The incredible shrinking inventory

By James Howsley

A few years ago I wrote an article, “Demographics, Development and Demand,” in which I predicted a return of the housing market by late 2010.

Well, we all make mistakes.

But the underlying theory behind the article is taking shape: Namely, that because over the past several years housing starts fell well below the historical average of approximately 1,544,000 units a year between 1978 and the end of 2007, a return to near-normal production had to occur at some point simply to satisfy the need of new household formations.

According to the U.S. Census Bureau, the nation saw about 906,000 units in 2008, 554,000 units in 2009, 587,000 in 2010, and 609,000 units in 2011. According to data released by the bureau on Sept. 19, housing starts are at an adjusted annual rate of approximately 750,000. This is a five-year average of about 681,000 units a year, well below the 1,544,000 unit average.

If we accounted for the overproduction that might have happened during the robust cycle of 2003-07, the underproduction of 2008 and 2009 should have normalized the numbers’ historical average already.

But a weak economy continued to persist during the remainder of 2010 and all of 2011. While many economists declared the end of the “Great Recession” some time ago, it continues to linger.

In the past two to three months I have noticed an emerging trend. Builders and developers dormant for some time have begun calling again not just to chat, but to inquire about land that only had a preliminary plat on it or even raw land.

Why is this important? Conventional wisdom would suggest a severely dwindling lot inventory, the very thing that I warned about in that 2010 article.

The warning to the real estate community might seem a bit strange given the state of the market in the past few years. But if housing production doesn’t return to the historic norms mentioned above as soon as the economy has fully recovered, we will be facing a severe housing shortage that could cause housing and lot prices to reach the fevered pitch they had during the height of the real estate boom. Because land is a commodity in the development world, builders and developers would be out there once again competing for an ever-decreasing supply of lots and land.

This follows some words of advice a developer client gave me years ago. He had seen several cycles and said that things would remain sluggish until 2014 and then, look out. He knew, and still knows, how long it takes to bring new lots to market. In the Portland-metro market it takes at least two years, and in some cases four or more, to bring raw land through the approval process and have the infrastructure in place to begin building and selling new platted lots.

According to New Home Trends’ September 2012 data, since 2007 about 7,800 new lots have been brought to market and about 9,700 new home sales have taken place. This would suggest that the supply of lots should be extremely low, even if a glut of more lots were created before 2007.

And the rate at which new lots have been brought to market during the past few years also is telling. In 2009, the total was 839 lots; in 2010, the total was 642; and in 2011, the total was 526.

During the downturn, the negative news in real estate artificially suppressed developers from seeking approval of new subdivisions and apartments. Even when a developer wanted to pursue new approvals, it would be stymied by strict lending requirements, all of which created an odd paradox of sorts.

Banks were told by the Federal Deposit Insurance Corp. that they needed to reduce their real estate holdings and hence began selling lots. The FDIC forbade many banks from lending for new projects. Yet now we are on the edge of a shortage.

I am hopeful that we will continue the upward trends, but we should remind ourselves that we could slide back to some very frantic times that could once again produce negative results.

James Howsley is a shareholder in Jordan Ramis PC and a member of its Dirt Law practice group. He focuses his practice on land use and real estate while serving clients in Oregon and Washington. Contact him at 360-567-3913 or at [email protected].