From a small northwestern observatory…

It’s an interesting question for a couple of reasons. First, I’m in the real estate analysis biz, and since housing is a b-i-g chunk of real estate, it’s interesting from a purely academic perspective.

Second, though, there is a fair argument that at the apex of the recent housing bubble, we got the mix wrong. Congress, in their infinite (cough… cough….) wisdom, encouraged home ownership for all. It sounds like a noble idea, but one without too much economic sense. Simply put, even though the United States is LARGELY a nation of homeowners, we are not ALL homeowners. There are a lot of important economic reasons for this, w-a-a-a-a-y behond the scope of this blog. That having been said, over a reasonably long period of time, (say, a few years), the supply side of the equation can more-or-less match demand, and an equilibrium of sorts can emerge.

The problem arises when non-economic forces enter into the equation (such as artificial government stimuli) and home ownership is foisted off on market participants who really should be renters. There are plenty of ways to do this — mostly through artificially high levels of liquidity.

It’s hard to say exactly WHEN the recent housing bubble crested, but a quick glance at the Census Bureau’s American Housing Survey as of the end of 2007 is probably pretty close. (Anything closer than that would be pure conjecture anyway). We had 124.4 million housing units in the U.S., both rental and owner-occupied, of which 110.7 million were occupied. The different — a vacancy rate of about 11% — is pretty normal. This number includes new construction and actual vacancies, and there is a fairl amount of economic literature showing that a very low vacancy rate is not efficient in a healthy market, particularly among rental units.

Here’s where life gets interesting. Of the total number of occupied units, 75.6 million were owner-occupied, or about 68%. Many economists now agree that this proportion was too high — that the ownership rate in America was artificially propped-up by Congressional direction toward “easy” mortgage money. Since it was those “easy” borrowers who got in trouble first, one of the important questions being asked now is, “What is the best level of owner-occupancy for the market?” In a free market economy, “best” is what emerges at equilibrium without any external artificial interference.

We don’t really know where the market will level out, but discussions suggest the owner occupancy level should be closer to 60% than 68%. If this is the case, then in a static no-growth model, we would have about 66.4 million occupied dwellings. That’s a shift of about 9.2 million homes. Naturaly, many of these will be absorbed in the rental side of the equation, and that’s what we’ve seen lately — it’s why the fundamentals on new apartments has looked rugged for a while. That ruggedness won’t last long — much if not most new construction built for owner-occupancy is not suitable for rental, at least in the long-term. Luxury homes, luxury condos, and vacation “second” homes are either the wrong housing product or in the wrong place for such an easy shift to be accomodated. As such, we should see the apartment fundamentals get back to normal before the owner-occupied side of the market does.

Our natural “equilibrium” absorbtion of new housing in America is about 1.9 million units per year (about 1/3 rental and about 2/3 owner-occupied), so a big chunk of any excess will be eaten up by new demand as we come out of the recession. Nonetheless, it will take a while for the excess supply to be absorbed and for things to get back to normal in the new housing sector.