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Next Housing Market Crisis, Price Crash Could Be Caused by Too Many Homes

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The US housing market went haywire over the past two years for a simple reason: There just weren’t enough homes to meet overwhelming demand. But now one research firm is warning of a new threat looming on the horizon: too many houses.

After the housing bust of 2008, homebuilders — scarred by the crushing market collapse and sluggish recovery — were reluctant to ramp up construction again. This decade-long slowdown in new home completions culminated during the chaos of the COVID-19 pandemic as demand surged far past the existing housing supply. The results were soaring home prices, fierce bidding wars, and rising rents as more people were forced to lease rather than own. 

As the economic winds shift in a post-pandemic world and the housing market heads towards a slowdown, most experts don’t foresee a 2008-sized housing bust, in part because of the persistently low supply of housing — which they say stands in sharp contrast to the overzealous building that helped lead to the last crash. 

But Zelman & Associates — a housing research and investment banking firm led by a pair of former Credit Suisse analysts who famously called the housing market’s peak ahead of the last crash — has a different perspective. At a time when most experts are honing in on supply tightness, CEO Ivy Zelman is concerned about longer-term trends that indicate housing demand is bound to weaken. Her firm’s demographic analysis of the US reveals slowing household formation and population growth, as well as declining immigration levels. Sooner rather than later, Zelman says, we’ll be left with more homes than people who want them.

That flies in the face of conventional wisdom today, particularly since the pandemic seems to have laid bare the need for more housing. But Zelman argues that the recent buying frenzy represents an anomaly spurred on by government stimulus payments, record-low mortgage rates, and heightened investor activity. As those factors fade and a record backlog of new housing construction comes onto the market over the next two years, demand might not be able to keep pace, according to Zelman. 

“You start to think about the pipeline over the next few years — you have all this supply coming, and it’s not there yet,” Zelman told me. “Will we be able to fill up all of these homes?”

Gloomy demand and booming supply

While Zelman earned her legendary status in housing circles by calling out bubbly activity in the mid-2000s, she and her firm haven’t always taken a dim view of the housing market. 

Around 2013 and 2014, Zelman & Associates’ outlook was actually “very optimistic,” according to Dennis McGill, who started the firm alongside Zelman and now serves as its head of research. 

“We felt like you had this reverse of a lot of financial crisis headwinds” McGill said. “Older millennials were aging out of apartments and into single-family homes.” At that point, growing demand meant the market had “room to run,” according to McGill.  

From 2016 through 2019, the market achieved roughly the ideal balance between growing supply and sustainable demand, McGill said. The market was generally on an upward trajectory, aside from some fits and starts. Home-price appreciation was steady in the mid-single digits, builders were incentivized to keep adding units, and there weren’t too many of them sitting vacant. 

“Nobody was getting overleveraged,” McGill said. “Investors weren’t crowding the market. That’s the kind of market you’d like to have.”

Then, in the early summer of 2020, the market went into overdrive, kicking off a chaotic two-year sprint. But the factors that contributed to the soaring housing market are now subsiding as mortgage rates climb and government support fades, sending demand back to earth. 

Housing market

The housing market went wild during COVID: packed open houses, bidding wars, and soaring prices. But according to one real estate expert, that’s all about to change.

Newsday LLC / Contributor/Getty Images


Soon, according to McGill, the housing market will be forced to confront sobering demographic trends — just as developers are set to deliver new housing units in volumes that haven’t been seen since before the Great


Recession

. In a market defined by booms and busts, the coming increase in supply, combined with a long-term downshift in demand, could spell problems for the broader US economy, McGill said. 

First, let’s look at the demand side of Zelman and Associates’ thesis. Since the mid-2010s, US population growth has been slowing due to decreasing fertility, lower immigration rates, and an aging population. COVID-19 only amplified those trends, and Zelman’s firm estimates that by the end of the decade, organic population growth — births minus deaths, excluding immigration — will turn negative for the first time ever. 

While US household formations — the net change in the number of households around the country — showed a remarkable rebound during the pandemic, the metric’s growth over the past decade was the lowest ever recorded. And any boost to housing demand from more household formations “may be outweighed by the weakening of US population growth,” according to a May note from the


Federal Reserve

More immigration could offer a remedy to slowing population growth, but that has also taken a severe hit over the past decade, particularly since 2016. Between 2020 and 2021, government policies and the pandemic resulted in the lowest levels of international migration in decades. Fewer households, fewer people being added to the population, and fewer immigrants all adds up to fewer people needing homes. 

Long-term demand worries aren’t the only thing ailing the housing market. Home buying activity already appears to be cooling thanks to rising mortgage rates, which recently shot above 6% for a 30-year loan, up from record lows of less than 3% in early 2021. That’s dealt a significant blow to demand, and real-estate companies are already feeling the pain. Homebuilder sentiment has been on the decline, dropping to a two-year low in May, according to the National Association of Home Builders/Wells Fargo Housing Market Index. 

But McGill cautions against taking these recent shifts as confirmation of his firm’s theory about long-term demand, which he said will take more time to play out. 

“If our analysis and data is correct, it’s really about what’s going to happen over the next 18 months, 24 months, as a lot of this supply comes to market,” McGill said. “If the economy is stabilizing, and you’re not absorbing it as quickly as people would have hoped, or you’re seeing pressure on price or rents to get it absorbed, then the whole ‘deep demand’ and ‘pent-up activity, lack of supply,’ starts to lose a lot of credence.”

These demographic trends, combined with a cyclical market slowdown, are set to kick in at a time when the housing industry has been ramping up supply efforts. In January 2020, US developers were on pace to begin construction on 1.6 million homes per year, the highest volume since 2006. The pandemic briefly put most new building activity on pause, but construction quickly rebounded as the market heated up. By April of this year, projected annual housing starts had climbed to more than 1.8 million, according to US Census Bureau figures, although recent headwinds have pushed that number back down to 1.55 million. 

home construction

The number of homes under construction has soared, as a backlog of inventory built up during the pandemic.

Reuters/Rick Wilking


Builders of both rental and for-sale housing have been optimistic about their ability to deliver more and more units in part because investors have been clamoring for more homes, McGill told me. However, he added, that investor demand can disappear quickly if home-price appreciation slows considerably. But at that point, many builders might be too far along to adjust. Builders across the housing spectrum “have sort of already baked their cake with respect to supply coming over the next six, 12, or 18 months, depending on the product,” McGill said. 

A mixed bag of effects

For homebuyers and renters who have watched helplessly over the past two years as housing costs climbed ever higher, a swing in the other direction could provide an opening for them to finally snag a home of their own or upgrade to a larger space. For some Americans who have been left behind in the housing market’s record-setting run, overbuilding could present a chance to start catching up.

“The consumer is going to have a lot more choice, and will have a lot more negotiating leverage, when all this product is coming to market,” McGill said.

While a housing correction would provide some price relief, overbuilding will present more of a mixed bag for the housing market and overall economy. A slowdown in the housing market could coincide with a recession that would disrupt the wider economy, contributing to higher unemployment and less spending on big-ticket items. Large purchases are often about confidence in the future, McGill said, and potential homebuyers might choose to hold off if home values look unstable or the labor market is in turmoil. McGill offered up a parallel to the period between 2008 and 2012, when mortgage rates were falling and homes were getting cheaper. 

“The mantra was not, ‘Finally, some cheap homes,'” McGill said. “The mantra was, ‘There’s this downward spiral on value and no one knows where to step in.'”

Other groups would also feel the ripple effects. Developers and the investors who have grown accustomed to strong returns from the housing market could see projected profits shrink or disappear. In turn these builders would pull back, ​​which could lead to layoffs for construction workers and a slew of negative downstream economic effects. Current homeowners would see their value appreciation slow down or, in a worst-case scenario, fall. And potential sellers may be encouraged to stay put rather than test a flailing market — making it harder for homes to turn over and get new people in the market.

Others have a sunnier outlook 

John Burns, another housing expert who leads an eponymous market research and consulting firm, concluded in 2016 that the US needs to be building about 1.4 million housing units per year to catch up to demand. Today, Burns estimates that US developers are building 1.8 million units per year, including manufactured housing. So in a sense, Burns said, we are building too much on a year-to-year basis, but he doesn’t foresee that level of building causing a crash or the other negative effects that concern Zelman’s firm. That’s because the underbuilding in the wake of the financial crisis created a 1.7 million-home deficit, he said — so even as builders outpace the county’s long-term needs, most of the oversupply is just a correction from the past decade of underbuilding. 

“Once we’ve covered that shortage of 1.7 million, if we’re still building more than 1.4 million, yeah, we’ll be overbuilding the market,” Burns told me. “But that should be five years from now, not this year.”

Freddie Mac pegs the housing shortage at an even larger figure, estimating in the fourth quarter of 2020 that the country needed 3.8 million more homes to truly reach a balanced market. That was up from 2.5 million units in 2018. Even that most recent estimate might be conservative, Len Kiefer, the deputy chief economist for Freddie Mac, told me. He pointed to the recent uptick in household formation during the pandemic, despite all the affordability challenges, as proof that plenty of demand remains. 

“We absolutely need more building over the long run,” Kiefer said.

home house construction

Despite Zelman’s warnings, other experts are les convinced that more building will be a problem for the US housing market: “We absolutely need more building over the long run.”

Mark Blinch/Reuters


Daryl Fairweather, the chief economist for the real-estate brokerage firm Redfin, said that even the decline in immigration is an intentional “choice” on the part of the US government that could be reversed through policy. Fairweather pointed to the “long line of people waiting to get into the US.”

“I feel like the future of America involves more immigrants, not fewer, not the same amount,” Fairweather told me. “So we’re going to need more homes.” 

Pay no attention to the looming problem

Most people, McGill said, aren’t focused on the worrying demographic trends that Zelman & Associates highlights in its report. 

“Even executives that have read the report and looked at the cadence, sometimes you get the reaction, ‘OK, so what you’re telling me is this is kind of a longer term problem, but I can still keep building and everything’s OK for the next couple years? Is that what I’m reading?'” McGill said during a webcast in October, shortly after the research firm debuted its analysis. “So it’s almost finding the silver lining of, ‘OK, we’ll worry about this tomorrow.'”

That kind of complacency could lead to messy outcomes for developers and investors, McGill said. But in fact, the recent slowdown in demand, as sudden and obvious as it has been, might end up being a good thing if it moderates overbuilding and prevents the situation from getting more out of hand in the coming years, McGill said. 

“The last couple of years, you felt like you were on this rollercoaster on the way up, and you knew you were going over the hump, but you just didn’t know when, and the higher you go, the farther you’re going to fall,” McGill said. “I think we kind of capped maybe how high the rollercoaster is going right now because of how clear that demand shift has been, which hopefully means it doesn’t have to come down as fast and far on the other side as it might have a couple of months ago.”

If all this discussion is giving you whiplash after years of talking about low housing inventory, you can chalk that up to the peaks and valleys that define the housing market, McGill told me. When the market is at one extreme, as it is now, it can be hard to imagine a world where the opposite is true.

“We are in a cyclical industry,” McGill said. “And I think sometimes it just kind of gets forgotten in short periods of time. And this cycle right now feels a little bit like that.”



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