This article discusses the importance of residential construction in California’s economy, and the special part it has to play in the recovery from the 2020 recession.

Even as the impacts of COVID-19 continue to weigh down the economy and the 2020 recession settles in, we look ahead to the recovery. With the elongated recovery from the 2008 recession still fresh in our minds, will the coming rebound be anything like the last?

The recovery from the 2008 recession was long and drawn out, sliding into depression territory. During the recovery, housing construction occurred in California at a sluggish pace. For example, compared to the prior cycle’s 2005 peak when roughly 205,000 housing units were started, residential construction peaked in this past cycle in 2018 with just 116,000 units.

Further, the majority of the housing units started over the past decade have been in the high tier, leading to a high-tier housing inventory surplus and a dearth of housing in the low and mid tier. This has squeezed not just the low- and mid-tier inventory, but wallets. When too much of a household’s income goes toward paying housing expenses, there is none leftover to participate in the local economy.

Obstacles to building

The San Francisco Bay Area Planning and Urban Research Association (SPUR) suggests development fees have been a major obstacle to building low- and mid-tier housing. In fact, high development fees can act as a quiet form of zoning to push out low-income developments.

Cities in California charge impact or development fees for new homes at an average rate of three times that of other states, ranging from 6%-18% of the area’s median home price. For an extreme example, cities like Fremont and Irvine collect fees amounting to $150,000 or more per new home, according to a 2018 study from UC Berkeley.

Development fees are set by each city, thus they vary wildly. Further, the systems used to determine each new development’s impact fee are not always standardized, and thus the final amount is unpredictable.

With high development fees per unit, builders tend to profit more when they construct fewer, larger (high tier) units rather than a greater number of smaller units, with each unit having fees attached. This naturally reduces the number of low- and mid-tier units being built across California’s cities.

As an alternative, SPUR recommends California restructure how impact fees are calculated, instituting some state-level standards while allowing cities some flexibility to charge necessary fees.

The obstacles continue

Due to the low number of housing units constructed during the past decade, there is currently not enough housing to accommodate our ever-expanding population. This has led to rapidly increasing home prices and rents, especially for low- and mid-tier units. As a result, households have been forced to:

  • move in with roommates;
  • spend more of their income on housing;
  • save less money; and
  • accept lower standards of living.

Worse, California’s level of homelessness has risen to a flashpoint, concentrated in expensive coastal cities.

Enter today’s triple whammy of recession, financial crash and COVID-19. What was already a tenuous and unacceptable situation for housing has now become a full-blown emergency. Moreover, already low construction numbers have fallen back further in 2020 in response to social-distancing-induced construction delays, and tightening lines of credit.

Multiple types of assistance are available to keep renters housed during the state of emergency. But when the state of emergency is over and the recession turns to recovery, what will happen to the scores of households unable to cover their missed rents?

For homeowners, interest rates have declined to historic lows, which have helped homebuyers and sellers in today’s low-inventory and recessionary environment. However, despite today’s record-low interest rates, housing affordability has declined across the U.S. According to the National Association of Home Builders (NAHB), the nation’s least affordable housing markets are all found in California, including the  metro areas of:

  • San Francisco;
  • Los Angeles;
  • Orange County;
  • San Jose; and
  • San Diego.

More building will be necessary

While housing didn’t propel the economy out of the last recession, this was actually against the trend. As noted by the Joint Center for Housing Studies of Harvard University, construction typically makes up a significant share of gross domestic product (GDP) growth during an economic recovery, exceeding 25% in the recovery from the 2001 recession and 18% following the 1990-1991 recession. In contrast, construction during the recovery from the 2008 recession equaled just 6% of GDP growth.

However, unlike in 2008, the housing market going into the 2020 recession is experiencing historically low vacancy rates and supply, meaning high demand is present for more housing. Therefore, as in the recoveries from prior recessions, housing is primed to provide an economic boost to the economy in the years following 2020.

California’s lawmakers are already well aware of the need for more housing, and the potential it has for improving quality of life. Legislation to increase residential construction has become more urgent in recent years, focusing on taking the bite out of not-in-my-backyard (NIMBY) advocates and incentivizing more dense housing choices such as accessory dwelling units (ADUs).

Thus, with today’s low vacancy rates and increasing legislation that encourages building, the stage is set for a recovery propelled by new construction.

In the meantime, expect the construction contraction to continue in 2020 and 2021, slowed by social distancing measures and held back by tightening access to credit. But when the recovery rolls around in 2022-2023, residential construction will pick up at a pace not seen since the early 2000s.