Recovery Approaching the Precipice?
Stock markets remain strong, volatility remains low, and the economic recovery remains solid. Or does it? Home sales, both for new houses and existing, came in ahead of expectations for May, but a week earlier, the report on housing starts disappointed for the third month in a row. Is the housing market pointing to further life to this recovery, or imminent demise?
Total housing starts in May declined 5.5% from April to 1.09 million units, and that drop followed month over month declines in April and March. Within the total, multi-family construction continues to fall after very strong activity in recent years, but surprisingly, single-family home starts also came in lower. At first, this may warn of a weakening in the housing market, but year to date, starts are 3.5% higher than last year. Moreover, even though permits fell 4.9% in May, residential building permits still rose 5.5% during the first five months of 2017 relative to last year. Housing supply growth may have slowed over the last three months, but is that weakening likely to persist? A look at demand provides a clue since home builders primarily respond to two things: demand and prices. Costs weigh in also, but more on that later.
Home sales are continuing to climb, and, more importantly, homes are selling at higher prices. Those combined observations indicate that demand is indeed strengthening. Last week, the National Association of Realtors reported that new home sales rose 2.9% for May relative to April, while existing home sales climbed 1.1%. Relative to last year, these were up 8.9% and 2.7%, respectively. Sales are clearly growing nicely and the underlying demand is driving prices higher; the median price of new homes sold hit a new record in May at $345,800, up 16.8% from last year, while the median price of existing homes rose 5.8% year over year (to $252,800).
Some have pointed to a new “housing crisis” in these dynamics; the US is facing a persisting shortage in the housing market. Anyone who has considered moving recently has been confronted by the frustrating lack of choice in houses for sale. Inventories have dropped to only 4.2 months’ supply of existing homes on the market, down from 6.1 months in 2012. New homes’ inventory stands at 5.3 months, down from its 6.1 months 50-year average. And “starter homes,” those below $200,000, dropped to 14% of the market in May from 21% in April, confounding millennials who are just beginning to leave their parents’ basements.
The housing recovery continues to be a gradual one and lack of labor and land seem partly to blame, rather than lack of demand. Labor, land and supply costs are all rising; lumber prices are up 14% since June 2016. Builders cite shortages of construction workers, many of whom left the industry when housing builds dropped precipitously following the housing bubble’s collapse in 2008. Shortages of land in growing locales seem also to be holding back new construction.
Despite low inventories, some remain concerned that the new record in housing prices could be a sign of a newly forming bubble in the real estate market. The chart below should remove any such concerns. The pace of housing sales is only half that of 2005 and the ratio of housing prices to rental costs of housing remains well below bubble levels.
Sources: S&P Dow Jones Indices LLC, U.S. Bureau of Labor Statistics
Housing builds at an annual rate of 1.09 million remain well below historical averages and below the pace needed to meet underlying growth in demand, estimated to be 1.4 million per year. The need for new homes arises from two sources: needed replacement of existing homes in disrepair and new homes to provide for new household formation – first-time home buyers. And while millennials have taken a bit longer to buy homes, they are now making that move.
Housing (purchases, rents, and utilities) accounts for 15-18% of the US economy and when furnishings and accessories are added would be considerably larger. Low inventories, strong demand, and year-over-year construction trends are all pointing to further growth in housing and so ongoing economic recovery. And while interest rates are rising, the underlying demand for housing appears sufficiently robust to offset the modest rise in housing financing costs. There is no shortage of investing opportunities related to housing and these span multiple sectors –REITs, Financials (and especially mortgage and mortgage insurance companies), Industrials (construction equipment, home fixtures), Materials (insulation, chemical companies), Consumer Discretionary (home builders, furniture, accessories), and Information Technology (security, consumer electronics)—and the challenge remains only in finding the most promising candidates within that very broad group.
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