A better alignment of housing supply and demand is adding to the continued recovery in the housing market, despite sluggish growth in the overall economy. 

Several years of extraordinarily slow construction, slow processing of foreclosures and reduced housing turnover is significantly reducing the inventory of homes for sale, said analyst Michelle Meyer at Bank of America Merrill Lynch (BAC).

“There is little focus on the latter, but we think it is an important part of the story,” Meyer said. “Housing turnover has fallen to a historic low, particularly for voluntary turnover (not due to foreclosure). Of course, a reduction in turnover not only translates to less supply, it also curbs demand.”

The health of the economy is one of the few interrelated reasons for the exceptionally low rate of turnover. With low income growth and high unemployment, there are fewer “move-up” buyers.

The HousingPulse report from Campbell Surveys illustrates limited supply for non-distressed homes. The average time that non-distressed homes are on the market notably declined over the past few months (click on graph below), while a similar decline occurred in short sales, but not for foreclosed properties.

The reduction in non-distressed inventory is helping to support prices and create opportunities for new construction. Housing starts elevated to 760,000 in June, reaching their highest level since October 2008.

“A large part of the initial turn is owed to multifamily building, but we are now seeing single-family construction turn higher as well,” Meyer said.

And home builders are optimistic about the future, shown by the jump in the National Association of Home Builder’s housing index to a five-year high in July.

“That said, optimism must be tempered by recent weakening in the labor market and overall economy,” Meyer cautions. “While we expect this pick-up to continue into the summer, we expect a period of renewed softness as the year-end fiscal cliff approaches.”