A Detailed Analysis At Projected Home Prices: A Look At Underlying Supply And Demand Forces

Tyler Durden's picture

As everyone who has taken Introduction to Voodoo Bullshit, better known Econ 101, can attest the following chart is basically as ugly as it gets: in simple terms when you have a collapsing demand curve coupled with a surge in supply, the bottom line is that no matter how much intervention is involved, nothing can help to restore the pricing equilibrium to its old level (at least not for a long, long time).

And as can be expected from economists, despite having come up with the S-D concept, they consistently focus on the part that's (relatively) easy to control - the supply side, and tend to ignore the "demand" aspect, which is far more difficult to jigger in the desired direction (think the constant blaming of banks for not lending when it is in fact the consumers who do not want loans). As such, using data from Bank of America, we focus on the complete picture, with an emphasis on the much ignored Demand side of the home price equilibrium, to conclude that prices are set to drop much lower from current levels.

The simplest way to analyze the outlook for the housing market is to compare the evolution of housing demand and supply. Housing demand comes from the creation of new households and purchases of vacation homes. Households are defined as the number of separate housing units, either families or individuals. A household can be created when children move out of their parents’ homes, couples separate, or roommates decide to live apart. Housing supply is a function of new construction and, in today’s market, foreclosures. The foreclosure will only create net new supply if the former homeowner moves in with friends or family rather than becoming a renter. By this reasoning, we also do not count “turnover” – transactions from existing owners – when analyzing demand and supply. If homeowners decide to sell their home and move to a new house or a rental unit, it will show up as both supply and demand. As a result, we are only focused on new housing demand and vacant housing supply.

Of the above paragraph, the key notable is the highlighted sentence, or the ever critical "household formation" variable. Unfortunately as the chart below shows, household growth has plummeted over the past 3 years, declining by about 700,000, after clocking in materially positive numbers in the 6 years prior.

So focusing on the far more critical Demand side:

Demand: fewer new households

Household creation depends on the state of the economy. The combination of high unemployment, weak wage and salary growth, and tight credit has led to a decline in household growth over the past few years. The two main surveys of household formation from the Census Bureau – the Housing Vacancy Survey and Current Population Survey – show that about 500,000 households were created annually over the past three years compared to an annual average of about 1.2 million during the first half of the decade (Figure 6). How can we explain such a notable drop in household formation?

Moving in with the folks

The obvious answer is to look at homeownership rates, which have tumbled to 66.9% from a peak of 69.2% in 4Q04. This translates to a loss of nearly 2.5 mn homeowners. Most of these homeowners became renters, which means they remain a household, but not all. As can be seen by the surge in the rental vacancy rate to 10.6%, it seems that there was not a perfect shift from homeowners to renters (Figure 7). This begs the question: what happened to these former households? There was doubling up among economically stressed households; in other words people moved in with friends or family. Many of these former homeowners were probably foreclosure victims (Figure 8).

As Figure 8 shows, household formation can also decline if there are fewer young households created to replace the aging homeowners. Given the nearly 10 point surge in the unemployment rate among 16 to 24 year olds from the trough to peak during this cycle, it seems like this was a considerable factor. A recent paper sponsored by the Research Institute for Housing America estimates that the probability of a young adult forming a household declines by 4% during a recession, and up to 10% if unemployed. In addition to the slowdown in “headship rates” domestically, there was a drop in household formation from immigration. According to the Office of Immigration Statistics at the Department of Homeland Security, the number of unauthorized immigrants decline by 1.0 million from 2007 to 2009 compared to a net gain of 1.3 million from 2005 to 2007.

Household growth to improve, but with a lag

Household formation will naturally pick up as the economy improves, but if our forecast for a sluggish recovery is realized, household growth will also be lackluster. The main factor influencing household growth will be the state of the labor market. The above-referenced paper finds that the unemployment rate must fall by 2pp from current levels to return to normal rates of household formation of about 1.2-1.4 million a year. We do not expect the unemployment rate to reach the mid-7% range until 2013, implying another two and a half years of sluggish household formation of about 800,000 a year. This is also when we expect the pace of foreclosures to slow notably, which means that fewer households will have to double-up.

Looking ahead to 2013 and beyond, we use forecasts from the Joint Center for Housing Studies at Harvard University. They present two possible trajectories for household growth: 1) an average of 1.48 million annually through 2020 assuming net immigration returns to the 2000-05 pace and headship rates at 2008 levels; and 2) an average of 1.25 million annually through 2020 assuming the same 2008 headship rates but slower immigration. We believe the latter is more likely and use this as our baseline forecast (Figure 9).

Renters will take market share

Although we expect household formation to start to improve in 2013, the homeownership rate should still fall further, suggesting that most of the gain in households will be due to an increase in renters. This is because there is still a considerable number of homeowners with mortgages in some stage of delinquency that are likely to end in foreclosure. Based on data from the Mortgage Bankers Association, there are about 5.5 mn seriously delinquent mortgages currently outstanding.

A recent paper by economists at the NY Federal Reserve (Haughwout, Andrew, Richard Peach, Joseph Tracy. “The Homeownership Gap”, Federal Reserve Bank of New York Current Issues in Economics and Finance, Volume 16, Number 5, May 2010) attempts to quantify the effective lower bound for the homeownership rate. They make the assumption that underwater borrowers (negative equity), who currently account for about a quarter of mortgage holders, will transition to renters over time. Subtracting these underwater borrowers yields an “effective homeownership rate” of 61.6% (Figure 10). This would be a record low in the data which goes back to 1965. We do not expect such a precipitous drop because not all underwater homeowners will become renters. Indeed, a recent study by Trulia.com and RealtyTrac found that 59% of respondents would not go into foreclosure simply because of negative equity. We believe it is more likely that the homeownership rate will bottom at 65%, returning to mid-1990s levels.

It is plainly obvious why the demand-side is so often ignored in polite conversation: it is the consumer-driven aspect of the house price variable, over which neither the Fed, nor the Treasury, nor the FHA has any authority, and which is a function purely of expectations of the future. Alas, those right now are lously and getting worse. We expect that Demand-side housing economics will take on progressively more importance in the future, as it becomes obvious that no amount of Supply-side tinkering will prevent another 20% drop in prices.

And speaking of Supply, this is also a critical factor, if much more prevalent in the daily media. Alas, that in itself does not make the problem any easier to resolve.

Supply: out of balance

The drop in housing demand triggered homebuilders to slash new construction. In theory, this should have balanced the market. A shift lower in the demand curve will temporarily depress prices until the supply curve shifts to balance the market at a lower quantity. The problem is that this model does not take into account the additional source of supply: foreclosed properties that have returned to the market for sale. As a result, housing supply has not normalized and greatly exceeds housing demand, creating a large imbalance in the housing market.

We can measure this imbalance two ways. The simplest method is to calculate the number of excess vacant homes for sale. Assuming a normal homeowner vacancy rate of 1.7% and rental vacancy rate of 8%, there is an excess of 1.87 mn vacant homes (again, see Figure 7).

Another, more detailed, way to measure the imbalance is to estimate the gap between housing supply and demand over the past few years. We define housing demand as the sum of household formation, demolitions and purchases of vacation homes, and housing supply as the sum of new construction, mobile homes and foreclosures from households that double up (Demolitions: Assume historical average of 0.24% of housing stock; Vacation homes: annual survey from National Association of Realtors which is about 10% of sales – we assume that 80% plan to use the home for vacation rather than rent it out and of which about three quarters plan to keep their first home; New construction: single and multi-family completions; Foreclosures: measure REOs (real estate owned) – we assume that half of the former homeowners will double-up). We estimate an excess of about 2 mn homes created over the past four years, consistent with our estimate from the vacancy data.

It will take years to clear the excess

Our mortgage strategists expect approximately 6 mn additional foreclosures to enter the market for resale over the next three years. It will then take a few years for the pace of foreclosures to gradually normalize to about 200,000 a year. If we plug in our baseline forecast for household formation (as explained above) and assumptions for the remaining variables (as explained in the footnote), we can run a few scenarios for the amount of time it will take to clear the imbalance under different paths of housing starts. At one extreme, if housing starts fall to zero, translating to zero completions next year, the excess supply will be cleared by early 2013. At the other extreme, if housing starts surge back to the historical norm of 1.5 mn next year and hold indefinitely, there would be another 2 mn homes added to the excess, bringing the total to 4mn, which would take until 2027 to offset. We believe the truth falls somewhere between these two extreme scenarios.

If we pencil in our baseline forecast for housing starts of 590,000 this year and 690,000 next year, another 500,000 excess homes will be created. Looking ahead, we must be more judgmental. A reasonable scenario is that starts slowly edge higher to 1 mn by 2013 and reach the “normal pace” of 1.5 mn by 2015. At this point, most of the excess supply will have nearly cleared, allowing starts to pick up to match the pace of demand (Figure 12).



Why any building given shadow inventory?

We often get asked why builders would start new construction given the considerable number of vacant homes on the market for sale. As the above example showed, if housing starts fell to zero, the market would return to normal much quicker.

There is a good reason for new construction: a foreclosed home is not a perfect substitute for a new home. Foreclosures will sell at a discount to a new home, but will often require a great deal of renovations. This will discourage some buyers. In addition, foreclosures are not equally distributed geographically or across price ranges. The bulk of foreclosures are in the lower end of the housing market. This creates two types of markets: “passive” and “active:” The passive market has the undesirable foreclosures, which are either in very poor condition and/or in a foreclosure-dense, and therefore suffering, neighborhood. It is likely that many of these homes will remain vacant and on the market for sale or rent. In contrast, the active market will contain foreclosures that can compete with regular homes in a market with housing demand.

The regional difference is particularly interesting. According to RealtyTrac, 37% of foreclosures are in either California or Florida and 65% are in the 10 states with the highest foreclosure rates. Even within these states, there are stark differences between zip codes. Homebuilders will avoid building new homes in the areas with a large presence of foreclosures. In the first half of the year, only 27% of housing starts were the top 10 foreclosure states (Figure 13). Comparing two large states is noteworthy: about 22% of foreclosures were in California, but only about 6% of housing starts, compared to Texas, which had only 4% of foreclosures and 15% of housing starts.

So now that both the very dire Demand and Supply sides of the pricing equilibrium have been discusses, what does this imply for the broader economy?

Unlike in prior recoveries, it is clear that housing will lag rather than lead the recovery. The monetary policy transmission typically has a very strong impact in the housing market – low rates encourage home sales and greater residential investment. In turn, job creation picks up in the  construction sector, further supporting consumer spending and home sales, and creating a virtuous cycle. This feedback loop is currently broken. Mortgage rates have plunged to record lows, and yet have done little to stimulate home purchases because credit conditions are still incredibly tight and consumer confidence is depressed. That said, we believe the direct drag from housing, through construction, is nearly over. Our forecasts for housing starts imply that residential investment will subtract from growth in 3Q, but then consistently add to output going forward. Still, the contribution to growth will be feeble relative to prior cycles, where housing was decidedly the force of growth (Figure 14).

While housing construction is the most direct link to the economy, it is not the only one. The path of home prices is also very important as consumers respond to changes in housing wealth. Our baseline view is that national home prices will edge lower over the rest of the year and then bounce around the bottom for some time. The downside risk is that foreclosures flood the market at a rapid pace, depressing home prices greatly, which could tip the overall economy back into recession.

Alas, we are already there, and yes, it is BofA's job to put a favorable spin on the data. Look for another 15-25% drop in home prices from here on out, and another wave of hundred billion+ charge offs at undercapitalized banks.

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Strider52's picture

Home Loans, Bitchez! (had to do it just once before I die).

Strider52's picture

Hah! My first Junk! Boy, what a great Monday. I'm *somebody* now!

tmosley's picture

According to some people, that means you are "right".

So congratulations.

Johnny Bravo's picture

Yeah, typically the people with the most sense get the most junks on ZH.

Fred Hayek's picture

As of this moment, you have none.  Corroboration!

rocker's picture

#1 Problem: To many houses. So banks sell them.

#2 Problem: Too many stocks, (Supply). So MM's sell them.

#1 & #2  Solution for both. Simply economic rule of supply and demand.

 * If their is less demand and too much inventory, the price must come down. 


redpill's picture

Existing homeowners with a mortgage have a minimum they can sell their house for.  Builders who have to cover their costs and run their businesses have a minimum they can sell their houses for.  Banks who are writing off the loan anyway, not so much.  As a result, there is absolutely no price resiliency when banks dump these distressed properties on the market.  And since the prevailing appraisal model relies on comparable sales, a bank sale is akin to dropping a bomb on that neighborhood when it comes to home values.


dark pools of soros's picture

true, but there is still descretion on part of the appraiser to pick 3-5 out of the mix and drop off some of the worst offending sales.. as long as your area is not rife with foreclosures they won't nose dive the neighborhood

Fred Hayek's picture

I hope you're right.  I'm selling my condo and waiting for the appraiser to come back with a number, one at least as high as the agreed price, I hope.

But there was one sale in the complex for less than my price 3 months ago by a guy who had had an intent to foreclose filed against him by Wells Fargo in addition to a complaint by the condo association that he was something like $3,500 behind on his condo fees, just over a year's worth at our fees.

Take that sale out of the picture and all the other sales are for more than I'm getting.  Include it and things become dicey.


redpill's picture

Negatory on that one, there's no longer any incentive for them to get the best value.  Appraisers have to go through an exchange now, so from their perspective it is to their advantage to be conservative so they don't get blackballed by underwriters.  If anything that means making sure they don't submit a value that isn't supportable under the most pessimistic review conditions.

Robslob's picture

I don't see how all these numbers account for all the new "tent cities" popping up all over America...?
My guess is that would also be considered "supply"....?

Translational Lift's picture

"tent cities"= temporary housing....

chunkylover42's picture

that's some top-notch research by BOA-ML to put that first chart together.  good thing they made sure to name themselves as the source on it, given it doesn't appear in every economics textbook on the planet.

Cow's picture

that's some kinda funny


Bolweevil's picture

And what's with the Harvard shill picking 2013 for the turn? Bullshit always comes with a 2-3 year horizon.

Nihilarian's picture

You sure this isn't just "economic hypochondria"? FASB accounting rules will prove you wrong!

Bearster's picture

If you look at each aspect of this depression in isolation, the analysis is depressing.  Another 20-25% drop in housing prices.

If you look at how that will feed back (did this analyst recursively revise upwards the number of homeowners who would be underwater with another 20% decline in prices, vs. today?  And if so, then estimate how many additional would walk away?  And this would recursively feed back into prices, etc.)

But few are looking at the sum total of all of these vignettes in concert.  There are non-linean synergies.  Just look at the banks' dire predicament in light of this housing analysis.

The banks have exactly how much tangible common equity right now?  As Mish keeps pointing out, they are not admitting what their assets are really worth, and the ratio of loan loss reserves to non-performing loans is at a low point.  So the banks already are facing more losses that they haven't written down yet.

And this housing discussion suggests a lot more pain to come to banks, as the gross price of the houses declines by 20%, what does that do to the value of the loan?  Obviously it goes down more than 20%, and in many cases will go down to zero (certainly any second mortagages and HELOCs will).

What does this mean to shareholders of banks?  Likely they take big losses, if they don't get wiped out altogether.  And further losses in 401K's and other accounts will do what to the consumer's willingness (and ability) to spend?

This will drive down retail sales further...

We had one heckuva ascending spiral on the way up over the past 28 years.  But all of those dynamics are now turned into reverse, and it promises to be one heckuva ride down.

cyclemadman's picture

Speaking of banks.  I haven't seen any updates on banks closed by the FDIC last week.  They closed down 8 on August 20, I have a hard time believing they didn't close down any last week.

mynhair's picture

Yep, no banks.  Shorebank is taking all Sheila's resources.

bronzie's picture

can't close any banks when Benny Baby is talking at J-Hole

mikla's picture

+1 to both of you -- Sheila is out of money, and can't do anything with B-Hole at J-Hole.

Gully Foyle's picture


Will they hit any before Labor day weekend? They usually don't close just before a holiday.

Does that mean if two weeks are missed they close three times the usual when they return?

molecool's picture

"If you look at each aspect of this depression in isolation, the analysis is depressing.  Another 20-25% drop in housing prices."

WHY is this depressing again? Why does everyone want homes to be expensive?

Bearster at car dealership: 'Alright, I take the red 323 - let's do the paperwork.'

Car salesman: 'Excellent choice, sir! I have that one on special for only $19,500'.

Bearster: 'What are you talking about? I came here to spend money! I'm not spending a penny below $40,000 - is that clear?

Some of you guys need to have your head examined. Especially if you bought a home at the peak of the housing bubble. Unfortunately some people never learn...


Bearster's picture

Oh I agree with you, to the buyer it's better if prices are cheaper.

Let's see how that will look in this case.  Homebuyer Joe has been saving his money in a bank account.  Prices fall to the level where he wants to buy.  He goes to "withdraw" his money and that's where the problems begin.

He does not "have" "money" "in" a bank.  He has lent money to a bank and now he has a piece of paper that says they will pay him on demand.  But the  banks are already drowning, and that's before we took into account another 20% drop in home prices!

So where is the money going to come from to pay off Joe so he can buy the house?

Right, from the taxpayers.

Bearster at car dealership: wow, the price is only $20,000.  Good thing molecool is paying for it anyways! :)


merehuman's picture

lets not forget..Carpenters, bricklayers, plumbers, electricians,roofers, carpet layers, gardeners, earth movers,Glass installers, supply stores, carpet suppliers and suppliers and manufacturers of all other goods going into a house. There is a huge amount of jobs lost until housing restarts.

cars arent pushing along either, and again a huge amount of jobs involved.

Contractor 30+ years, now i garden and enjoy the fruit of my labor. Government has not found a way to tax my garden produce..yet

RockyRacoon's picture

...other than the fact that you can't sell one ear of corn or a tomato without collecting sales tax.  My wife does ceramics for a hobby and went to a local craft show with some of her wares.  No go.  She didn't have a sales tax permit.  Sonsabitches.

Gully Foyle's picture


Craft shows are big business. People can make their profit in a few weeks hitting the seasonal circuit.

RockyRacoon's picture

This was a local yokel deal, people selling off card tables.  No big air-conditioned arena thingie.  It was patrolled by folks from the State!

mamba-mamba's picture

There is no federal sales tax. Yet. Here in California, grocery type food is not taxed. Take out is, but not groceries.

Gully Foyle's picture


"Government has not found a way to tax my garden produce..yet"

Um, property tax and tax on things like fertilizer and water, tax on the tools purshases, tax on the energy used to can or freeze.

Only way to avoid tax is live naked in some tropical paradise where the fruit falls into your hands.


Johnny Bravo's picture

That supply and demand graph is all wrong.  Shouldn't S1 be to the right instead of to the left?

How can you have an increase in supply AND a decrease in demand, and have equilibrium equal to the old equilibrium price before the supply increased and the demand decreased?

whatsinaname's picture

28 years ride is correct - 401k programs started in 1982 and set the ball rolling for a phony middle class prosperity charade.

Ripped Chunk's picture

Yup, more and more people living with people that they would rather not live with.

Assaults and murders skyrocket this Christmas.

H H Henry P P P Paulson's picture

I blame this on Rosie O'Donnell.

Rainman's picture

Whole families are moving housing to Walton's Mountain. Here comes the kiddies and grandkiddies. G'night Grandpa. G'night Granma. G'night John Boy. McMansions bought on the cheap can house 12.

Translational Lift's picture

"McMansions bought on the cheap can house 12".........Americans...........144 illegals.......


Translational Lift's picture

RE: two junks......Well....there's two illegals....142 to go.........

Lucky Guesst's picture

What do we consider a mansion? Nothing over $750K sold in the last 2 months.....

long on bunkbeds?

Nathan Muir's picture

Careful there, no new home construction over $750k sold in the last 2 months.  This little omission caused me some embarrassment over the weekend while arguing/discussing with a friend.

Lucky Guesst's picture

Oooops, thanks for setting me straight on that.


My tax dollars will be used to tear down houses to temporarily prop up the construction industry and lower unemployment stats in order to jack up the price of a house I might buy!!

Ragnar D's picture

Yep, just like the Agricultural Adjustment Act during the first Depression.


Entire fields of crops were plowed under, and millions of pigs, chickens, etc were bought by the gov't at premium prices to be slaughtered and removed from the market.

Keynesianism in a nut shell.  The problem wasn't that people were broke (some starving), with prices falling as a consequence, the problem was "overproduction".  Their perverse solution was to destroy stuff (in this case food), so that they'd have to outbid each other for the diminishing supply, pushing prices back up where they were during the bubble.

So everyone is poor and hungry, being taxed to have their food prices forced back up to levels they never should've reached to begin with.  Problem solved.

stollcri's picture

I have heard that there was some sort of program [in the very recent past] to encourage dairy farmers in the midwest to do this sort of thing, but I didn't catch the details.

septicshock's picture

What's this ten year outlook thing? Does anyone really expect this whole farce to even last more than two years?

VK's picture

Bullshit is always in a bull market.

Bolweevil's picture

VK said it best first (itchy comment finger by me).

Translational Lift's picture

It took 30 years to get here....do you really think this is going to end in a year or two??

THE 4th Quadrant's picture

"What's this ten year outlook thing?"

Isn't that the average lifespan of an American house before it's crunched and hauled away to the landfill?

Fred Hayek's picture

Maybe a Toll Brothers house.  They're a huge real estate company that started in Pennsylvania or Maryland and invaded Massachusetts about 12 or so years ago.  They built big $900,000 status boxes. 


A small independent house builder explained to me, several years ago, all the ways that Toll Brothers houses are shoddily made.  If my alternative was a hovel carved out of peat, I'd take the peat hovel over a Toll Brothers house.  If you ever consider buying a house and find that the title traces back to Toll Brothers or one of their corporate subsidiaries, I strongly advise that you don't purchase.