‘Underlying demand’ (or ‘pent-up’ demand) is the common method used in calculating whether there is a housing shortage. Put simply, underlying demand estimates what the demand for newly-built housing might be given the growth in population, trends in household size, demand for second (or holiday) homes, and economic conditions (e.g. employment, interest rates, etc). Underlying demand differs from ‘effective (actual) demand’, which is the quantity that owner-occupiers, investors and renters are actually able and willing to buy or rent in the housing market.
In the years leading-up to the US housing bust, underlying demand was running strong. Unemployment was low, the US economy was growing strongly, credit was readily available, and the number of new households being formed was running well above the long-term average of 1.25 million household formations per year (see next chart).
The surge in household formations led to numerous suggestions that the US was facing a housing shortgage, especially in areas where land supply was restricted, such as California, Nevada, and Arizona.
The rest is history. The US housing bubble burst, economic conditions deteriorated, and the rate of household formations fell to 65-year lows in the three years following the Global Financial Crisis, leading to a large oversupply of homes that exacerbated the downturn in both prices and rents.
An article published earlier in the week in USA Today provides further context on the slump in US housing demand caused by deteriorating economic conditions:
The Great Recession has upended the American tradition of moving to greener pastures. Instead of moving to a bigger home or for a higher-paying job, more Americans moved because they can’t afford to stay where they are.
During the 2007-09 recession, 9% of Americans — about 4 million — moved locally, the highest level in a decade. And a growing number moved to cheaper housing or doubled up with family and friends, according to an analysis out Wednesday of Census data through 2010…
People moved the most in metropolitan areas with the highest unemployment and highest foreclosure rates, particularly in hard-hit parts of the Sun Belt…
In Las Vegas, for example, one in five people moved locally during the recession…
“Typically, over the last couple of decades, when Americans moved, they moved to improve their lives,” says Michael Stoll, author of the research and chairman of UCLA’s public policy department. “This is the shock: For the first time, Americans are moving for downward economic mobility. Either they lost their house or can’t afford where they’re renting currently or needed to save money”…
The key lesson from the US experience is that the demand for housing is highly changeable depending, largely, on prevailing economic conditions.
Should economic conditions deteriorate significantly, such as through a disorderly unwinding of the mining boom, the number of Australians opting for group accommodation (or the number of young people moving back into mum and dad’s) could rise significantly, turning a perceived housing shortage into a surplus.
There is also the risk that any reduction of housing demand arising from deteriorating economic conditions crimps the rate of new home construction, in turn shattering the RBA’s and Treasury’s plans for housing to fill the void as the mining boom unwinds.
unconventionaleconomist@hotmail.com
Spot on! Supply and demand don’t dictate property prices (or of anything else!), it’s the capacity to pay that does. End of story. There can be one house for sale in a shortage-Australia and 100,000 ‘buyers’ for it, but if the asking price is $100,000 and no one has more than $10,000 available in saving, or most importantly, debt capacity that house won’t sell…until it gets to $10,000
Supply and demand don’t dictate property prices (or of anything else!), it’s the capacity to pay that does
Nonsense. When using the term “supply and demand” demand means willingness and ability to pay. In other words demand includes the capacity to pay.
If you would like to redefine “demand” to mean some measure of need, then you are correct. Neediness does not determine price.
Janet is correct in so far as property spruikers continually overlook “ability to pay”, perhaps willfully. That is, they overestimate “demand” because they base it on population trends etc. See the first paragraph of Leith’s posting – the spruikers tend to regard “underlying demand” AS “demand”, going forward.
Your analysis fits for the US but I see a further issue in Oz. In the US, where demand fell and there was excess supply, prices fell and fell to find the point where demand was eventually stimulated.
In Oz an effective floor price on new dwellings set by the developer/banker cartel and this distorts the rest of the market.
Demand falls in Oz.
Prices are discouted by gifts and rebates by 5 or 10%.
Demand falls further.
But instead of the price falling the FIRE lobby scream for rate cuts and FHB grants and immigration to stimulate demand and soak up excess supply.
In our relatively small market the price mechanism is jammed by the ability of the developer/banking cartel to effectively price-fix regardless of supply/demand levels. It makes property development a far less risky game. Banks are happy, developers are happy and the punters and productivity get screwed.
The anti-competitive price-fixing cartel must be broken. But how?
I understand your frustration, but similar conditions existed in California et al, where developers cornered the market. The difference is that the US experienced a catastrophic fall in demand caused by a once-in-a-centrury economic shock. Australia hasn’t experienced any such shock. The big risk for Australia is a massive unwinding of the commodity boom (both commodity prices and mining investment).
The jammed mechanism will inhibit our ability to deal with the unwinding.
I remember believing the following:
* The Cold War would never end.
* Mutually Assured Destruction is a permanent feature of geopolitics.
* The Northern Ireland problem will never be resolved.
With those errors-of-judgement in mind, I like to think that the vested interests ‘jamming the mechanism’ here will find the traditional fixes to their short term problem of shifting house/land packages (FHB grants, immigration & rate cuts) does bugger-all when falling mining-related income strikes directly at the grants, immigration rates, and, fourthly, wages.
They are all pretty well still there in one way or another. Sorry.
Did I say they weren’t?
If a 5 – 10% discount of gift is enough to get the punters in, then why wouldn’t developers (“the cartel”) do it?
If consumers showed a bit more common sense, and stopped believing every bit of spruik they get from the RE lobby & it’s cronies.
I don’t think there is anything that would change the price-fixing behaviour overnight, but a few of the basics that would help include…
1/ removal of buyer’s incentives/subsidies
2/ quarantine deductions on investment properties (essentially remove neg gearing)
3/ govt. to buy up land on urban development fringes (esp. places like Melbourne & Brisbane) before re-zoning for urban development, and sell or (ideally) lease to FHBs…
4/ Include part (say, 50%) PPR in pension assets test
Would also help if the banks got together and decided not to pass on any further rate cuts: for the moment we (I would argue) could do with some downward pressure on the $AUD, however we don’t want a renewed debt orgy.
yes – demand at a particular price level can quickly dissipate regardless of underlying demand. My rule of thumb is:
- rent rises are caused by changes in real demand (ie number households needing to live in a house v housing stock)
- change in house prices are caused by real demand plus or minus changes in speculative demand.
So compare growth in house prices v growth in rents and thats how much speculative premium is built into the price. Clearly in Aus there is a lot.
Exactly.
With some adjustment for interest rates
This article will provide needless fuel for the shortage-deniers out there.
Of course it is true that a shortage can turn into a surplus. Consider a small town where a large mine opens up. During construction many workers are needed. Of course there is a shortage of housing (compared to normal). Then construction ceases and the mine runs for a while. Did I mention it was a Uranium mine? Then govt bans the mine. Suddenly there is a surplus of housing in that town.
Could Sydney “suffer” a surplus of housing? Yes. When rents fall to historical lows feel free to declare the surplus. Until then – SHORTAGE.
claw – the point being made is that “demand” is an elastic concept, especially demand at a particular price point. There is an absolute shortage of waterfront sydney harbour property becuase everyone wants to live there, but few people create demand at the price level being asked because few can afford it. Mainstream property is the same. Any of the following can affect demand at existing prices:
- job losses
- int rates
- ease of credit
- tax laws
- anticipation of future growth
- better yielding alternative investments
- removal of govt subsidies /guarantees/rbms purchases etc
So regardless of whether there is a dearth of property or not, the market can be oversupplied where people refuse or are unable to pay the prices, in which case house prices must drop to meet the market.
squirell, All those things are true. Price is effected by many things.
I’ve been saying:
In Sydney there is a severe shortage of ordinary housing – a severe structural shortage due to high immigration and choked supply.
Price of superior housing will always depend on many factors such as the wealth of the rich
Price of basic fringe housing should reflect cost of production.
“…..So regardless of whether there is a dearth of property or not, the market can be oversupplied where people refuse or are unable to pay the prices, in which case house prices must drop to meet the market…..”
But RE prices are notoriously “downwards sticky”. Look at the UK. The “brownfields” sites that the planners say must be developed first, are owned by people who “hold out” for prices that are so high that the resulting development, if any is done, is unaffordable to most people. Hence a few sites get developed with high-end-of-the-market condominiums, the owners of all other sites expect the same prices, and sites sit undeveloped. The cost of sites that need new buildings on them is an obstacle to anything actually getting done with them.
The planners in the UK point to these undeveloped sites, and empty homes owned by speculators also “holding out” for “top of the bubble” prices, as evidence that “there is no shortage”; while any parcel of greenfields land that does get rezoned for urban development increases in value overnight by a factor of about 250……..!
Employment in “construction” in the UK is apparently now around one quarter what it was in the 1960’s, even as the average age of houses has gone up, overcrowding among the lowest income group is a disgrace, housing-related health outcomes are deteriorating, the size of new sections is the smallest in the OECD even including Japan, the size of the cohort who will never own their own home is rising, the size of the cohort that reaches retirement still with a mortgage is rising, and some studies estimate that the market could swallow several million new homes if the prices were right.
If I recall correctly, in the UK there is a requirement for a portion of most large developments to be allocated as “affordable” housing, in order to avoid only high end development taking place.
As PhilBest says
Employment in “construction” in the UK is apparently now around one quarter what it was in the 1960’s, even as the average age of houses has gone up, overcrowding among the lowest income group is a disgrace, housing-related health outcomes are deteriorating, the size of new sections is the smallest in the OECD even including Japan, the size of the cohort who will never own their own home is rising, the size of the cohort that reaches retirement still with a mortgage is rising, and some studies estimate that the market could swallow several million new homes if the prices were right.
But a shortage-denier will still find some pathetic excuse to deny there is a shortage …
As PhilBest says
The planners in the UK point to these undeveloped sites, and empty homes owned by speculators also “holding out” for “top of the bubble” prices, as evidence that “there is no shortage”;
Shortage-denier is as shortage-denier does
Why quote employment as an indicator rather than number of houses constructed or a more explicitly relevant stat to support your assertion?
They were building loads of ugly square towers all over the place in the 60′s… But also employment in construction may have fallen due to efficiency gains and/or reduced requirement for manual labour in the construction process since then?
You can see the concrete evidence of housing completions in the UK HERE:
https://www.gov.uk/government/statistical-data-sets/live-tables-on-house-building
Scroll down to Table 241 (Excel spreadsheet): Permanent dwellings completed, by tenure, United Kingdom, historical calendar year series
Right through decades of steady population increase, economic cycles, rising incomes, and increasing actual shortage of homes, the number of housing completions per year “cycled” around a lower and lower trend point. It is clear that for decades over which Britain needed around 400,000 new homes per annum, there has been almost NO YEAR in which this many WERE built, and the “MAXIMUM” built during the peak of a “boom” has slipped steadily down through the 300,000′s into the 200,000′s and even LOWER.
Unconventional E,
Do you have the equivalent data for Australia? Has there been oversized house formation here in the past 10 years?
That’s the key question.
There are constantly articles in the papers about how children are staying at home longer and longer because they either can’t afford to buy/rent or just like being looked after.
I don’t have any stats to hand to prove it, but my feeling is that there is a lot more share households and kidults at home in Oz than there was in America. So when the sh1t hit the fan there, a lot households consolidated because there was space to do so. Is that the case in Australia? I’m not so sure…
Another phenomenon is of course the level of crowding at which young singles “flat” together. I pick that this has gone very high.
Immigrants are also often prepared to “crowd” much more than local born people. This is a dirty secret of “high urban density” in London and Vancouver at least, possibly more cities as well.
Coincidentally, I now notice news that London has just gone “majority immigrant”.
http://www.dailymail.co.uk/news/article-2281941/600-000-decade-white-flight-London-White-Britons-minority-capital.html
Is sharing a flat really “crowding”? I think its an effective utilisation of available accommodation. I’ve shared many flats and have mostly positive memories of the experience.
I was not criticising young people sharing rental accommodation as a lifestyle choice, I am criticising a forced increase in the numbers of such people in a given space purely because of declining affordability.
It is like the difference between being on a diet as a matter of choice, or being malnourished due to bad government, as in North Korea.
Note that it is common knowledge among health researchers that the connection between income levels and health outcomes, is “the housing conditions people live in”.
If it is 2 or 4 non couples/bedroom … or time sharing a bedroom.
Interestingly, the 2011 census showed that average household size went up ever so slightly.
Considering household size has been falling for the best part of a century, this suggests to me that the cost of housing recently is hindering household formation.
Across the nation, the increase was 0.005 people per household, so that pent up demand is probably not as great as you think.
I doubt that anyone can rely on a Census for pin point accuracy, it’s very good for trends and social implications, for the rest it would be called “interesting”.
It’s quite true that demand can both ramp up or down very quickly especially if there is an “event” that quickly changes perceptions.
As pointed out above there has not been any negative event other that stories from overseas countries.
I would think that we are close to normal in household formation perhaps after a few years of slightly below normal. Australians probably have a little catching up to do, which should marginally increase demand over the next few years.
We can see from the chart above that the US household formation rate has almost gotten back to pre great recession levels and should probably exceed that over the next few years to make up for some lost ground.
Household formation is certainly on the ‘up’ in one respect – older singletons, re-coupling, and getting rid of the ‘extra’ house. Economics as well as social dynamics at work there! More stock to the market, I guess……