Now that we don’t have a housing bubble that will inflate prices, home prices will need to return to something that approaches income parity. During the bubble years, when many homeowners bought more home than their income justified, the income-to-home-price matchup was something that disappeared. Instead homeowners relied on continuous refinancing, made possible by constantly increasing home values, to keep payments at a level they could manage.

Since smaller homes were not as profitable as large homes, homebuilders were eager to oblige the homebuyers by building ever-larger homes. This was particularly true in Orange County. The post-boom result is that Orange County is short on small, and therefore more affordable, homes.

As we know now, home prices are no longer increasing; they are decreasing.  The home building business model of the past can not be sustained. As economist Chris Thornberg, a principal at Beacon Economics, has said, the housing market will not recover until home prices match incomes. (For a look at what that means in Orange County and how much more O.C. home prices will need to drop, see one of Jon Lansner’s posts.)

An Associated Press article backs up this smaller-home theory.

“KB Homes slashed its first-quarter losses by 75% as first-time homebuyers flocked to the builders’ smaller and more affordable homes…”

The article went on to say:

“First-time buyers accounted for 70% of its first quarter sales, up from 53% in the first quarter of 2008, and they represent ‘the most attractive segment of the market, as they do not have to sell a home before purchasing,’ said Jeff Mezger, chief executive.”

Other homebuilders might benefit by following this example from KB Homes. Potential homebuyers might also benefit from a housing market that has homes that they can actually afford. And Orange County businesses might benefit if the available housing stock can accommodate workers at all levels of the job ladder. This is something that Orange County businesses have been championing for some years.

According to Green, 1.5 million homes can be built and sold in the U.S. annually. However, in the go-go building day of the recent past, 2.2 million homes were being built annually. The inference is that this contributed to the large inventory of homes currently on the market.

Green’s conclusion is that the current reduced level of construction will eventually help to reduce the number of homes on the market. His reasoning is that, since the population will continue to grow and current homes will get older and deteriorate, this will help us to return to a more stable housing market. As he stated on AirTalk , this will help recovery return “sooner rather than later.”

The Orange County Register’s Jonathan Lansner had some related information that is relevant for Orange County. The information is from a recent jobs report from the California Employment Development Department. According to the EDD report, construction jobs in Orange County are down 29% from the peak in May 2002. This translates into a loss of 32,200 Orange County construction jobs. (California’s number is 33% fewer construction jobs than were present at the peak.)

These numbers suggest that reduced housing construction in Orange County will help to deplete the supply of housing that was built up in the boom years and aid a return to a stable housing market. I hope that this mean no more extreme highs or lows—rather a steady state of construction.

However, until we get to that steady state, more pain is in store. A recovery “sooner rather than later,” although necessary, doesn’t mean painless.

“In Orange County, homebuilding dropped to the lowest level in figures dating back to 1946, amounting to a $1.8 billion drop in the industry’s contribution to the local economy, according to estimates.”
—Jonathan Lansner, “More homebuilding cuts seen in 2009″

PHOTO COURTESY THE BUILDING ASSOCIATION OF SOUTHERN CALIFORNIA