Here's more from ProSales editor Craig Webb's interview in August with Jonathan Smoke, executive director of Hanley Wood Market Intelligence, which was published in September's edition of ProSales.
Gauging Potential Growth
ProSales: A few years ago, people used to say that America had the kind of demographics that could lead us to expect demand of roughly 1.7 million new homes per year for the foreseeable future. Lately we've been building no more than 600,000 new homes. Shouldn't there be some huge, pent-up demand that will lead to an explosion in new-home construction once we get out of this slump? And if not, why not?
Smoke: I don't see a huge amount of pent-up demand that would cause a dramatic bounce back in new construction volumes in a short amount of time. Some of the rosy estimates of future demand were driven off of strong immigration and even stronger household formation that dissipated dramatically when the recession began. We have been producing historically low levels of new homes, but we've also seen historically low numbers of households being formed, while at the same time we have seen home ownership fall dramatically. If you look at national numbers on what the household formation rate and ownership rate declines imply, we had an enormous excess of housing stock that has taken us the last several years to work off. We are just now getting back more into equilibrium between supply of housing stock and owning household demand.
On the margin, there may be households that haven't formed that might soon, and there may be would be owners who have put off buying that are now thinking about it, but at the same time, we still have elevated levels of vacant homes. If there's any substantial imbalance where demand exceeds supply, we will see prices jump, and that would cause a faster rise in new home production, but purchases are still challenges by mortgage approvals and conservative appraisals, and that leads me to believe that the recovery will be gradual.
ProSales: If 1.7 million isn't the actual core demand level in this country, what is it today?
Smoke: We look at this as the basis for our forecast for single family starts. For the next two years we think we climb above 600,000 and approach 800,000. I think it takes us to 2015 to cross 1 million again, and then I expect the growth will taper off to a long term range 1 to 1.3 million a year. I'm very skeptical of any long term forecasts expecting single family homes to be above 1.5 million units on a sustainable basis.
ProSales: How do you come up with that number?
Smoke: Modeling household formations, changes in home ownership rates, and factoring in economic conditions. Historically, the long term average of singe family housing starts from 1960 through 2000 was just over 1 million units per year. If we look over every year since 1960, that average is barely higher because the artificial boom we experienced from 2002-2006 has been almost complete offset by the bust since.
To get above 1.5 million and in the territory of 1.7 million, you will be more than two standard deviations off the long term average and that would imply the top of a cycle much like we just lived through and the carnage that came after it. There is no basis to believe that our future fundamentals for housing demand will be any stronger than the long term average for the last 50 years, so it's crazy to believe we will see those 1.7 million unit numbers again for the foreseeable future.
How Economists Work
ProSales: Why do housing forecasts vary from economist to economist? What goes into making such a forecast?
Smoke: Each economist has their own data inputs, assumptions, and modeling techniques to derive their numbers. No one reveals their exact recipe, but forecasts clearly vary based on the type of data that economists have access to. We forecast at a local market level and add them up and we take into account far more variables than I believe most economists have access to. As a result, I believe our forecasts are far more realistic—after all, we never called for recovery until this year. We take into account real local data on home closings, local household formations, local changes occurring in home prices and home ownerships, local market health, etc. Some forecasts merely model starts based on national data and very simplistic assumptions tied to factors like population change and jobs. Like housing, we think forecasts should be local in focus to be realistic.
Focus on Local Numbers
ProSales: Suppose you're a building material dealer who has to make forecasts for his operation in 2013 and then update those plans as the year progresses. What economic indicators should that dealer pay most attention to? And within those economic indicators, what should he/she look for in terms of various key signals?
Smoke: Across markets we've found that home sales are most correlated to changes in home prices, changes in household incomes, the volume of household formations, changes in the unemployment rate, and the volume of total home sales. So watching for inflection points in these variables is key. At this point in the market, I would pay most attention to home prices, as that is the single metric that can overnight slow down foreclosures, push the would-be buyer off the fence, and drive would-be sellers to think of moving.
I personally would not recommend paying much attention to national statistics or forecasts. This business is local and the conditions vary so dramatically across the country based on local factors. Think of it like a big farmer. Farmers can seek free information on the weather forecast from local media or buy fancier forecasts from companies that cater to precise insights into local conditions. But no farmers base their business decisions on a national average temperature or even a broad forecast on the Today show.
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