Market Memo: Housing has a ways to go
This week’s surprisingly strong surge in both housing starts and permits—up 25% and 45% year-over-year, respectively, to four-year highs—confirms what the price, buying and construction data has been suggesting in recent months. The industry hasn’t just bottomed; it’s on the road to recovery. But what investors need to keep in mind is this: It’s a long road, and the journey has just begun.
In other words, while housing may help pick up the slack in a domestic economy where manufacturing activity appears to be slowing, don’t expect it to become a significant engine of growth. The numbers tell the story. At the peak of the housing bubble, housing starts were running at a 2.2 million annual rate, nearly triple September’s pace. Housing construction was running at about $800 billion annually, roughly 5% to 6% of the economy, and residential construction employment had surged to 3.5 million. Now, at about $375 billion, housing construction is less than half its peak and less than 3% of the $15 trillion economy. And residential construction employment has fallen to about 1.5 million jobs, a staggering 2 million—or 57%—below its 2006 peak.
This isn’t to suggest that housing’s turn up isn’t good news. It is. As home-building activity picks up, so will construction employment as well as demand for supplies and services. As prices rise, so eventually will property tax revenues, helping bolster strapped local and state government finances and potentially boost investments in schools, roads, bridges and other educational and public works projects that have been delayed or put off amid tight budgets. That could help lift state and local government hiring—a missing ingredient so far in a recovery that, statistically speaking, is well into its fourth year. Overall, the National Association of Home Builders estimates each home that is built generates three full-time jobs and $90,000 in new tax revenue.
A slog, not a sprint
But this improvement, if it continues as expected, will be a slog, not a sprint. Remember, the problems which contributed to the financial crisis were years in the making, so working off excesses of debt and housing will take years as well, although recent improvements are encouraging. The underlying economy, including employment and income growth, isn’t strong enough to create an ongoing surge in home building and buying, even with historically low mortgage rates and still extremely low housing prices that are making affordability better than it’s ever been. Banks also are being stingier and stricter when it comes to closing on a loan, be it for a purchase or a refinancing.
Then there’s the Federal Reserve. Through its newly minted QE3 program and other quantitative-easing programs already in place, it’s buying $60 billion to $65 billion of Fannie and other agency mortgage-backed securities every month, accounting for the vast bulk of the market. The Fed’s open-ended buying program provides tremendous mortgage-market support while driving yields to historic lows. In this effort to spur economic growth, the Fed has indicated the accommodative monetary policy will remain even as the economy strengthens as it does not want to risk pulling the stimulus away too soon—a sure sign of its deep-seated concern over the pace of growth and the high unemployment rate. When the expansion produces both strong growth and a significantly lower unemployment, policymakers will be faced with the challenge of ending QE. But that’s a topic for another day.