Housing Construction: When Will It Resume, And at What Levels?

by: Casey Mulligan

Housing construction will resume when housing prices are anticipated to be at or above construction cost for the duration of time it takes to build a house.

Okay, when will housing prices be anticipated to be at or above construction cost for the duration of time it takes to build a house? That will occur when the demand for housing is expected to exceed the current stock of housing. The U.S. stock of housing, measured in year 2000 prices, was $12.9 trillion at the beginning of this year. If demand continued to follow the trend of the 1990s (a period without a housing boom), then at the beginning of this year, the demand for housing at 2000 prices would have been $12.6 trillion. In other words, we need a sustained demand increase of three percent in order for the houses we have to be worth construction cost.

During the 1990s, demand increased an average of 0.2% per month (2.4% per year). At that pace, demand would reach $12.9 trillion (today's housing stock) by April 2009. Below is a chart showing actual housing and 1990s housing trend. Notice from the chart below that the trend exceeds this year's actual value before the beginning of 2010.

click to enlarge

If demand returned to the 1990s trend, there are a few reasons why housing construction could resume sooner than April 2009:

  1. Some of the housing built during the 2000s boom may have been built in the wrong places, so the current housing stock is over-valued at year 2000 prices.
  2. Although in hindsight we can say that housing demand that was high enough to sustain boom time prices never materialized, housing demand might still have increased beyond the 1990s trend (that is, the housing boom was exaggerated but based on something real, wasn't it?).
  3. Houses are depreciating for the usual reasons, plus some additional neglect due to the foreclosure process.

Of course, we are in a recession and a financial crisis now, which may reduce demand below the 1990s trend. Also, the actual stock has not been frozen at $12.9 trillion because a bit of building has occurred this year. I expect the size of this demand reduction and the contribution of 2008 construction to be small, and therefore expect to see housing construction resume next summer, if not earlier.

Epilogue: When Will Housing Prices Return to Boom Levels?

Boom-time housing prices were much above construction cost, and therefore much above where I expect them to be next summer. It will take either general inflation or another housing boom for housing prices to return to boom levels. Some other economists and I have recommended some inflation, but if that recommendation is not followed and inflation rates continue in the 2-5%/year range, it will take a number of years for housing prices to return to what they were in 2005 or 2006.

Disclosure: None