing-home purchases made by first-time buyers was 30 percent and had remained at or above 30 percent since the beginning of the year, according to NAR. A year earlier, by contrast, first-time homebuyers were only 28 percent of the market.


Relief may be on the way, however.


Moody’s Analytics’ Zandi expects this year that the first-time homebuyer share of the market will rise to between 35 percent and 40 percent, and next year will hit 40 percent to 45 percent.


Zandi also expects that the national homeownership rate, which has been in steady decline for years, will stabilize by end of this year. The homeownership rate fell to 63.4 percent in the second quarter--its lowest level since 1967.


The role of the first-time homebuyer is tied to the economic plight of the millennial generation, or as they are sometimes called, Generation Y--those born between the early 1980s and the early 2000s. For the most part, members of this generation have postponed marrying and starting a family in part because it has been difficult to break into the job market in the seven years since the financial crisis.


Household formation is rising. The estimated number of households stood at 117.3 million in June 2015--2.2 million higher than the 115.1 million households estimate from a year earlier, according to the U.S. Census Bureau.


During the worst of the recession and the subpar recovery--2009 to 2011--household formation barely budged. Between 2012 and 2014, it moved up very slowly.


Another positive sign for the housing market is that the birth rate also rose in 2014 after steadily declining every year since 2007, according to preliminary estimates released in June by the National Center for Health Statistics.


The argument about housing supply and demand is not unlike the old question about which came first, the chicken or the egg, as Crowe duly noted. Some economists like Yun believe supply is the key factor while others like Crowe believe that it will take a pickup in demand to boost supply in the housing market.


“We’re waiting for the average consumer to feel comfortable that the recession is fully over, that the housing market has healed, that housing prices will stabilize and rise so they won’t lose their money, that they can get a mortgage,” says Crowe.


“It’s the comfort level of the buyer, and particularly of the current existing-home owners, who need to start up the ladder,” Crowe says. That will lead the existing-home owner to put a house on the market and find a first-time homebuyer. That, in turn, allows the homeowner to buy another home. “It’s a domino effect, and the dominoes really haven’t started falling yet,” says Crowe.


There are signs that first-time homebuyer demand is beginning to pick up. “We’re beginning to see the first wave of first-time homebuyers just arriving. If that continues to sustain itself, then I think we’ll start seeing evidence of that next year in 2016 and probably more of a full effect in 2017,” Crowe says.


“Even by 2017 we’re not likely to be building the number of houses you would expect, given the population,” says Crowe. “That’s probably going to happen in 2018, while 2017 will bring a level much closer to normal,” he says.


Permits for new single-family home construction are running about 700,000 a year right now, far below what is considered a normal market of 1.3 million units a year for single-family homes. That puts the pace of new-home construction at just over half way toward that 1.3 million goal, he adds.


Part of the reason there has been lower demand is due to demographics, according to the Joint Center for Housing Studies. Generation X--the age group born between the mid 1960s  and the early 1980s is the population most likely to be trading up to a better house. Yet, this is a smaller age cohort than the baby boomers, the older generation ahead of Gen X, and it is smaller population than the younger millennials behind them. Because there are fewer Gen X’ers to trade up, when they do trade up, they release fewer existing homes back into the inventory, according to McCue. He points out that homeownership rates are down significantly for those aged 25 to 44 years old.


Fannie Mae found some bright spots in its June 2015 survey of consumer attitudes toward housing that may signal a stronger purchase market ahead. The share of consumers surveyed who believe now is a good time to sell a home rose to 52 percent, crossing the 50 percent threshold for the first time in the history of the survey.


Consumers who expect rental prices to rise also rose to a survey high of 59 percent. “With an increase in housing supply from those ready to sell, combined with higher rental cost expectations, more potential homebuyers may be encouraged to leave the sidelines,” says Duncan.


When will we see a balanced market?


The pace at which home builders can construct new homes remains fundamental to the view that the housing market will come into balance by 2017 or 2018, according to Fannie Mae’s Duncan. To achieve a market balance in the housing market based on the nation’s demographics will require home builders to construct 1.5 million to 1.6 million units of housing every year--not the 1.3 million level in the past.


Fannie Mae expects total home construction this year to be only 1.18 million, a production level that is 320,000 below what is needed for the 1.5 million target and 420,000 below the 1.6 million target that Duncan sees as the needed range of new homes.


How fast can the market rev up to that level? To find out, Duncan looked back over the last 52 years--since federal housing data was first collected--and found that there are only five years since 1963 where the pace of new-home construction rose by 200,000, and all five of those occurred before 1984. “Even if you get the highest level of year-over-year increase, it will take more than two years to get to the 1.6 million units that will be needed,” he says.


Zandi believes that the higher home prices will be key to the market’s recovery. Once prices rise to their pre-recession highs across the nation, it will lead more people to list and sell their homes, he contends.


“In some markets that’s already happened. As a whole, however, prices in many parts of the country are still 5 percent to 10 percent below their prior peak, and it will take another year or two before it is back to pre-recession peaks,” says Zandi.


Rising demand will be the key that unlocks the door to higher prices, according to Zandi. “The fact demand is lackluster keeps house prices below their pre-recession peaks, and it further constrains inventory. Once demand rises, the wheels will get greased and the marketplace will see more activity,” he predicts.  MB



Copyright © 2015 by Mortgage Banking Magazine


bio: Robert Stowe England is a freelance writer based in Milton, Delaware, and author of Black Box Casino: How Wall Street’s Risky Shadow Banking Crashed Global Finance, published by Praeger and available at He can be reached at This email address is being protected from spambots. You need JavaScript enabled to view it..



Robert Stowe England is an author and financial journalist who has specialized in writing about financial institutions, financial markets, retirement income issues, and the financial impact of population aging.

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