Not since last autumn have these
pages directly addressed the condition of the U.S. housing market. At that time
data were mixed at best, with optimists predicting….well praying….that the
sector’s inevitable recovery would
provide a needed boost to overall economic growth. Those with a more cautious nature
fretted over the number of properties underwater, tight credit conditions, and
the difficult-to-pin-down, but nefarious sounding, shadow inventory looming over the market. Members of the bullish
camp saw the formation of a floor in home prices as well as a bounce in new
home construction as signs that housing, as it had done prior to the crisis, would
boost consumer wealth (and confidence) and that the sector again would provide
a multiplier effect across other industries. Home sales tend to share the love
with furniture and appliance purveyors along with service providers such as
cable-TV operators and the local lawn boy. Less directly, rising prices of one’s
largest asset should lead to general consumer giddiness, which translates into
looser purse strings.
While theoretically all valid
points, absent from that logic was the reality of supply and demand. During the
crisis aftermath, there was too much supply, and demand…given tepid jobs growth
and restrictive credit standards ….was nowhere near sufficient to sop up the
excess inventory. In recent U.S. recessions…those caused by inflation-inducing,
overheated growth forcing the Fed to raise interest rates….the subsequent
lowering of borrowing costs would boost activity in credit-dependent segments
of the economy like housing. Not so this time around. America’s attempt to create
a perpetual motion machine by having housing become a primary driver of growth, led to absurdly high building activity
and once the crisis hit, the stratospheric level of inventory had to be
rationalized.
Home building on this frenetic
scale inevitably outstrips a country’s needs. We cannot export houses like we
can automobiles or farm equipment. Back in 2007 one prescient economist stated
that in housing-based recessions, first equities turn around, then the economy enters
recovery and lastly housing finds a bottom as the inventory overhang is worked
through and shell-shocked (and overleveraged) consumers regain the confidence
to make big-ticket purchases. Sadly this process could take over a half-decade.
The good news is that we are more than that far along since the crisis’s onset
and, as evidenced by the following data, housing has apparently turned the
corner.
If You Build It, They Will Come…..And Did They Ever.
The country’s ill-fated push into
creating an equity society was met with enthusiasm by the building industry. In
the 20 years beginning in 1980, U.S. home starts have averaged just over 1.4
million per year. At the housing bubble’s zenith it reached over 2 million. In
a particularly nasty example of mean reversion, starts plummeted in the wake of
the crisis, averaging 687 thousand (half the long-term trend) over the past
five years. The silver lining is that
2012’s number of 781 thousand was a 28% jump over the prior year’s activity.
The good news has continued into 2013 with March’s monthly data cresting over 1
million on an annualized basis. May’s figure of 914 thousand represents a 29%
gain over the May 2012 figure. True much
of the gain has come from multi-family units, the domain of renters, rather
than the single family space, which has a more positive knock-off effect across
the economy. But this development could be considered beneficial as it
rebalances the market away from marginal (i.e. risky) owners and allows the
rental space to play catch up.
The overhang in
housing inventory can be seen in the chart below. At the end of 2006 there were
nearly 540 thousand new homes on the market. As fate would have it, this peak
occurred just about the time the easy credit spigot got turned off. Over the ensuing
six years, this glut had to get worked off before the industry could once again
ramp up its core operations.
.
Sales of new
homes followed a similarly depressing trajectory. Monthly sales on an
annualized basis peaked at nearly 1.4 million in July 2005. Sales plummeted to
270 thousand by early 2011, nearly one-quarter of its pre-crisis average. Time has
healed this wound as well, given that monthly sales have risen 76% since the
bottom to 476 thousand (annualized) this past May. Even when ignoring the distorted figures of
the bubble years, if demand for new homes continues to climb towards its pre-crisis
average, the increased building activity should provide a tailwind for the
broader economy.
Although a
painful process, this culling of inventory was necessary to meet the toned-down
demand from homebuyers. The same dynamics have played out with existing homes,
which represents 85% of the housing market. May’s inventory of existing homes for sale is
10% below figure from 12 months prior. Existing home sales ticked up nearly 13% over the
same period. While this segment does not prime the overall economic pump as new
home activity, it is evidence of a market finding a new equilibrium. The combination
of rising sales and lower inventory has pushed the widely followed figure of
market supply at the existing sales pace to 5.1 months, below the accepted
equilibrium of six months. The market for new homes has proven even tighter
with the inventory to sales figure at 4.1 months.
A Wealth Effect That the “Rest” Of the
Country Can Appreciate
Normalization of
supply and demand has led to a welcome bump in home prices. The S&P
Case-Shiller Home Price Index for 20 major cities has posted positive
year-on-year gains for the past 11 months. April’s 12.1% gain represents the
largest advance in the post-crisis era. Still home prices remain 26% below the
market’s peak. A consequence of that is a large amount of homes still
underwater, hindering the owner’s ability to enter the market for an upgrade or
borrow against the home’s equity for some good old-fashioned personal
consumption.
The fact that prices
remain so far below the market peak partly explains why existing homes
inventory is at such a low level. Owners….well those not already tossed onto
the street….may be willing to wait for prices to rebound rather than take the
immediate hit by putting a house on the market. As prices rise, potential
sellers…and there are lots of them…may be drawn into the market, which could
act to keep a lid on any rapid price gains over the near term. This is especially true as buyers would
likely be unable to stomach higher prices given that other factors impacting
the home-buying process…job security and access to credit….remain flighty at
best.
A Remaining Hurdle: Lending Standards Still
Tight
A consistent
theme during the post-crisis environment is the lack of access to credit for
much of the public. In order to atone for past stupidity, the majority of banks,
as seen in the chart below, have steadily tightened lending standards. Only
within the past four quarters have a net number of banks surveyed by the Fed
begun easing credit standards for prime borrowers. If one has less than stellar
credit, then forget it. The draconian conditions imposed in the wake of the
crisis have yet to ease. Welcome (back) to the world of renting.
For the blessed
few that qualify, then rates are deliciously low thanks to the Fed’s
intervention into the Treasury and Mortgage Backed Security (MBS) market. Yet
rates eventually will go up. And when they do, it will add another headwind to
the housing market. According to
Bankrate.com, the rate on a 30-Year fixed mortgage has risen nearly 100 bps
since December to 4.3%. That said, that is still over 2% below the 2000-2013
average. And while higher rates add to
the cost of ownership, the slightly juicier returns for banks may entice them
to loosen lending standards. One unforeseen consequence of the Fed’s strategy
is that with rates so low, it is simply not worth it for banks to take on the
risk of originating long-term loans.
Instead they have kept these funds stashed in ultra-safe and ultra-low
yielding short-term instruments.
While Not the Pilot in GDP Growth, Housing
At Least Contributing
An easing of
lending standards while interest rates remain near historic lows could provide
a needed boost to housing demand to complement the aforementioned rationalization
of supply. Such a development could ensure that home building ceases to be a
drag on economic growth. Over the past 20-plus years, residential construction
has averaged a 4.7% slice of GDP. During the housing boom, the sector accounted
for as much as 6.1%. While a relatively small piece of the economic pie, given
its multiplier effect, having housing continue its climb back to the long-term
average will be a necessary step if economic growth is to escape from its
current funk.
Already this is
occurring. In 10 of the past 12 quarters, residential construction has been a
positive contributor to overall GDP growth, with the past six quarters being
especially strong. This contribution is welcome given that overall GDP growth
has averaged a forgettable 2.1% over that period. For full-year 2012, 0.27
percentage points of the overall 2.2% rise in GDP was attributable to home
building. That was after a six year run of the sector being a net drag on
economic growth.
Despite Turnaround, Additional Housing Gains Need Support From Broad-Based Growth
While it has
indeed been a long, tough road, the U.S. housing sector appears to have turned
the corner. Hopefully the country won’t once again put the cart before the horse.
As has been previously argued on these pages, a robust housing sector should be
the consequence of a strong economy,
not the source of it. Economies built for the long haul would be better suited
to rely upon manufacturing, professional services and other productive sectors
as growth engines. For housing to reach the next stage of recovery, an
improvement in the jobs market will be necessary. Recent employment gains have
largely come in the temporary, retail and food-service segments; a pool of
borrowers that despite higher interest rates, likely won’t get banks off the
sidelines.
Still the overall
news is good. Higher home prices could also aid economic growth by serving as collateral
for entrepreneurs who often rely upon personal assets to fund new ventures.
Higher property prices will also stop the bleed on tax-starved municipalities
across the country. One could argue that
the prime beneficiary of the Fed’s extraordinary policy initiatives has been
Wall Street rather than ordinary Americans. While financial market participants
may indeed feel wealthier, at least ephemerally, it is difficult for Joe
Consumer to thump his chest when his primary asset is still at 2004 levels…and
possibly underwater. In a twisted irony, in the absence of retail buyers, major
asset managers with cash to burn and access to cheap credit have scooped up
homes as investment vehicles, and in the process have become some of the
largest homeowners/landlords in the country. And we wonder why current Fed
policy has produced its fair share of cynics.
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