Housing Starts Still Weak - Analyst Blog

In July, Housing Starts rose to a seasonally-adjusted annual rate of 546,000, an increase of 1.7% over the 537,000 rate in June. However, the June rate was revised down from 549,000 so, relative to where we thought we were yesterday, it is a decline of 0.5%. Relative to the 587,000 pace of a year ago, it is a drop of 7.9%. Housing was not exactly booming a year ago, when we were near the deepest point of the Great Recession. Housing starts were also below the consensus expectations of a 555,000 annual rate. The numbers are even weaker than they appear in the headline number.

All of the strength was in the extremely volatile Condo and Apartment segment. Starts of single family houses fell 4.2% to an annual rate of 432,000 from 451,000 in June and were down 13.6% from the 500,000 annual pace of a year ago. Starts in buildings with five or more units rose to 95,000, a gain of 17.3% from June and up 31.9% from last year. This is happening in the face of the lowest mortgage rates on record. The graph below (from http://www.calculatedriskblog.com/) shows that housing starts remain close to all time record low. Total housing starts are now 76.0% below their peak in June 2006 while single family starts are down 76.3%.

Regionally there was a lot of disparity in the numbers. The Northeast is showing a strong rebound in starts, up 30.5% for the month and up 26.2% year over year. However, even with the rebound, the Northeast was responsible for only 14.1% of all starts. The Midwest also had a solid month (at least in terms of direction, still extremely depressed on any absolute basis) with a rise of 10.7%, but are down 15.5% from a year ago. For the month, the weakness was centered on the South, which is by far the largest and thus most important region of the country when it comes to housing. There housing starts dropped 6.3% on the month and are down 7.9% on a year over year basis. Still 48.9% of all starts were in Dixie. Out West, starts were unchanged in July from June, but down 13.5% from a year ago.

The best indicator of future housing starts are Building Permits. The news was not any more upbeat there. Permits fell 3.1% from June to an annual rate of 565,000, and were down 3.7% from a year ago. For the month, single family permits were down 1.2% to an annual rate of 416,000 while permits for structures of 5 or more units (measured by unit, not by number of structures) fell 9.2% to a rate of 129,000. The picture is very different on a year over year basis as single family permits are down 13.2% while Condo permits are up 44.9%.

Regionally, the permit numbers are very different from those for starts. Permits in the Northeast plunged 25.9% from June but are up 1.6% from a year ago. Out West permits dropped 4.9% for the month and are down 9.4% from a year ago. In the Midwest permits were 1.1% lower than in June and off 15.6% from a year ago. The South saw a 3.9% rise on the month and is up 2.1% from a year ago. The old saying about ‘the last being first’ appears to hold for the housing data, although, really the competition seems to be for last place not first.

Part of the short term weakness is still due to the hangover from the end of the home buyer tax credit, which should fade in coming months. However, the deeper problem is that we simply over-invested in housing as a country during the housing bubble. Housing is sort of the ultimate durable good, and one that can easily be postponed when the economy is weak, at least in terms of building a new home. Used homes make very good substitutes for new homes, and homebuilders are thus now in competition with the banks, which are selling off the houses they foreclosed on. Before they decide to build a new house, people generally want to know that they will be able to sell their old house, and that when they sell they will have at least enough money from the sale for the down payment on the new home. For the millions who are now underwater on their current home, that is simply not the case.

If you want to know why this recovery is so anemic, look no further than the housing sector, particularly housing starts (and NEW home sales, which allow builders to build without being stuck with massive levels of expensive inventor). Used home sales are more or less irrelevant to overall economic activity, except to the extent that they spur redecorating when the new family moves in. Thus the transaction volume in existing homes is not that important.

On the other hand, used home prices are extremely important as they represent the largest store of wealth (or at least used to before it all vanished) for the vast majority of American families. The lower used home prices go, the more people become underwater on their mortgages. Being underwater is a necessary (but not sufficient) condition for a foreclosure to occur. After all, if the mortgage is $200,000 and the house can sell for $201,000, you are better off selling the house than just letting the bank take it. In both cases you no longer have the house, but if you sell you at least end up with $1000. It also avoids any damage to your credit rating.

Each new home built and sold generates an enormous amount of economic activity. For starters, new construction employs people directly as framers and roofers. These are relatively high paying jobs for people without a lot of formal education. The construction industry has been particularly hard hit in this downturn, dropping jobs every month for over two years now. Sine the start of the recession the construction industry has lost almost 2 million jobs. For the economy as a whole, there are 7.7 million fewer jobs than in November 2007. In other words more than a quarter of all the job losses in the country have come from this one industry.

Beyond the direct employment, and the benefit to the home building companies like D.R, Horton (DHI) each new house uses a lot of materials. The companies involved in making this stuff range from Berkshire Hathaway (BRK.B), which owns Johns Manville and Acme Brick, to the Lumber companies like Plumb Creek Timber (PCL) to the makers of plumbing fixtures such as Masco (MAS) and paint companies like PPG (PPG). The job losses in construction do not count any of the layoffs at those companies as a result of the lower demand for new houses. Of course an out of work construction worker is much less likely to go out to eat at the Olive Garden (part of Darden (DRI)) than when he is employed, and that means fewer jobs for waiters and cooks.

If you are not convinced as to just how important housing starts are to the overall economy, take a good look again at the chart above. Notice what happens to housing starts in the middle of or towards the end of most recessions. They turn sharply higher. As they do, they are like the starter motor on a car, turning over until the main engine starts. Given the huge imbalances in the housing market going into the Great Recession; that is simply not happening this time around.

Housing, even under normal times is an extremely heavily subsidized part of the U.S. economy. After all, what else is the mortgage interest deduction but a massive subsidy for the housing industry, and one that benefits the rich and upper middle class far more than the poor or even the middle class. As a deduction, its value is greater in high tax brackets than in low tax brackets, and one must itemize your deductions to take advantage of it. The lower middle class are more likely to use the standard deduction than the upper middle class and the wealthy.

In addition, the government has tried a number of other things to get the housing market going again. The Fed has bought up $1.25 Trillion in mortgage backed securities to lower mortgage rates. It has used the wards of the state, Fannie and Freddie, to try to cushion the blow in the housing market, and they are not being run with profit maximization in mind right now. As a result they continue to bleed red ink. Much of that red ink is due to deliberate policies to ease the strains the housing market is putting on the rest of the economy.

The latest effort was the homebuyer tax credit. It was a particularly poorly targeted and wasteful way to prop up the housing market. For the most part is simply pulled demand forward, and now that it has expired, we are suffering the hangover from it. It also applied to used homes as well as new homes, and as I mentioned earlier, the level of used home sales is almost totally irrelevant to the overall economy (except it is important to how much used home dealers, a.k.a. Realtors make). Most of the people who took advantage of the credit would have bought anyways, only they decided to agree to buy in April instead of May to collect their $8,000.

The tax credit did temporarily prop up the price of used homes, as when any transaction is subsidized by a third party, both the seller and the buyer will split the benefit. The sellers get their cut through a higher sales price, the buyer in their tax refund check. Now that the subsidy is over, used home prices are likely to start to fall again. To the extent that the credit simply moved people out of rental properties and into owned homes, it also simply created more vacant apartments. That will put downward pressure on rents, which will eventually translate into lower prices for homes.

While this report was not that unexpected, it was a bit on the disappointing side. It underscores just what a tough situation the overall economy is in and why we are not having a V-shaped recovery. The great locomotive that has traditionally pulled the economy out of recessions is derailed. Getting the locomotive back on track is going to be difficult. Without the jump start that is normally provided by residential investment, something must take its place, such as fiscal stimulus. Residential investment is normally exquisitely sensitive to interest rates, yet mortgage rates are at record lows, and housing starts are still below where they were in the early 1980s when mortgage rates were in the high teens. Eventually, a growing population is going to need more housing, and demand is getting pent up. It will not take very high absolute levels of housing starts to generate some very big percentage gains. When that happens the economy is likely to start to boom. Unfortunately, there is no sign that the pent up demand is going to be released anytime soon.

 
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