We got some fairly good news on the housing front this morning. Housing Starts fell in September to a seasonally-adjusted annual rate of 628,000 from 630,000 in August, a drop of 0.3%. But the number was much better than the expected level of 603,000. However, the September numbers were revised sharply lower from 658,000. Thus it looks like a lot of the starts we thought happened got pushed into October. So call the beat of expectations and the downward revisions a wash.
Relative to a year ago, they are up 16.5%. The question is: Are the higher starts are being absorbed by the market? Or are they simply adding to inventory? That question should be answered on November 28th when we get the New Home Sales figures.
If one looks at only single family houses, the picture was better for the month, but much worse on a year-over-year basis. Single family starts rose to 430,000 from 414,000 in September, an increase of 3.9% but down 0.9% from a year ago. The volatile multi-family (Apartment, Condo and Co-op) sector dropped by 13.3% on the month to an annual rate of 183,000/ Year over year, multi-family starts are up 96.8%.
The level of housing starts is still awful. The extremely weak rate of new home construction is a major drag on the economy. It is the principal reason that this recovery feels so anemic. We still face an inventory glut, so a weak home building industry is a key part of the repair process for the housing market. However several years of low starts has started to put a dent in the backlog. After all, the population does continue to grow. The inventory glut is concentrated in the used home segment of the market, and that is also where the “shadow inventory” resides.
New home inventories are actually near historic lows in absolute terms. The absolute level of used homes on the market is not particularly high, especially if just measured by those that are currently listed. Inventories are, however, still high relative to the current sales rate. Used homes are pretty good substitutes for new homes, but only if they are in the same market. An empty used house in North Carolina is a very poor substitute for a new house in North Dakota. Housing Starts peaked in June of 2006 at an annual rate of 2.273 million. We are thus 72.4% off of the peak levels, and about 50% below “normal” levels.
Lower starts, however, will only bring down inventory levels as long as New Home Sales do not also come down. The level of housing starts has been very depressed for almost three years now, and the overall inventory situation (new and used) is still bad relative to the sales rates. That means downward pressure on prices. We will find out about the level of Used Home Sales (and very importantly, inventories) next week.
It is hard to overstate just how important housing starts are to the economy. Yes, at this point, residential investment has declined to the point where it looks almost insignificant; just 2.23% of GDP in the second quarter, down from 6.34% of GDP at the height of the housing bubble. Over the long haul, residential investment averages about 4.3% of GDP. However, historically residential investment, of which new home construction is the largest part, has always been the main locomotive in pulling the economy out of recessions.
Even the 2001 recession, which was not caused by a housing downturn, saw a sharp acceleration in housing starts as the recession came to an end. Of course, since starts were jumping but were not starting from a depressed level, that boom later became known as the housing bubble that put us in this mess to begin with. Every other recession was preceded by a sharp fall in housing starts, every other recovery saw housing starts lead the way.
This is no coincidence. Each new home built generates a huge amount of economic activity. It put construction workers back to work, and construction workers have been particularly hard hit in the Great Recession. They account for over 31.8% of the total private sector jobs decline since the start of the downturn. That is despite being less than 6% of the total workforce when the recession started. That is just the direct construction jobs, but lower building activity also means fewer jobs in the factories that produce building materials, which are counted as manufacturing jobs. Clearly jobs in mortgage finance are also affected by the housing slowdown. They are not included in that almost one out of three jobs lost figure.
If they and the construction workers could go back to work, they would have more money to spend, perhaps even go out to eat, thus creating jobs for cooks, waitresses and busboys. Housing starts are not just about profits and jobs at D.R. Horton (DHI) and the other home builders, but about jobs and profits at firms as diverse as Plum Creek Timber (PCL), Masco (MAS), and Berkshire Hathaway (BRKB). Indirectly, Wal-Mart (WMT), Darden Restaurants (DRI) and every other firm that depends on middle and working class discretionary income.
Why is housing so central, as opposed to other industries? Why does it hold the key to the economy booming or busting? Because it is exquisitely sensitive to interest rates; or at least it was before the avalanche of houses in foreclosure simply swamped the housing market. The key reason that the Fed tries to lower interest rates when the economy weakens is to jump start residential investment. This time around, even record low mortgage interest rates don’t seem to be moving the needle. The simple fact is that during the housing bubble we built far too many homes, and we now have a glut of empty homes around the country. Most estimates put the excess vacancies at between 1.0 to 1.3 million (including rental units).
The graph (from http://www.calculatedriskblog.com/) shows the total (homeowner and rental) vacancy rate over time, relative to housing starts. While it is off its peak, it is still far above normal. In such a situation, it seems economic folly to simply build more houses and add to the glut. But if we don’t build houses, the economy remains stuck in a rut. From a strict “allocation of resources” point of view, we would want to see slow housing starts until the vacancy rate fell back to more normal levels (say under 4.0%). Unfortunately the graph only goes through the end of 2010. However based on other data it looks like the vacancy rate has continued to fall so far this year, particularly in the apartment sector. Thus the rise in multi-family starts is less of a problem.
Thus, one can argue that in the long term, low housing starts are a good thing, as it means fewer new homes adding to the glut. That, however, is extremely cold comfort to the millions of construction workers who are out of work. It is also going to be very difficult to create a sustained growing economy if home building continues to be a drag.
For the month, regionally the results were very mixed. The West was the weakest, with total starts plunging by 16.5% on the month. On a year over year basis though, it is the strongest with starts up 36.1%. The all important South region was up, but just barely, with starts up 1.6% on the month. However it was up 23.0% year over year. The South was responsible for 51.9% of all starts in October. The Northeast saw a 17.2% rise, but it is the smallest of the regions, accounting for just 10.8% of all starts. Relative to a year ago though, starts in the Northeast were down 17.1%. The Midwest was relatively strong for the month with a 9.7% rise and up 7.4% year over year.
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