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Why the housing market is still stalling the economy

If the economy still feels stuck, blame the housing market.

That may not match how people in a handful of big, prosperous cities see things. After a disastrous and historic crash, housing is booming in places like San Francisco and New York. Bidding wars are back, and the question is not whether the real estate market is recovering but whether new bubbles are inflating.

But there's another reality that is more important for the national economy. Except in a few booming markets, housing is nowhere close to pulling its economic weight. Consider this:

Investment in residential property remains a smaller share of the overall economy than at any time since World War II, contributing less to growth than it did even in previous steep downturns in the early 1980s, when mortgage rates hit 20 percent, or the early 1990s, when hundreds of mortgage lenders failed.

Real estate agent, left,  shows prospective buyer a home on April 22, 2014 in Coral Gables, Florida.
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Real estate agent, left, shows prospective buyer a home on April 22, 2014 in Coral Gables, Florida.

If building activity returned merely to its postwar average proportion of the economy, growth would jump this year to a booming, 1990s-like level of 4 percent, from today's mediocre 2-plus percent. The additional building, renovating and selling of homes would add about 1.5 million jobs and knock about a percentage point off the unemployment rate, now 6.7 percent. That activity would close nearly 40 percent of the gap between America's current weak economic state and full economic health.

So what is holding housing back?

Sure, a glut of housing was built during the last great mania, and in some markets buyers are still working through those supplies. Bank lending is only now thawing, both for homebuilders and buyers. But those restraining factors have eased a lot in the last few years. The bigger thing holding back housing is simply demand. Fewer people can or want to fulfill the American dream of starting a household of their own.

It may yet prove to be temporary, but for now at least, millions more people are doubling up with roommates, living at home with parents and otherwise finding ways to avoid doing the one thing that would get the housing economy back to normal: buying a home.

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Overbuilding, Underbuilding

The housing market in Roanoke, Va., is a good place to see what's happening. A city of just under 100,000 people in the foothills of the Blue Ridge Mountains, Roanoke has a history as a rail and manufacturing hub and nowadays has a strong health care industry. It also has this distinction: Its housing market—based on measures like housing prices and building activity—closely matches the nationwide data.

The number of new houses and apartments that are needed in the United States is determined over the long term largely by demographics—immigrants arriving and young people moving away from home. From 2000 to 2007, the number of households rose 1.24 million a year on average—about what economists would expect, given those demographic trends.

Add in the 300,000 or so homes that fall into disrepair each year and need to be replaced, and builders would have to construct around 1.5 million homes a year to keep up with the longer-term demand.

During the boom, builders were much busier than that, putting up 2.1 million more houses from 2000 to 2006 than if they had stuck to that 1.5 million trend rate.

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But the correction underway since the housing bubble burst has been far more severe than the overbuilding that preceded it. From 2007 to 2013, builders constructed 4.8 million fewer homes than they would have had they kept to the trend rate. In fact, if the challenge was solely to work through the 2.1 million "extra" homes created during the boom, that job would have been finished around the middle of 2010.

"We built a heck of a lot of homes during the last housing bubble," said Stan Humphries, chief economist of the real estate company Zillow. "And it's taken some time to work off that glut. But we have largely worked off that glut at this point. Now our main challenge is housing demand, and that means we need more people forming households."

Roanoke never experienced the sort of extreme bubble in prices and construction of a Phoenix or a Miami, or the structural economic decline of the industrial Midwest, or the kind of humming regional economy that spurred a speedy rebound in the likes of San Francisco and Washington. In that sense, Roanoke is like hundreds of midsize cities nationwide that are trying to climb out of a long, deep downturn.

Back in 2005, builders in the Roanoke metropolitan area took out permits for more than 1,600 new housing units. At the low point, in 2009, they took out just 449. The rebound since then has been modest, with only 656 permits issued in 2013.

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Peter Fields, the president of Fields Construction, was responsible for more than a few of those 1,600 homes started in 2005. That year, he began work on a 100-house subdivision called North Oaks, in neighboring Salem, Va. Just as the empty streets of North Oaks started filling in with new houses that were to be priced at approximately $300,000, the housing bust hit and demand collapsed.

"A lot of builders just quit building," Mr. Fields said. "They parked their trucks and decided to do something else." Banks stopped lending for new development. Nearby subdivisions that had been in the planning stages remained only blueprints. Houses that had been started before the bust sat empty, waiting for buyers.

Now, though, those houses have owners, and new houses are rising. But things aren't good enough to lead a builder like Mr. Fields to crank up the pace of production. Whereas three years ago a builder would offer a $20,000 discount to a willing buyer, now the discounts run only $5,000 or so. Thanks to a run-up in prices for supplies like lumber and wallboard, his profit margins remain squeezed.

Standing over the granite countertops in a house nearing completion, waiting for a washer and dryer to be installed and some tile work to be finished, Mr. Fields explained that he wants no more than three houses in inventory at any given time, to avoid the risk of being stuck with empty houses.

What is keeping Peter Fields from building more houses isn't too much competition from foreclosures or excess houses from the boom years (inventories are fairly tight by historical standards) or a shortage of land (he has 30 more lots graded and ready to build upon) or a shortage of capital (his bankers are eager for him to continue building). It's simple as can be: "We'll build more houses as soon as we see some people ready to buy them," he said.

Mystery of the Missing Buyers

Given demographic trends, there should be plenty of housing demand. Immigration has slowed in recent years, but the nation's population has still grown by about 20 million since the housing downturn began in 2006. Yet those additional people are translating into fewer new households than historical patterns would predict.

This is a problem for the whole economy, and at its core is the mystery of the missing buyers.

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"Household formation," as economists call it, is the foundation of demand in the housing market. When a young adult moves away from home and gets her own apartment, a household is formed; when a retiree moves out of his own place and into the apartment above an adult child's garage, one ceases to exist. The number of American households is in constant motion; it is determined by millions of individual decisions that Americans make about their living situations.

Since 2007, those decisions have tilted overwhelmingly toward not dividing up into as many households as in the past. The number of households rose by an average of 569,000 a year from 2007 to 2013, according to census data, down from 1.35 million a year from 2001 to 2006.

Using different data sources, Jed Kolko, chief economist at the real estate information company Trulia, estimates that by last year there were 2.3 million of these "missing" households—households that would exist if historical patterns had held, but instead are nowhere to be found.

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Why the missing households? To a large degree, they can be explained by young people choosing—or being forced by circumstance—to remain at home longer than they have in previous generations.

Before the recession, 27 percent of 18-to-34-year-olds lived with their parents. Now that share is 31 percent. That is surely attributable in part to the lingering effects of a downturn that struck young adults particularly hard. Only 62.9 percent of 20-to-24-year-olds had a job in March, according to Labor Department data, down about 7 percentage points from the spring of 2007. The overall employment rate has fallen by only 4.4 percentage points.

But while the weak job market for young adults is an important element of the story, it's not the only one. Even young people who have jobs are more often living with their parents: Among employed 25-to-34-year-olds, the rate has risen to 25 percent in 2013 from 22 percent in 2007.

"The younger generations do not seem to have a significant lower preference for homeownership," said David Crowe, chief economist of the National Association of Home Builders, citing surveys. "They just can't do it now. They stayed home because they couldn't get a job or couldn't get a good enough job to live independently."

Reed Bergloff, 28, is a Roanoke resident with a solid job selling windows and doors. He lives at his parents' house, he said, not because of the cost of a rental but because he wants to save money to buy his own place.

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"If I rented a place, something decent that doesn't have bedbugs and stuff like that, I'd be looking at $600, $700 a month plus cable and Internet and all that," Mr. Bergloff said. "I'm just trying to put away as much as I can. It's harder for people to get a loan these days. For a while, banks were just handing money out left and right to unqualified people, but I know I'm going to need a solid down payment. It just makes sense to save as much as possible while I can."

For other young people, there are different explanations: They may sense that their jobs are not secure, or they have a lot of student debt that limits what they can spend on rent or a mortgage payment. Whatever the cause, the effect is to delay signing a lease or getting a mortgage.

The reason Peter Fields doesn't see the kind of demand for houses that might coax him to speed up building activity, in other words, is precisely that there aren't the new households that would normally snap them up.

Mixed Blessing of Apartments

Andy Kelderhouse's company, Fralin & Waldron, bought a 117-acre apple orchard in Daleville, Va., just up the road from Roanoke, in 2005, and made big plans for it. There would be a town center with shops, restaurants and office space, and 300 homes ranging from apartments overlooking the square to big single-family homes on the outer edges of the property.

The company constructed the first building of Daleville Town Center more than seven years ago. It's a two-story brick commercial structure, with the Town Center Tap House, a restaurant with a seemingly endless beer list, on the ground floor, and the developer's offices on the second.

The little center is starting to bustle, with residents attending concerts at an open pavilion or popping into the Tap House for beer and a $12 lobster mac and cheese. But it's not because Mr. Kelderhouse sold many houses.

At the end of 2012, he broke ground on three buildings with 120 rental apartments. It seemed an unconventional step to take in the rolling hills of southwestern Virginia, where the default domicile is a detached single-family home. But apartment demand has proved surprisingly strong, especially for larger units. The 83 units that were complete as of early April were all leased—some with higher rents than the company had projected. It has already raised the rent on three-bedroom units from $1,250 a month, when they first went on the market last year, to about $1,500 today.

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"It's not just for young professionals or young families," Mr. Kelderhouse said of his rental units. "We've had a lot of retirees as well who don't want the hassle of a house."

So there is something of a boom underway in the nation's housing market. It just isn't for single-family homes.

Building of rental multifamily properties, as the industry calls them—buildings with five or more housing units as part of one construction—was higher last year than it was even at the peak of the housing boom. Some 34 percent of all housing permits issued nationwide were for multifamily properties in 2012 and 2013, the highest since 1984.

It appears that many people who once set their sights on buying a stand-alone house are now deciding that renting an apartment is a better option. While renting may make plenty of sense for cash-short individuals or downsizing retirees, the boom in apartment construction is doing less to support the overall economy than if it were happening with single-family homes.

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On average, it cost $102,000 to build each of those new apartment units last year, according to census data, compared with $224,000 for each single-family home. Moody's Analytics estimates that every single-family home that is started creates 3.7 jobs over the ensuing year, compared with 1.8 jobs for a unit in each multifamily home.

In other words, it's great that the Daleville Town Center is finally starting to fill up with residents. But because each apartment is less expensive to build than a stand-alone house, the impact on the Roanoke regional economy is less than you might expect.

From his office window, Mr. Kelderhouse surveyed the distant hills that were meant to contain $350,000 brick houses by now but are still occupied by apple trees. All these years later, there is only one small cluster of five single-family homes on the fringe of the property.

The United States economy has been stuck in a vicious cycle: A moribund housing market saps the economy of strength, and the ensuing weakness—high unemployment, slow wage growth—means that fewer people are leaving the nest for a home of their own. Those who do are choosing smaller rental apartments that generate less spillover benefits for the broader economy.

How to get out of the cycle? Through a grinding, gradual process in which the 2.3 million missing households start looking for their own places, which generates more building activity, which strengthens the economy and results in more jobs and higher wages. It will require people like Reed Bergloff to decide that their savings have built up enough for them to buy a house, which people like Peter Fields and Andy Kelderhouse build on those long-vacant parcels of land, hiring more construction workers.

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None of that, however, can happen instantly through some policy change, like a tweak in federal housing rules to make it easier to get a loan, or further measures from the Federal Reserve to lower mortgage rates. More than anything, it takes time.

Mr. Kelderhouse says that 2017 "is the year everybody throws out as when we're back to normal. He adds, "That still seems believable to me."

By Neil Irwin, The New York Times.

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