Economic Factors Affecting Home Building Industry in the US - Essay Example

Economic Factors Affecting Home Building Industry in the United s Housing is a basic necessity as well as an important factor of the economy, ashousing acts as a major contributor of employment and income generation and helps the individual both directly and indirectly in their socio-economic development. In a dreary economic scenario the housing sector in the United States witnessed dramatic changes and gained never-before optimism and is gaining further acceleration. Increase in household income with high purchasing and borrowing power, decreasing interest rates, easy availability of home finance, and a stock market bashful of regaining its earlier momentum have contributed in a considerable measure to the revival of housing sector recently. Housing is globally recognized as productive sector of the economy rather than a form of welfare, because "housing and economic development are closely linked" and it acts as an instrument to improve the GDP. (Housing for Economic Development, 2005). Because a healthy housing stock provides safety for employees, taxes for state and local governments, and more customers for retail and service business, house building industry helps state and regional economy to flourish. Housing: a basic necessity: Every individual aspire to own individual dwelling unit and buying a home is a major life event. Major life events such as marriage, birth of a child, changes in employment, or retirement particularly influence the decision to purchase a house though mortgage rates, income and expected returns on investment also motivate their decision to invest in residential property. Young adults in the population constitute primary source for home buying and when there is upward trend to housing prices these first-time buyers will be more attracted to enter into homeownership under the notion that rising prices will make future purchases unaffordable. Housing is an important basic need and focus of social concern and should be viewed as one of the key elements of social policy. Some of the U.S markets may not have sufficient housing supply to accommodate the influx of new residents, while the state and local governments may lack the resources to provide supportive services. The ability of America's working immigrant families to obtain decent and affordable housing has implications for the social and economic well-being of the United States. Studies found that there is a direct proportionality between housing price and homeownership, establishing that "housing market's volatility is amplified by buyers' responses to the trends in market fundamentals." (Myers & Ryu, 2008, P.17-33). Housing market provides "mechanism for equity growth, liquidity and financial flexibility for individual households, while also providing relatively safe, productive investments for institutions through secondary mortgage markets." (Housing for Economic Development, 2005). "Housing shortages have historically gone hand-in-hand with rising housing prices and rents, higher housing cost burden, lower homeownership rates, increased crowding, and longer commutes." (Landis, 2000). It is admitted that State's economy is one of the chief determinants of producing more housing units, because when the economy goes into recession housing demand falls quickly and deeply. "Economic recovery revitalizes the housing market, though expansionary peaks rarely even out the recessionary troughs." (Landis, 2000) According to Professor Michael E. Porter of Harvard Business School, "the only reliable test of economic value is sustained profitability, measured by superiority in long-term return on investment" and "industry structure is a key driver of homebuilder profitability". However, he asserts that "market assessments of homebuilding stocks appear to be out of line with other industries that have similar structural characteristics." (Porter, 2003). "The conduct of monetary policy by the Federal Reserve has profound impacts on the housing sector and its contribution to the overall economy" as reducing inflationary pressures and encouraging stable economic growth are Fed's primary role. An estimate by NAHB found that "one percentage point increase in mortgage rates renders 4.7 million potential home buyers ineligible to buy a median-priced home." (Federal Reserve Monitory Policy, 2008). Mark Thornton (2004) admit that, "booming home prices and record low interest rates are allowing homeowners to refinance their mortgages, "extract equity" to increase their spending, and lower their monthly payment!." (Thornton, 2004). Literature reviews show that there is interrelationship between housing prices and rents, and economic activity as it has long been known that during periods of job growth housing prices and rents tend to rise. Real estate market generally remains buoyant and home prices in most of part of America continuously increase despite gloomy job growth and consumer confidence because low mortgage rates largely support building business. With low interest rates and readily available mortgage credits many households will venture to busy residential units sooner than they normally would. In addition, when the stock market crumble and investors get less return on their cash many households will be prompted to shift their portfolios in stock to housing. Since a home is a commodity to be retained for a long period, different from liquid asset, the concept of rapid sell-off at deflated prices is not realistic in the case of residential property. (McGarity, 2003). Shift and price elasticity of supply and demand: The three basic laws in economic related to price elasticity of supply and demand enunciates that: 1. When, at the price ruling, demand exceeds supply, the price tends to rise. Conversely when supply exceeds demand the price tends to fall; 2. A rise in price tends, sooner or later, to decrease demand and to increase supply. Conversely a fall in price tends, sooner or later, to increase demand and to decrease supply; and 3. Price tends to level at which demand is equal to supply. (Henderson, 2004). There are many factors that affect price of a product, such as: income of a person; price of a complement, price of substitutes, individual tastes and preferences, anticipated price escalation, scarcity of product, and the number of prospective buyers and they are called determinants of demand for a product. In home building industry changes in price causes a less than proportionate change in quantity demanded, because of the lack of substitutes or alternatives, showing relatively inelastic nature of this industry. The nature of land, a gift of Nature, distinguishes it from all commodities produced by man and its supply is fixed and unalterable. The price and rent of land is thus dependent on its scarcity and variations of quality, preferences and taste among purchasers, and its productivity and profitability. Demand for land and its price rise are interlinked and changes in demand for land highly affect its price beyond control, compared to other ordinary commodity that could be flexed and manipulated by humans. An increase in supply of labor directly increases supply of capital, whereas the supply of land remains unchanged leading to stringent land ownership policies and high taxation of land value. Influence of Monetary and Fiscal policies on house price: Historically increases in the value of house are largely determined by its location, as well as differences in income and population growth. When there is rapid population growth supported by greater income opportunity there will be an unprecedented increase in house price in the market. According to US Census Bureau, measured by a house price index derived by the Office of Federal Housing Enterprise Oversight (OFHEO), certain select States and local housing markets, for example California had 100 percent increase between 1999 and 2005, show housing boom. (Wheelock, 2007). However, many analysts are surprised at the phenomenal rise in house prices in some markets of the United States during last five years, and rely on "speculative bubble" for the brisk escalation in average house prices. The economist Robert Shiller defines a speculative bubble as "a situation in which temporarily high prices are sustained largely by investors' enthusiasm rather than by consistent estimation of real value." (Wheelock, 2007). However, it is argued that the price growth projected by OFHEO may not be realistic as this index is based only on "recent sales, and houses that sell in down town market are likely to be relatively more appealing than average and perhaps hold their values better than other houses do, and excludes sales involving mortgages over $417,000." (Wheelock, 2007). Positive and negative externalities: Changes in housing sales and construction mainly affect persons engaged in housing industry, and sharp reduction of house price will distress the national economy. During housing boom the household wealth of benefactors will increase, which in turn will enhance consumer spending. In the same vein any decline in house prices would reduce household income and proportionately reduce consumer spending, leading to economic recession. "Standard economic theories of consumption argue that an increase in wealth will lead to an increase in spending, but that higher spending will be spread over a person's life time and have relatively little impact in any one year." (Wheelock, 2007). Major influence of housing boom is found to be obtaining funds from the refinancing of mortgages and home-equity lines of credit by home owners, generally lower-income households, and slump in housing wealth could adversely affect consumer spending. Decline in house price will also affect capital of banks and financial institutions as there will be more loan defaults on real estate loans. Researchers admit that there is correlation between age and housing demand because "different age groups typically occupy different types of housing" and "homeownership rates rise with age." (Myers & Ryu, 2008). In addition, according to the US Census Bureau "people willing to migrate are more likely to have higher education and to be moving to accept new job" they are also likely to have higher income, and therefore "add to the pool of people competing in the owner-occupied housing market, helping to drive up prices in the face of limited supply." (Housing for Economic Development, 2005). But, higher income level of migrants exerts market pressure on the moderate and lower income people already in the area. The pressure to spend more on housing by moderate and lower income groups indirectly affect other expenditures and impact life quality of these families. In clear terms, high payment for housing on the cost expenditure for local retail and services and reduction in discretionary spending adversely affect local economic activity. Negative influence of economy on house building industry: Some researchers argue that American housing market is expected to undergo unforeseen transition with most of the 'baby boom' generation, who are born between 1946 and 1964 will be reaching age 65 by 2011, will relocate and finally withdraw from the housing market. The baby boom generation is considered as the major contributors to housing industry for decades since they entered home buying in the 1970s and their increased rate of earning is major component that provided stability in the housing market. Myers and Ryu (2008) opine that the ratio of seniors to working age residents will increase "roughly by 30% in the each of the next two decades" and this change will make "many more homes available for sale than there are buyers for them. The exit of the baby boomers from homeownership could have effects as significant as their entry, though with different consequences." (Myers & Ryu, 2008). During the baby boom period there was surge of demographic pressure for more housing construction and rapid population growth in large metropolitan areas gave fillip to housing industry in the United States in the 1970s. Simultaneously there was more local activism to protect the environment that prompted development restrictions and setting physical limits to urban expansion, which in turn restricted new construction. This development restriction is considered as one of the major contributor for housing price escalation because it created wide gulf between demand and supply, which could not be bridged with subsequent corrective measures. Hence, there is a slow down in the sale of homes as potential buyers are waiting for the market to settle down and investors opt to keep their down payment dollars in the bank or invest in hedge and private equity funds. There is also a trend among construction trade industry to bid for contracts with extremely thin profit margins due to market competition. However, there is increased demand for single-family homes, which outweigh supply in many markets, and will bolster prices. Conclusion: Industrial development naturally promotes immigration and growth of population creates favorable condition for house building industry Housing construction tends to promote retailing, and a trade area having more home ownership "will be able to support more than one competitor in a category, since customer preferences and loyalty are divided within any population." (Housing for Economic Development, 2005). Maximum presence of retailers provides more tax revenue to the local government, which will in turn enhance its ability to provide infrastructure and services to support economic development efforts of the State. Proximity of a variety of affordable housing to work place also benefits people in improving their productivity and quality of life. Even in the face of inflation and escalation of food prices, health care costs, and oil prices as well as increase in home prices people could afford to finance home, because mortgage rates are low in the United States. Though it is difficult to quantify the relationship between housing and economic development, it is quite apparent that housing industry "enables, stabilizes, and sustains national, state, and local economies." (Housing for Economic Development, 2005). Reference Housing for Economic Development, (2005). Washington Research Council. Retrieved June 21, 2008, from http://www.researchcouncil.org/publications_container/housing_and_the_economy_final_draft.pdf Myers, Dowell., & Ryu, SungHo. (2008). Aging Baby Boomers and the Generational Housing Bubble: Foresight and Mitigation of an Epic Transition, Journal of the American Planning Association. InformaWorld. Vol.74. Iss.1. P.17-33. Retrieved June 21, 2008, from http://www.informaworld.com/smpp/sectioncontent=a789053981&fulltext=713240928 Henderson, Hubert D. (2004). The Project Gutenberg EBook of Supply and Demand. Landis, John D., Elmer, Vicki., and Zook, Matthew. (2002). New Economy Housing Markets: Fast and Furious-But Different, Housing Policy Debate. Vol.13. Iss.2. P.268. Landis, John D. (2000). California. Raising the Roof: California Housing Development Projections and Constraints, 1997-2020, California Department of Housing and Community Development. Retrieved June 21, 2008, from http://209.85.175.104/searchq=cache:exSjU4UoiNIJ:www.hcd.ca.gov/hpd/hrc/rtr/int1r.htm+DETERMINANTS+OF+DEMAND+AND+SUPPLY+IN+HOMEBUILDING+INDUSTRY&hl=en&ct=clnk&cd=13&gl=in Porter, Michael E. (2003). The U.S Homebuilding Industry and the Competitive Position of Large Builders, Retrieved June 21, 2008, from http://www.isc.hbs.edu/pdf/US_Homebuilding_Industry.pdf Federal Reserve Monitory Policy, (2008). NAHB. Retrieved June 21, 2008, from http://www.nahb.org/generic.aspxgenericContentID=3479 Thornton, Mark. (2004). Housing: Too good to be true, Ludwig Won Mises Institute. Retrieved June 21, 2008, from http://www.mises.org/story/1533 McGarity, Mary. (2003). Hot time for home Builders: (Cover Report: Business Outlook), All Business. Retrieved June 21, 2008, from http://www.allbusiness.com/personal-finance/real-estate-mortgage-loans/440108-1.html Wheelock, David C. (2007). Housing Slump Could Lean Heavily on Economy. The Federal Reserve Bank of ST. LOUIS: The Regional Economist. Retrieved June 21, 2008, from http://www.stls.frb.org/publications/re/2007/b/pages/slump.html Read More