It sounds premature to say that the housing market should be booming again already, but it’s true. “[T]oday’s level of home construction cannot last,” my colleague Morgan Housel observed at the end of last year, “it’s just far too low to meet demand.”
The economics behind this assertion are straightforward. Every year, the population of the United States grows, leading to an increase in the number of American households, which thereby fuels the demand for new homes.
Here are the numbers to drive these relationships home. Between 2002 and 2007, the population of prospective homeowners grew at an average annual rate of 2.5 million. Over this same time period, the number of households increased by average of 1.1 million. And to accommodate these newly formed households, homebuilders built an average of 1.7 million housing units a year.
But here’s the rub. Since the onset of the financial crisis, the relationship between these numbers has broken down. In 2012, while the population grew by 3.2 million people and the number of households shot up by 973,000, homebuilders built a total of only 650,000 housing units. You can see how these figures compare in the chart below.
The main thing to focus on here is the low number of housing units that were constructed last year compared to the growth in both population and household formation. The numbers before the crisis make sense, as there were always more than enough new housing units to shelter the growing number of households. What doesn’t make sense is the fact that an estimated 973,000 households were formed last year, yet only 650,000 housing units were built. You don’t need to be a rocket scientist to appreciate that this can’t persist indefinitely.
Over the past few years, homebuilders have been able to compensate for the difference simply by liquidating their existing inventories of new homes. At the end of 2008, there were an estimated 352,000 new single-family homes in inventory. By the beginning of this year, that number had fallen to 148,500. in the intervening time period, in other words, more than 200,000 new homes that sold did not need to be built.
Fortunately, there’s reason to believe that we hit the bottom of this trend in the middle of last summer. You can see this in the chart below. Twelve months ago, the existing inventory of new single-family homes was at the lowest level on record — that is, since the government started tracking the statistic in 1969. But if you look at the far right, you can make out the beginnings of what could very well amount to a robust rebound.
We were reminded of this on Monday, when the Commerce Department released an estimate of construction spending in May. According to its figures, spending on residential construction was at a seasonally adjusted annual rate of $322.3 million last month. While this was only 1.3% higher than the rate in April, it was an impressive 22.7% above May of 2012, and it still has a long way to go.
We’re also starting to see the proceeds of the nascent recovery reflected in the earnings of homebuilders. Last week, Lennar Corporation (NYSE:LEN) and KB Home (NYSE:KBH), two of the nation’s largest homebuilders, reported markedly improved results. Lennar Corporation (NYSE:LEN)’s home deliveries shot up by 36% on a year-over-year basis while KB Home (NYSE:KBH)’s increased by 39%. And in PulteGroup, Inc. (NYSE:PHM)‘s first-quarter earnings release in April, its chief executive officer observed that homebuyers are “feeling a greater sense of urgency given the combination of limited product inventory and rising prices found in many markets throughout the country.”
The significance of a full recovery in home construction simply cannot be overstated. In the first instance, there are multiple industries that look to it for revenue. Home improvement retailers such as The Home Depot, Inc. (NYSE:HD) are a perfect example. It’s no coincidence that the housing recovery was referred to 19 times on the company’s most recent conference call. And lenders like Wells Fargo & Co (NYSE:WFC) fit the same bill. In the first quarter of this year, the San Francisco-based mortgage giant underwrote $109 billion in home loans alone, accounting for roughly a third of domestic mortgages.
Beyond this, homebuilding is an important source of jobs in and of itself. Again, as my colleague Morgan Housel has noted, it’s estimated that each new home generates between two and three new jobs. This is why Warren Buffett is able to confidently proclaim that, “We will come back big time on employment when residential construction comes back.”
At the end of the day, it’s no longer a question of if the market for newly constructed homes will recover; it’s already in the process of doing so. What remains to be seen, in turn, is precisely what shape the recovery will take. But either way, one this is certain, if you want to profit from this quickly approaching profit tsunami, one of the safest and most profitable ways to do so is to invest in the so-called “only big bank built to last.” Unlike the majority of other mega lenders, it’s proven its mettle as one of the safest investments around. And on top of that, it pays out a highly respectable dividend each quarter to its admiring shareholders.
The article The Housing Boom Is Almost Here originally appeared on Fool.com.
John Maxfield owns shares of Bank of America. The Motley Fool recommends Bank of America and Wells Fargo. The Motley Fool owns shares of Bank of America and Wells Fargo.
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