Real Estate Shadow Demand Outweighs its Shadow Inventory

March 20, 2013

by Mike Simonsen

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Quit your yapping about how strong the real estate market is, Simonsen. It’s a fake rally. There is no actual demand.

That’s the bearish argument I’ve been hearing lately. I’m not buying it.

For years we’ve been watching the phenomenon of “Shadow Inventory” of potential homes that need to be sold, and looking for impact on the market. This set of underwater or distressed properties is now shrinking rapidly.  The number of homes with underwater mortgages fell by nearly two million last year. According to the Fed, home price gains of 10% will be enough to move 40% of underwater borrowers back above water. These home sellers are highly likely to buy another home in the same or comparable market, off setting new supply with new demand.

Meanwhile another phenomenon that emerged from the bubble burst has been developing, and it’s hit the market with full force. Shadow Demand. Demand for homes that went unsatisfied, primarily due to financial and economic uncertainty, that can now emerge as jobs recover and mortgages remain cheap.

Housing’s Shadow Demand

Let’s look at the source of new demand. Increased demand for housing comes from new “households.”

household formation Cumulative Household formation surpluss/defecit relative to 5 year average (millions). Source: Federal Reserve Bank, Altos Research

From 1997 through 2007, each year an average of 1.3 million new households were formed per year. Our population grows via immigration and kids maturing. These people need to  rent or buy homes, or they double up with friends and family. During the Great Recession, household formation was closer to 600,000 per year. Population growth continued at about the same pace but people didn’t move into homes of their own.  That means for the three years of 2008, 2009, 2010 we had “Shadow Demand” forming around 2 million potential homes that can’t wait to launch on their own.

In the chart above, you can see that households get formed during times of economic strength. People hide when the economy is bad.

Household formation in the five years of the housing bust was lower than any five year period since the 1960s.  This is the Shadow Demand and it’s now hitting the real estate market. These millions of potential buyers were waiting until they were financially stable and until the bargains arrived. In 2012, these conditions converged. In 2013 employment and recovery is stronger. Real estate demand is higher. 

Despite all the risks in the US and global economies, the 2012 real estate market’s demand is a function of years of pent up purchases. After years of historic lows, this demand trends seems poised for a multi-year recovery.

 

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