We got a very mixed picture on the housing front this morning. Housing Starts were down but Building Permits were up, and while permits are a leading indicator of starts, they usually move in the same direction.

It was not simply a case of the very volatile apartment and condo (5 or more until structures) numbers causing this anomaly. Single-family permits were up while single-family starts were down.

The regional data was also very mixed. While the data is seasonally adjusted, I suspect a colder than normal December played a role in the numbers for the month.

A Look at Housing Starts

Nationwide, housing starts fell to a seasonally adjusted annual rate of 557,000, down 4.0% from the upwardly revised 580,000 rate in November (was 572,000), but up a slight 0.2% from a year ago. Total housing starts bottomed out in April at a rate of 479,000, so we still have a few months of easy year-over-year comparisons.

Single-family starts were running at a 456,000 rate, down 6.9% from the 490,000 rate of November but up 16.0% from a year ago. The bottom in single-family starts was in January of last year at 357,000. Apartment starts rose by 15.0% to a rate of 92,000, but are down 40.3% from the year-ago level of 154,000.

Just for perspective on how far things have fallen, the peak for housing starts was in January of 2006 when a total of 2.273 million housing units were started, including 1.823 million single family homes. So from the peak we are down 75% on both total and single-family starts. Even if housing starts were to double from here, they would still be only half of peak bubble levels.

The history of housing starts, both total and single-family, is shown in the graph below (from http://www.calculatedriskblog.com/). Regionally, the Northeast was the hardest hit, with starts tumbling 19.0% from both last month and a year ago. The Midwest was close on its heels, dropping 18.5% from last month, however starts are up 15.8% from December 2008. The West was almost flat from last month, falling 0.9% but is down 19.4% from a year ago. The South, which with 55.6% of all starts in December is by far the most important region, saw a 3.3% rise in the month and is up 9.5% from last year.

As for Building Permits…

Turning now to Building Permits, which are the best leading indicator of housing starts, they rose 10.9% for the month to an annual rate of 653,000, up from 589,000. The November permit rate was revised up from a 580,000 rate. Relative to the December 2008 seasonally adjusted rate of 564,000, permits were up 15.8% year over year.

Single-family permits rose 8.3% on the month, and are up 37.3% year over year. Apartment permits jumped 33.7% for the month but are down 27.0% from a year ago.

Regionally, the Northeast was the strongest on permits, with a 27.9% monthly rise and a 45.0% increase from a year ago. The Midwest saw a 10.5% monthly rise and a 36.5% year-over-year increase. The West was also strong, with a 18.0% monthly rise and a 12.0% year-over-year increase. Things were more subdued in the South, with a 4.6% rise from November and a 5.6% increase from a year ago.

Why Each Is Important

Building permits are about getting the paperwork done, while starts are about actually putting the shovels in the ground, and if the ground is frozen solid, it often makes sense to wait. The fact that the divergence between the starts and the permits numbers were most stark in the Northeast and the Midwest was so much larger than in the South helps support the idea that weather played a significant factor in the December numbers.

Given that, I think that the permit numbers are a better reflection of what is really going on. The housing construction industry is slowly getting back on its feet, but it will be a very long time, perhaps decades, before it returns to the glory days of the middle of this past decade.

One does not have to make heroic assumptions about the level of housing starts to have very impressive percentage increases from the currently very depressed levels. However, I’m not sure that it would be entirely a good thing if we do have a big increase. We still have a bit of an inventory overhang in new houses, although it is nowhere near as bad as it was a year ago.

The “Shadow Inventory” Looms

There is a huge “shadow inventory” of existing homes that are far behind on their mortgage payments but have not been foreclosed upon yet. In part, the trail modifications under the HAMP program have slowed down the foreclosure process. However, the vast majority of trial modifications in the HAMP program have not become permanent, and a very large percentage of the ones that do become permanent will run into trouble again.

In part, that is because the HAMP program — not to mention other voluntary efforts by the big banks like Bank of America (BAC) and JP Morgan (JPM) — are mostly about lowering the monthly payments to more affordable levels. Sometimes this just means extending the term of the mortgage, and tacking the missed payments onto principal. Other times it means reducing the interest rate.

While these actions are helpful, if a homeowner is deeply underwater on their home, it still makes economic sense for them to stop paying on their mortgage, even if they are still employed and have the cash flow available to pay it. I expect a second wave of foreclosures to hit later in 2010. Most of the time, a used home is an excellent substitute for a new home. If there is going to be a huge supply of existing homes coming on the market in the near future, perhaps it is not a good thing to be putting lots of resources into creating more new homes.

Residential Investment & Economic Growth

The problem, though, is that Residential Investment (which is mostly new home construction, but also includes improvement of existing homes) is generally the main locomotive powering the economy out of recessions. Just take a peek at the graph and the relationship between the blue recession bars and the direction of housing starts. While we will probably get a nice percentage increase in housing starts during 2010, the absolute level is likely to stay at levels associated with deep recessions in the past — under a million units a year on total starts.

Keep in mind also that these numbers are not adjusted for population growth, and there are a lot more people in the country now than there were during the recessions of the 1970s or early 1980s. In other words, it is not going to be a very powerful locomotive this time around. This, in turn, means that we will have a very sluggish economic recovery.

Further economic stimulus measures, particularly a “Cash for Caulkers” program to retrofit existing homes to make them more energy efficient, would be a good way to put construction workers back to work without exacerbating the excess inventory problem. Since the peak in January 2007, 1.83 million construction workers have lost their jobs, or 23.6% off the peak level. They could employ their existing skillset with such jobs.

Of course, there is also the long-term ancillary benefit of lower energy demand, and all of those implications for the environment, the trade deficit and ultimately our National Security that such a program would have. There would also be spillover benefits to the manufacturing sector, and jobs would be created at firms that make windows and insulation, for example. 

What Needs to Happen, Longer-Term

Ultimately though, that would be a stop-gap, temporary measure (but with lasting benefits). For the housing industry to really get back on its feet, the rate of household creation has to rise. That is mostly a function of jobs. A good job will get the 25-year-old college grad out of his mom’s basement and into a place of his own. A good job will get the family currently sleeping on the couches of their friends’ or family because they got foreclosed on back into their own place.

To the extent a “Cash for Caulkers” would help on the employment front, it would also help on the demand side of the equation for housing. But it would in and of itself not be sufficient. More jobs would of course solve a multitude of other problems in the economy and in society more generally.

Dirk van Dijk, CFA is the Chief Equity Strategist for Zacks.com. With more than 25 years investment experience he has become a popular commentator appearing in the Wall Street Journal and on CNBC. Dirk is also the Editor in charge of the market-beating Zacks Strategic Investor service.

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