Why on earth would anyone care about new homes right now? Isn't that a dead market?

Yes, in the U.S. the new home construction market is down 75% from its 2005 bubble levels.  The industry is badly hurting and won't go back to bubble levels.  But that still represents around 400,000 new home starts per year.  This is still a huge market.

During the last decade the way to make money in U.S. home construction was obvious:  Just throw up some homes and let people buy them.  It was a seller's market.  But now in the "new normal" where existing home sales are down and new home sales are way down, this puts pressure on builders and developers to think more creatively as market power shifts more to the buyers who are going to discriminate not only on price, but on value.

Meanwhile, we are seeing the early signs of backlash against commuting in this country.  The decades-long trend of suburbanization and exurbinization appears to be somewhat reversing itself.  It took the downturn to reveal this, but available market data indicates that the biggest price and default hits have taken place in the exurbs, and urban and near suburbs have been the most insulated from such effects.  Basically, as the real estate market has gotten softer, overall people have preferred to take advantage of availability closer to the downtown areas to migrate inward (or at least abandon the further out properties).

As people expect energy prices to continue to rise, this trend will continue.  So-called "smart growth" and "urban infill" are going to become more widely-heard buzzwords.

But energy prices don't only hit on the commute, they hit on the home itself.  Homeowners are going to increasingly care about the energy usage of their home... and they're going to be caring about other attributes (eg: indoor air quality, overall use of "sustainable" materials, etc.) as well.

All of this is on the margin.  I mentioned that the new home construction market in 2009 was around 400k units -- compare that with around 5M overall existing home sales per year.  And 72M in total owner-occupied homes in the U.S.  Any analysis of green homes in the U.S. needs to account for the fact that change is hampered by the deep installed base of existing inefficient homes.

Nevertheless, I think we can expect to see some significant changes over the next ten years.  

On the existing homes side, as energy prices do indeed rise (or at least become more volatile), we will see new residential construction further emphasizing efficiency and dense growth.  Oil price future are indicating long-term price expectations above $80/barrel.  Natural gas price futures indicate expectations of price rises of at least 50% over the next couple of years (and this will also drive marginal electricity prices).  Potential homeowners -- and even renters -- will start caring more about the energy efficiency of their homes.  And not just because of the energy costs themselves, but because of that as an indicator of construction quality overall.

There's a limit to how much premium potential homeowners and renters will be willing to pay for energy efficiency, but bear in mind two other factors: 1) as "smart growth" drives shorter commutes, that will free up more wallet-space for home "green-ness"; and more importantly 2) green attributes will be increasingly important to the developers themselves as it will help accelerate necessary approvals.

It's this latter point that's often forgotten, but all real estate markets are incredibly local, and any developer will tell you that construction is actually relatively easy to manage -- it's siting and getting necessary approvals that are the huge determinant of their profits.  The time it takes to get a development started and the costs along the way.  And the fact that evidence suggests "green buildings" have lower vacancy rates than other buildings. So even in the absence of a "green premium," developers have strong incentives to adopt green building attributes.

Not to mention new laws in many places like California that are often requiring zero energy homes and other similar mandates by 2020.  I expect that such deadlines will get pushed back.  But they still are important market signals.

Meanwhile, in the existing homes market, energy efficiency can be retrofitted, with compelling paybacks.  In a low energy cost market this type of activity has lapsed, but it is clearly coming back strong.  Again, it's on the margins, but even if only 1% of homes got energy efficiency audits and basic retrofits (air sealing, insulation, etc.) it would make a huge difference overall -- and certainly would be rewarding for that 1%.  And new government incentive programs designed to encourage such efforts are only now starting to have an impact and will not go away quickly even if the programs are not re-upped.  

So what does this all mean?

Well first of all, we can expect significant activity in the green homes market.  But it won't be geared around "sustainability", it will be focused on location and energy efficiency.  "Sustainability" implies environmentally-sensitive materials (ie: bamboo, or certified wood) and above-standard environmental performance (ie: water re-use, etc.) that appeals to a certain small high-end niche of the market, but most homeowners won't be willing to pay for (because of long payback periods, if any paybacks are even applicable at all).  But many more homeowners will care about the energy efficiency of a home because of aforementioned cost and quality indications.  And, barring a long-term drift downward in gasoline prices, on the margins new homeowners will increasingly care about shorter commutes as well, driving increased interest in denser, closer-in neighborhoods.  Mid-range "green homes" are a relatively untapped niche, but with strong latent demand.

Therefore, developers who can address energy efficient new home construction in a cost-advantaged way will be rewarded.  And developers who can do this in a dense-housing format will be doubly rewarded.  This is a tiny part of the market now, but I wouldn't be surprised to see a quarter of new residential construction in the U.S. (mostly on the coasts, but also in places like Chicago and Dallas) qualify under such concepts by 2020.  This will create an entirely new industry in new home construction done to tighter tolerances, using new processes and designs to improve energy efficiency, and with intelligence and automation built into the home from Day 1.

But this will add up to only a small dent in the installed base of homes.  But we can also expect a significant chunk of existing homes to start to adopt such technologies as well.  It will be hard to retrofit core designs to be more energy efficient.  But air sealing and insulation is easy.  And HVAC will be increasingly intelligent, able to incorporate retrofitted, very small (and cheap) sensors to more efficiently meet required comfort levels.  Home automation will be flirted with, but really boils down to HVAC controls from an energy perspective, and it would make sense that it would eventually be integrated into central HVAC rather than be a standalone add-on application.

All of this will be only a "niche" even by 2020.  But with such a huge overall market, even as a niche it will be measured in the billions of dollars by then.  And it will be growing quickly.