Last year, the reporting of U.S. housing data was increasingly positive. But the momentum in the housing market seems to have slowed this year. After suffering through the housing bubble and recession afterword, any mention of trouble sends tremors through the economy. Why?
Federal Reserve Chair Janet Yellen said during her semi-annual monetary policy report earlier this month that the U.S. housing market was witnessing a lackluster recovery. “The housing sector, however, has shown little recent progress. While this sector has recovered notably from its earlier trough, housing activity leveled off in the wake of last year’s increase in mortgage rates, and readings this year have, overall, continued to be disappointing.”
Except in a few stronger markets, housing is nowhere close to pulling its economic weight. Presently investment in residential property is a smaller share of the overall economy than at any time since World War II, contributing less to growth than it did even in previous steep downturns in the early 1980s, when mortgage rates hit 20 percent, or the early 1990s, when hundreds of mortgage lenders (a whole industry called savings and loans) failed.
Should building activity return to its postwar average part of the economy, GDP growth would jump this year to a booming, 1990s-like level of 4 percent, from today’s mediocre 2-plus percent. The additional building, renovating, and selling of homes would add about 1.5+/- million jobs and knock about a percentage point off the national headline unemployment rate, now 6.1 percent. That activity would close nearly 40 percent of the gap between America’s current weak economic state and what many would consider full economic health.
Here’s a quick recap of all the recent negative housing data.
• Housing starts unexpectedly plunged 9.3% to an annualized rate of 893,000, while building permits tumbled 4.2% to 963,000, though the weakness was largely concentrated in the South.
• Pending home sales fell 1.1% in June, missing expectations for a 0.5% increase.
• New home sales fell 8.1% in June to an annualized rate of 406,000, and sales fell in every region.
• Values have slowed according to most housing indexes.
• Mortgage applications fell 2.2% for the week ending July 25. Refinancing activity was down 4%, while purchase applications were up 0.2%, 12% below year-ago levels.
In a healthy market, housing makes up roughly 20% of GDP. Housing contributes to GDP in two basic ways: through home buying (residential investment – includes all construction new single and multifamily structures, residential remodeling, broker fees, etc.) and consumption spending on housing services. Historically residential investment has averaged around 5% of national GDP, leaving housing services to contribute 12-15% percent, for a combined contribution of around 20% of the GDP.
Real estate has always played an important role in the U.S. economy and continues to be an important bellwether of the national economy. Residential real estate provides housing for millions of families and is often the greatest source of wealth and savings for many families.
Last year, real estate construction contributed $925 billion, or an anemic 5.8%, to the nation’s economic output as measured by Gross Domestic Product (GDP). This is down dramatically from its peak of $1.195 trillion in 2006. At that time, it was a strong 8.9% portion of GDP. The economic effects of real estate are huge. Look at the procurement and manufacturing process of the industry. Real estate construction is labor intensive. Therefore, this decline in housing construction was a big contribution to the recession’s high unemployment rate. That said, 2013 was the best year since the great recession caused by the ‘housing bubble’.
To see what effect housing has on the economy we have to look no farther than the decline in home prices during the 2008 financial crisis. In July of 2007, the median price of an existing single-family home nationally was down 4% since its peak in October 2005, according to the National Association of Realtors. However, analysts and economists couldn’t agree on how bad that was. The decline in values had a dampening effect on real estate sales. The decline on real estate sales eventually lead to a further decline in real estate prices. This then reduces the value of everyone’s homes, whether they were actively selling it or not. This then reduces the amount of home equity loans the homeowner can get. This, then, reduces consumer spending, and changes the consumer’s economic psychology. As stated before in this column, nearly 70% of the U.S. economy is based on personal consumption. A reduction in consumer spending will contribute to a downward spiral in the economy. This results in further unemployment, further reduction in income, and further reduction in consumer spending. That is when we see the Federal Reserve intervening by reducing interest rates, otherwise there is the great possibility of the country falling into a recession. The only good news about lower home prices is that it lessens the chances of inflation.
As of 2Q14, there was a sharp bounce back in our national GDP in the second quarter, with a 4 percent growth rate. This assures that a recession is not in the cards and that job gains will continue. The latest growth was led by solid gains in residential construction (7.5 percent gain) and a respectable growth in business spending (5.5 percent gain). Consumer spending growth was humming along at 2.5 percent. The fact that GDP grew solidly on the heels of a measurable decline in the first quarter is reassuring that people’s income and job gains will continue. That in turn will help build an additional pool of homebuyers and increase leasing activity in commercial and residential real estate.
Housing has the ability to make household owners feel as though they have more money in their pockets. We call this ‘the wealth effect’. The common thought is that a house is an investment that should appreciate. As any investment, the investors will constantly re-assess the value of their investment overtime. The psychological effect of housing is real – just look at how deep the 2008 recession was, which was fueled by a housing selloff. According to the National Association of Home Builders, it only takes a 6% drop in home values to wipe out $1 trillion in household wealth. In this last recession, the loss was over $8.5 trillion in household wealth.
Texans are more than aware of the millions of jobs created during housing expansions. Consider the devastating effect of the loss of jobs in the Texas recession of the late 80’s. If you were to look at the number of construction jobs since 2003, you would notice a very strong correlation between construction job growth and housing. Using statistics from Bloomberg, just before the crisis about 8.5 million constructions jobs were filled; however, during the recession this number dropped by 26%. Since then we have recovered 560,000 jobs, leaving us with several million jobs left should we get back to average building permits/housing starts. The importance of housing and the potential job creation is significant if you understand the breakdown of U.S. GDP. Consumer spending as of last quarter was nearly 70% of the GDP, meaning if construction jobs revisited pre-crisis levels, consumers feel that they are better off, therefore spending money, stimulating the economy.
So what is holding housing back?
The two big constraints on the housing market continue to be tight supply and tight credit. Regionally we have seen a material easing in the latter; an easing in the former would not likely be far behind given the improving labor market conditions and pent up demand for housing. What was that movie line – if you build, it they will come? Modify that to if you lend it, they will build.
Lending is only now thawing, for both homebuilders and buyers. The great economic year we all felt last year was because of low levels of inventory caused by lack of lending. But those restraining factors have eased a lot in the last few years. However, as we in Texas can attest to, meeting that supply is not something that can happen overnight.
Another thing holding back housing is simply demand. It may yet prove to be temporary, but for now at least, many consumers are doubling up with roommates, living at home with parents, continuing school and otherwise delaying one thing that would get the housing economy back to normal: buying a home. Fewer consumers have shown a need the last few years to want to fulfill the American dream of starting a household of their own. There was question that was this change or a delay in making the decision. Most feel that it was a delay. A healthy national housing market should have around 1.5 million new housing units a year to meet long-term demand. 2007 was the last year that we saw those numbers.
The good news is there is over seven years of housing formation catch up. Household formation, as economists call it, is the foundation of demand in the housing market. When a young adult moves away from home and gets his/her own apartment, a household is formed; when a retiree moves out of his own place and into the apartment above an adult child’s garage, one ceases to exist. The number of American households is in constant motion; it is determined by millions of individual decisions that Americans make about their living situations, which has been delayed the last number of years. Since 2007, economic factors have prevented the formation of new households. The number of households rose by an average of 569,000 a year from 2007 to 2013, according to census data, down from 1.35 million a year from 2001 to 2006.
What should we watch to see if housing is going to improve?
Mortgage applications and delinquencies
Applications started the year strong and have been slower the last couple of months. Any slowdown, whether it be mortgage applications or sales causes some concern. This survey is taking weekly, and the good news is that it is not a long term trend presently.
In foreclosures and delinquencies, the trend is lower, and the three-year moving average is also headed lower. Here in Texas foreclosures even during the height of the recession were less than 1.5% of all sales. This number continues to improve nationally and regionally.
Household debt to equity
The measure really helps to analyze whether delinquencies will rise or fall. Household debt to equity typically has peaking periods, putting pressure on mortgage payments. We saw a sharp reversal in 2009, and the trend remains lower.
Foreclosures continue to fall from the 2008 peak and are expected to remain lower. As stated before it has been less that 1.5% of the Texas regional market, not much of a factor regionally.
Prospective Buyer Survey
The prospective buyer survey is a strong leading indicator and should be used as a consumer confidence indicator. Even though we saw a three-year peak a year ago, the overall three-year trend is higher. This is an indicator we are paying close attention to, given what looks to be a slowdown in the upward slope.
As consumers gain confidence in the economy they spend money. One of the economic indicators analysts watch is the consumer confidence index. When it is at 100, it means a healthy economy and consumers are spending. Nationally, it has stayed in the 80’s and the national economy reflects that. Regionally it has been a healthy 108, a very healthy economic environment.
Housing is important to the U.S. economy, and therefore important to national and global economy and financial markets. Housing has an effect on our national GDP on a standalone basis, and also from a consumer health standpoint. Housing today is slower, but nationally and regionally we are improving, with all indicators showing healthier signs.
The United States economy has been stuck in a vicious cycle, one of the longest in economic recovery recorded for this country ever. A weak housing market saps the economy of strength, and the ensuing weakness — high unemployment, slow wage growth — means that fewer people are looking to buy. The good news is that we are moving out of that cycle.
The good news for most of our readers is that they live and do business in Texas. Texas and its metros felt the effect of the national economic slump, but we have led and continue to lead the country with our growth. Other than a catastrophic event I don’t see any economic concerns on the horizon. May the blessing we receive continue!