In the October issue the importance of home construction and remodeling to the value-added wood products sector was highlighted. It’s safe to say that our industry will not fully recover from the current malaise until housing rebounds. So let’s take an amateur economist’s look at homebuilding today and its future trajectory.

Background

This housing bust has been the longest and deepest in recorded history. Prior to the current downturn, the record for the longest period with the annual rate of housing starts below one million was nine months during the recession of 1981-82. By the time this magazine is published, the current slump will be in its 31st month at or below one million starts. And remember that the average annual rate of starts since 1959 is over 1.5 million. Before 2008 U.S. builders had never started fewer than one million homes in a single year.

Remodeling also buoyed the wood products industry significantly from 2001 through 2005. But that sector too has fallen on hard times, plunging by 25 percent last year alone. With remodeling consuming over two-thirds of cabinet industry output and nearly half of wood flooring, the impact on many makers of value-added wood products has been devastating.

Combined with the departure of domestic wood furniture production to China and elsewhere, the slump in residential construction has knocked 50 percent off demand for hardwood lumber. All things considered, the decline of the wood products economy has been nothing short of breathtaking.

Clearly homebuilders, remodelers, and all of us in their supply chain are in uncharted waters. Contrary to earlier downturns that were caused by high interest rates aimed at reducing inflation, this downturn got its genesis from loose monetary policy. No one seems to have a ready cure for today’s mess. Forecasting the timing of a housing recovery is a crap shoot at best.

Challenges to recovery

Before looking at homebuilding’s future, let’s list the key challenges facing its recovery:

• Foreclosures: Over two million homes are in various stages of foreclosure. Those homes represent an overhang of supply that must be consumed before a full recovery in home building can resume.
• Delinquencies: The owners of another five million homes are seriously delinquent on their mortgage payments.
• Declining Prices: The excess of supply over demand is continuing to push prices downward. Between one-fifth and one-quarter of all homes are now worth less than the remaining balance on the underlying mortgage.
• Unemployment: The key to recovery is job growth. But far too many in the U.S. are out of work, and low home prices are limiting the flexibility of many to relocate to a new job.

Prediction: A sure bet

In spite of these challenges, a housing recovery is a sure bet, and the reason is demographics. Simply put, the future generation of homebuyers and renters has already been born. The first members of Generation Y, those born between 1980 and 1995, are forming households, renting apartments, and buying homes. At 78 million strong, that cohort is nearly as large as the Boomers who made the 1970’s the most prolific homebuilding decade in recent history. And with weak prices and very low interest rates, Gen Y is finding housing more affordable than anytime in the last twenty years.

Growth of new household formations is predicted to average nearly 1.5 million annually through 2020. During the current downturn that rate fell to one million. The higher number of new households combined with those already in existence will demand something like 1.65 million new homes and apartments annually over the next decade. That demand will push housing starts to and beyond its 50-year mean.

So when will the market make that move? The recently released McGraw-Hill construction forecast predicts a 27 percent jump in single-family starts in 2011. Construction of multi-family housing is expected to rise by 24 percent. If so, total starts next year will approach 700,000. The National Association of Realtors’ October forecast estimates 617,000 in 2010, 769,000 next year, and just over one million in 2012. The National Association of Homebuilders’ economist predicts 605,000 this year, 804,000 next year, and 1.18 million in 2012. Thus the latter two groups are seeing starts nearly doubling from the 2009 low by the end of 2012.

Looking longer term, Harvard’s Joint Center for Housing Studies projects new home demand between 16.4 and 18.7 million from 2010 to 2019. Since these estimates are for demand, not construction, the number must be adjusted for any oversupply that exists entering 2010. But even if the two million homes in foreclosure are considered, that deduction leaves Harvard projecting between 1.44 to nearly 1.7 million starts annually through 2019. Those numbers neatly bracket the long-term mean. The driver for this demand forecast is demographics.

Conditions for a rational market

At the end of the day, our industry requires a more rational market for housing, much less of the boom and bust seen over the last fifty years. At between 1.4 and 1.5 million, household formations have been remarkably steady through that period. Yet we’ve seen extreme peaks and valleys in housing starts. No one can run a business in such an environment.

Unfortunately the conditions for a saner market are beyond our direct control:

• Smarter bankers and builders – Tighter lending standards and more attention to the underlying market would go far toward matching supply and demand.
• Wiser homebuyers – Letting the buyer beware is not a sound policy. Better education and understanding of homeownership’s responsibilities would inhibit people biting off more mortgage than they can afford.
• Intelligent government intervention – Mortgage interest deductibility and the capital gains exclusion on the sale of primary residences have skewed demand artificially higher.

We as an industry should promote market improvements far and wide to ensure a more stable housing economy.

Bottom Line: Strong demographics and historically low mortgage interest rates will drive a nascent recovery in residential construction and remodeling beginning late next year. Its long-term strength depends on smart economic policy. Better times are just ahead, get ready, but keep your fingers crossed …