Learn How To Start Investing In Real Estate
Learn How To Start Investing In Real Estate

Are We Building Too Many Houses?

Written by Paul Esajian

Several indicators suggest that 2013 was, by all accounts, a successful year in the housing sector. Compared to previous years, home values increased dramatically and foreclosure rates declined. Equity returned to the majority of metropolitan areas and the recovery appears to have gained traction. According to the U.S. Census, new-home construction rates increased dramatically. Both single- and multi-family housing starts were up, by 15 and 25 percent, respectively. Of particular concern, however, is the rate in which these housing starts persist. Analysts familiar with the market suggest that the housing sector may be responsible for building too many houses. Such a scenario could weaken home prices in the future if buyers do not meet demand.

On a national level, housing starts rose 18 percent from 2012, the highest level the housing market has experienced since 2007. Surprisingly, single-family housing starts experienced their best year since 2009. In 2013, almost 618,000 single-family homes were built. However, expectations must be tempered, as that number was the fifth worst on record. New-home starts last year were insignificant when compared to 2005, when 1.7 million homes were built. Seeing as how the historical average is approximately one million, housing starts are less than encouraging.

Taking into account previous averages, you may be inclined to vote in favor of more new-home starts. The nation’s homebuilders would certainly agree. However, some fear that we may be building too many new homes.

“The vacancy rate has been declining, which means we are building less than the number of new households,” said Jed Kolko, chief economist at Trulia. “But the vacancy rate is still higher than it was before the bubble, which means we should be building fewer homes than the growth in households, because there still is an excess of vacant homes.”

Abandoned and empty houses, owned by both banks and investors, continue to prevent the housing sector from recovering fully. Essentially, these non-preforming loans are not contributing to the recovery. In addition to these properties, rental demand has never been higher than it is at the moment.

With rental rates increasing as they have, multi-family apartment construction projects have easily surpassed that of single-family starts. At just under 292,000 units started, construction volume is now almost three times what it was in 2009. Of particular concern, however, is the purpose of these respective projects. At the height of the previous housing boom, rental properties accounted for less than 60 percent of all multi-family construction projects. Forty percent of those same properties were sold as condos. Today, 92 percent of multi-family starts are intended for rental, the highest since the Census began tracking this data in 1974.

“Rents won’t rise as much as you might think, given the growing rental demand, because there is all this new apartment rental supply that should come onto the market next year. Without the increase in starts, rent increases would be much steeper,” said Kolko.

Current market conditions have already witnessed a slight moderation of rental growth, but home prices continue to rise. This is particularly unsettling, as most of the growth has been attributed to all-cash investors. All-cash investors tend to avoid new construction projects, as profit margins are less attractive. They are more inclined to purchase from the distressed market, where prices are more conducive to their particular exit strategy.

Even more concerning, however, is the persistent decline of home ownership. If you subtract the nearly 4.5 million borrowers who are not current on their mortgages or who are in the foreclosure process, that rate is even lower, according to Black Knight Financial Services.

With rental growth being what it is, and a decline in home ownership, analysts familiar with the market are concerned that new home sales will not meet new home starts. Will demand outweigh supply and allow builders to continue to raise prices?

With home values increasing and more equity returning to the housing sector, homeowners will actively participate in the market. As such, more existing-homes will be up for sale. Those properties will then serve as competition for newly built homes. If there are enough buyers, home prices will hold or rise. However, if a lack of buyers persists, prices will weaken.