Part I of this article series explores the economic factors that underlie growth in the construction industry and forecasts housing starts for five years to come.

This article is the first in a two-part series. For further analysis, including pricing forecasts and discussion of the government’s role in construction, look forward to the second part in this series, Construction factors and solutions, which will be published in December.

Do you believe construction starts will be higher, lower, or right about the same as the first tuesday forecast below? (Please comment and explain your answer!)

  • Lower (38%, 5 Votes)
  • Higher (31%, 4 Votes)
  • The Same (31%, 4 Votes)

Total Voters: 13

Housing inventory trends, present and future

Annual housing construction is currently stuck in an ongoing rut. In particular, construction starts for single family residences (SFRs) remain below historic lows and will stay low through 2014. Roughly 20,000 SFR starts will take place in 2011, 5,000 fewer than in 2009 or 2010.

Annual SFR construction will have little chance of returning to numbers above 40,000 (still low by the standards of the previous decade) until after 2017. Meanwhile, multi-family housing starts have just begun to climb upward.

SFR and multi-family housing starts both dropped to historic lows in 2009, with 25,454 SFR starts and 10,967 multi-family starts. SFR starts in 2011 will be 20% lower than in 2009, and will likely reach the bottom for SFR starts in this Lesser Depression. Recovery will be slow, however, and 2012 will likely see little to no change from 2011 in SFR starts. Multi-family starts, on the other hand, are expected to jump approximately 20% in 2012, and to continue rising for the years to follow.

Although overbuilt, apartment construction was more restrained than SFR construction during the boom years of the 2000s. Apartment starts will pick up quickly within urban areas after 2012, peaking toward the end of the decade. [For long-term projections of construction activity, alongside current data and analysis, see the first tuesday Market Chart, CA single- and multi- family housing starts.]

Construction trends, California present and future:

SFR StartsApt/Condo

 *first tuesday forecasts are based on current new homes sales trends, actual construction starts, age demographics and government fiscal and monetary measures taken in reaction to national and state economics.

Most forecasters, including the Construction Industry Review Board (CIRB), limit their forecasts to one-to-two years forward. first tuesday analysis pushes further into the future, nine years forward.

The demand for new housing is mostly inspired by user dissatisfaction with the inventory of existing homes and rental units available for homebuyers and renters to occupy. However, the real estate market is a complex web of interlinked economic elements, each of which affects the end demand for housing.

To a greater or lesser degree, all real estate behavior is influenced by 27 factors that collectively determine the direction of the market. This article series highlights the behavioral factors which presently exert the most influence on residential construction. To be discussed specifically are:

  • the behavior of local governments;
  • the age structure of the population;
  • job opportunities;
  • homebuyer confidence;
  • mortgage money;
  • sales volume;
  • sales pricing;
  • interest rates; and
  • location. [For a selection of major articles dealing with each of the 27 factors underlying the study of real estate economics, see the first tuesday feature, Real estate market factors.]

Age and demographics

The Baby Boomer generation (Boomers), defined by the U.S. Census Bureau (the Census) as those born between 1946 and 1964, is beginning to reach the age of 65, which was the magic age for retirement in the days before the Lesser Depression. Of great importance to brokers and agents: those aged 65 and over are more likely than any other age group to own an SFR according to the Census. [For more on the aging population’s propensity for ownership, see the September 2011 first tuesday article, Boomers will always be homeowners.]

Beginning in 2011, and for approximately 18 years to follow, the Boomers will be withdrawing from the work force. In the process of retiring, most Boomers will sell their now-inconvenient suburban homes, which are too large for their needs, too costly to operate and too distant from both social and cultural conveniences and their children and grandchildren. The majority will relocate to a more compact residence in a more convenient location. [For a study of the broader impact of Boomer retirement, see the September 2011 first tuesday article, Boomers bust open doors to real estate investment era.]

Using the last decade as a guide, first tuesday predicts that approximately 40% of the replacement homes these retirees purchase will be located within the same community they now live in. The majority of the remaining 60% will move to different cities and counties, but few will leave the state entirely.

Retirement homes will typically be smaller and closer to city centers, with a sales price equal to or lower than the empty nest (a result of property tax considerations) but a higher cost per square foot of livable space. To facilitate this demand, the density of construction on existing inner city parcels/lots will need to increase. If not, prices will soar beyond the rate of inflation until builders are able to construct housing where it is demanded. [For more information about price per square foot analysis in California, see the first tuesday Market Chart, Price-per-square-foot analysis of the California real estate market.]

The retiring boomer generation will boost home sales activity in the upcoming decade, but will play a much smaller role in the demand for new construction.

The retiring boomer generation will boost home sales activity in the upcoming decade, but will play a much smaller role in the demand for new construction.

However, the homes newly purchased by retirees will merely replace their current homes, adding nothing to the overall demand for new housing in California. Thus, the relocation of the retired will likely have a minimal effect on the total amount of new residential construction, even though retirees will have tremendous influence on the location and attributes of that new construction. As California’s general standard of living continues to slip, family members become more dependent on each other. Many have learned to share their living accommodations, thus reducing the demand for new or resale housing. [For more on the buying and selling habits of current and future retirees, see the first tuesday Market Chart, Boomers retire, and California trembles.]

The hunt for quality jobs

Importantly for home sales, the Boomers’ children, collectively called Generation Y (Gen Y) are now becoming young adults aged 25-35, the traditional age for the purchase of a first home. Unlike their Boomer parents, Gen Y’s job opportunities were set back by several years, maybe a decade, due to the financial crisis of 2008. That crisis has delayed the purchase of a first home for a large segment of aspiring first-time homebuyers.

Gen Yers have been forced to wait until they are gainfully employed, with sufficient pay to save for a down payment and qualify for a mortgage large enough to buy homes that meet their expectations. For the immediate future, at least up to 2016, employment levels in California will remain below the peak level achieved in 2007. While job opportunities will be greater in the inner city, they will be practically nonexistent in the suburbs for the well-educated Gen Y.

High student debt, low savings, and large-scale unemployment and underemployment have combined to keep much of this younger generation a decade or so behind the pace at which their parents purchased their first homes and began raising families. Many (more than the in the past) will remain renters, or will continue to cohabitate with family or friends until they become employed at levels of pay warranted by their education. Until then, Gen Y’s standard of living will not be what it was led to expect while growing up and completing college. [For more about Gen Y’s rough start in employment, see the October 2010 first tuesday article, The demographics forging California’s real estate market: a study of forthcoming trends and opportunities — Part I; for more information about how Gen Y will influence California’s real estate market, see the May 2011 first tuesday article, Where the buyers are.]

Among current homeowners, the working group aged 30-50, also referred to as prime-aged workers, continue to face permanent job loss brought on by a combination of the Lesser Depression and the growing number of Gen Y job seekers. Worse, many of their jobs will not be replaced, forcing willing workers into early retirement, while others pass their time employed in unskilled positions.

As a result, fewer than usual will have the resources to upgrade to a new residence. Instead, they will stay put. Many will become part of a growing underground market or gray economy, which works and lives on cash alone. These workers spent their pre-recession years in the suburbs, where the homes they own have continued to drop in price, turning positive equity into negative equity.  In the process, lost equity has destroyed demand for replacement construction – owners are imprisoned in their homes, unable to sell or otherwise get rid of them without destroying their credit (and thus their ability to get another mortgage). [For more on the options available to the currently under-employed, see the October 2010 first tuesday article, The demographics forging California’s real estate market: a study of forthcoming trends and opportunities – Part II.]

Willing homebuyers exist, but far too many lack the financial resources to purchase a home. Employment remains factor number one.

Willing homebuyers exist, but far too many lack the financial resources to purchase a home. Employment remains factor number one.

The situations of these age groups all point to continuing low demand for new construction starts, of any type, for the first half of this 2010 decade. Able buyers and renters among successful retirees and their employed children and grandchildren will demand higher-end properties in and near higher-density urban areas, close to the conveniences desired by the aged population and the jobs sought by the young. [For further analysis of new homebuyers in the market, see the first tuesday Market Chart, First-time homebuyers and new housing.]

Homebuyer confidence

Builders will not gear up building activity (and lenders will not provide cash) until it is clear that buyers and renters actually exist and are interested in new construction. Demand, in the form of willingness to buy drives the present market, not the “build it and they will come” supply thinking.

Some of the most useful measures of demand are consumer confidence indexes. One of the best of these is produced by the University of Michigan, which conducts large-scale surveys to assess the public’s outlook on the economy. Among the questions they ask are:

  • “Generally speaking, do you think now is a good time or a bad time to buy a house?”; and
  • “Now looking ahead – do you think that a year from now you and your family will be financially better off, worse off, or just about the same as now?”

The answers to the first question about timing of a potential purchase have been generally positive since an initial period of pessimism leading up to the start of the Great Recession in 2008. In contrast, the answers to the second, about financial conditions, have remained negative since late 2007, and have only gotten worse since early 2010.

These surveys indicate a fundamental contradiction about demand in the 2011 housing market. Homebuyers see low rates and low home prices, and sense it is an opportune time to buy… but not for them. As long as Californians believe their financial condition is unlikely to improve, they will remain reluctant to purchase a home – and ready and able builders will be unwilling to create new ones. There is simply no sufficient demand for new housing. [For detailed data and analysis on homebuyer sentiment, see the first tuesday Market Chart, Homebuyers feel ready and willing to buy, but not financially able.]

Today, the homebuying environment is in many ways near its historic best: for those with the resources to buy, both mortgage interest rates and home prices remain strikingly low in nominal figures (though not inflation-adjusted, real amounts). Rates and prices will remain where they are for as long as the supply of homes for sale remains high. Meanwhile, consumer confidence sufficient to trigger a decision to actually buy a home to live in remains almost nonexistent. Without confidence there is little demand for more housing.

Going forward, first tuesday does not anticipate any significant improvement in homebuyer confidence until at least 2016, since confidence requires both current employment and a perception of future financial and political stability. The number of detached SFR and condo starts will rise slowly into 2015, and then will increase only gradually until peaking at the end of the decade.

In conclusion, homebuyers are not going to naturally return to the big builders’ market in any meaningful numbers for several years to come – until 2016 and beyond. When they do start to buy, they will purchase only what they have come to believe are good deals, with an eye for value developed in an era of foreclosures and real estate owned properties (REOs).

Once today’s hangover inventory of inner-city condos is sold out and resales commence, builders will again have the ability to sell new construction starts. That is, however, if city governments take appropriate action to plan and zone for builders to construct high-density condos and apartments in their city’s core locations, where the homebuying and renting public is most eager to work and live. [For quarterly information and analysis of REO resales, see the first tuesday Market Chart, REO resales in CA.]

Stay tuned for the second article in this series, Construction factors and solutions, to be published in December.