The Economy

Peter R. Crabb: Lack of business investment will limit housing's rebound

PETER R. CRABB, professor of finance and economics at Northwest Nazarene University in NampaOctober 1, 2013 

Peter Crabb

Houses just aren't what they used to be. Don't look to the housing market for a signal of economic recovery.

In last week's Business Insider, we learned that the Treasure Valley housing market is doing well, with both the total number of houses sold and median prices rising more than 10 percent over the past year. Even though local prices declined slightly this past month, housing market analysts are finding more buyers. Demand appears to be picking up.

There is a similarly good story for the national housing market. The U.S. Commerce Department reports that through July of this year median home prices are 8.3 percent higher than last year and up 23 percent over the last three years.

Home builders are responding to current price changes with more construction. The Commerce Department also reports an 11 percent yearly increase in the number of new private building permits. However, building permits are at the same level as 2008 and 30 percent below 2007.

The recent price increases simply reflect continued low supply. Over the last four or five years there has been little housing construction.

Economic theory and market history show us that as the price of a good falls, the quantity demand (requested for purchase) rises. The large drop in housing prices following the financial crisis of 2008 led many to expect a quick turnaround in the market.

This didn't happen, because there are many other determinants of demand. Two important factors beyond the price of a good are income levels and expectations. Both current income levels and expectations for future growth remain low.

Economists use a measure called income elasticity to predict the rise or fall in the demand for a product for any given change in income levels. The income elasticity of demand for housing tells us how much the quantity demanded for home purchases responds to changes in consumers' income.

Compared with many other goods, housing is highly income-elastic.

A 2006 study by economists at Harvard University found income elasticity for housing in Western cities and suburbs to be two. That means a 10 percent drop in income for an area like Boise can lead to a 20 percent drop in demand for housing. This is close to the decline we experienced during 2008 and 2009.

Following the financial crisis, housing demand in Idaho fell dramatically and supply remained high. According to data from the Idaho Department of Finance, the Idaho housing stock increased 13.5 percent from 2004 to 2008. Since then, the stock has risen only 3 percent and is expected to be only another 7 percent higher by 2016, about the same as the forecasted increase in population over the same period.

Policymakers are still trying to increase housing demand. At its last meeting, the Federal Open Market Committee decided to continue its program of purchasing $45 billion worth of mortgage-backed bonds in an effort to keep home loans affordable.

These efforts appear futile when unemployment remains elevated and most households expect little or no income and wage growth during the next few years. The incentive of low interest rates does little for people with poor job and income prospects.

The full market picture described here suggests that demand still has a long way to go in order to catch up with supply. The housing market will truly recover when businesses start investing more. Incentives for business investment will do more for current consumer income levels and will increase expectations for future growth.

Business growth, not housing growth, is what we should look for in a good economy.

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prcrabb@nnu.edu

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