Overheated Housing Market Struggling to Recover

Harvard Releases the 2007 State of the Nation’s Housing Report

Cambridge, MA - The U.S. housing market continues to struggle under a cloud of sharp drops in housing demand and an oversupply of stock according to this year’s State of the Nation’s Housing report from the Harvard University Joint Center for Housing Studies. After years of setting records, housing starts and sales fell in 2006 and are on track to end this year even lower. Homebuyers on the margin of qualifying for mortgage loans finally pulled out of the market despite the availability of creative mortgage products that helped them keep up with higher house prices. “As buyers left, home sales fell and house price appreciation slowed in some areas and fell in other areas.  Investors and second homebuyers also started to leave. The air went out of the inflated housing market as higher home prices and interest rates finally tempered demand,” explains Nicolas P. Retsinas, director of the Joint Center for Housing Studies. “Many buyers are now waiting on the sidelines hoping prices will fall.”

The problems in the housing market put an end to the big lift that the economy enjoyed since the 2001 recession.  In the latter half of 2006, the drop in home building was so drastic that it shaved more than a full percentage point off national economic growth. Though builders cut back on housing starts, the numbers of vacant homes for sale rose by more than 500,000 from the fourth quarter of 2005 to the fourth quarter of 2006 and continued to rise in the first quarter of 2007. Meanwhile, the tightening of credit standards in the wake of worse than anticipated subprime loan performance is further dampening demand. It is unclear how the wave of subprime loans with steep initial discounts that originated at much lower interest rates will perform when the discounts expire and the loans reset to higher interest rates. Already, homes entering foreclosure increased by about 75,000 from the fourth quarter of 2005 to the fourth quarter of 2006. Until some of the excess inventory is absorbed by the demand cycle and credit conditions stabilize, housing will continue to struggle and home prices will fall in more areas.

Still, the nation’s largest housing challenge remains housing affordability. “In just one year the number of households spending more than half their income on housing increased a startling 1.2 million to 17 million in 2005,” notes Rachel Drew, Research Analyst. “Even if prices or rents soften for a period of time, the nature of US labor markets, the regulatory restrictions imposed on residential development, and the fiscal limits of government assistance to cost-burdened households will make affordability a long-term challenge.” Some Americans try to escape these cost burdens by taking longer commutes and incurring higher travel costs, while others double up or live in substandard housing or undesirable neighborhoods.  The prospects for a substantial easing of these problems are unfortunately dim.

In time, housing markets will recover. “While it will take time to work out current loan problems and work off the oversupply of homes, the long-term outlook for residential investment remains strong,” comments Eric S. Belsky, executive director of the Joint Center. Largely, as a result of a record number of new immigrants arriving in the United States in the 1990s and larger numbers entering this decade, net household growth is poised to accelerate by about 2 million to 14.6 million households 2005-2015.  In addition, incomes and wealth stand higher for most households in real terms than ten years ago. This should translate into solid growth in both new construction and remodeling spending over the next ten years compared with the last ten.

Harvard’s Joint Center for Housing Studies is the nation’s leading center for information and research on housing in the United States.  Established in 1959, the Joint Center is a collaborative unit affiliated with the Harvard Design School and the Kennedy School of Government. The Director of the Joint Center for Housing Studies is Nicolas P. Retsinas. The Center’s research and additional information about its programs and activities are available at www.jchs.harvard.edu.