Housing Starts rose in March to a seasonally adjusted annual rate of 549,000 from 512,000 in February, an increase of 7.2%. Also, the February numbers were revised sharply higher from 479,000, so it is possible to see the increase as 70,000, or 14.6%. Relative to a year ago they are down 13.4%. Quite frankly, a year ago was also a pretty lousy time for homebuilders, so the fall is off a pretty easy comp.
If one looks at only single-family houses, the picture was more or less the same, rising to 422,000 from 392,000 in February, a rise of 7.7%, and down 21.1% from a year ago. February starts were revised up from 375,000, so single-family starts are up 12.5% from where we thought they were last month. The volatile multi-family (Apartment, Condo and Co-op) sector, rose by 14.7% to an annual rate of 102,000 (revised up from 96,000). Year over year, multi-family starts are up 28.6%.
The total starts number was well above consensus expectations of a 520,000 annual rate. However, in any absolute sense, the level of housing starts is just plain awful. It is easy to get a nice percentage gain if you start with a low enough base.
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. The silver cloud is that fewer starts means that there are fewer houses added to the inventory of houses looking for buyers.
We still face an inventory glut, so a weak homebuilding industry is a key part of the repair process for the housing market. 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. Used homes are pretty good substitutes for new homes, so that is a bit of a distinction without a difference. Housing Starts peaked in June of 2006 at an annual rate of 2.273 million. We are thus 75.8% off of the peak levels. Single-family starts are 77.5% below peak levels.
The rebound this month will slow the adjustment process, but also means more economic activity over the next few months. On balance, I have to see the increase in starts as being a good thing, but if New Home Sales do not pick up, the new homes being built will simply make the inventory situation worse.
Housing Starts Vitally Important
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 2.25% of GDP in the fourth quarter, down from 6.34% of GDP at the height of the housing bubble. 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.
Take a good hard look at the first graph below (from http://www.calculatedriskblog.com/) and the relationship between when the lines bottom and the light blue recession bars. If you want to know why this recovery seems so anemic, look no further than this graph. 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, accounting for over 25% of the total jobs lost, even thought they were 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, but they are not included in that one out of four jobs lost figure.
As they and the construction workers go back to work they are also going to 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 homebuilders, but about jobs and profits at firms as diverse as Plum Creek Timber (PCL), Fortune Brands (FO) and Berkshire Hathaway (BRK.B). Indirectly, it even helps Wal-Mart (WMT).
Why Housing Is Central
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. Even near-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 1.2 to 1.5 million (including rental units).
The next graph (also 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%).
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.
If residential investment (of which new home construction is the largest part) had simply remained at the depressed levels of the second quarter, rather than declining further, the economy would have grown at a 3.25% rate in the third quarter rather than at just 2.50%. In the fourth quarter, residential investment was actually very slight positive contributor to growth, adding 0.08 points of the 3.20 total.
The residential investment locomotive was not pulling very hard, but at least it was no longer acting as a brake. That resulted in a 0.83 point swing in growth contribution, which was more than the total acceleration of 0.60 points from the third quarter to the fourth quarter.
The increase in March, combined with the upward revision to February means that housing starts averaged 563,000 in the first quarter, up 5.4% from the 534,000 average in the fourth quarter. This suggests that Residential Investment will be a positive contributor to first quarter GDP growth, although not a huge one.
Results by Region
For the month, three of the four census regions posted increases, but all were down from a year ago. The Midwest was the strongest, with total starts rising 32.3% on the month, but down 11.8% year over year. The West was also strong, with a 27.6% increase, but is the weakest year over year, down 18.4%. The Northeast posted a gain of 5.4% for the month, and is down 10.6% year over year.
The South, which is by far the largest of the four regions, accounting for 54.1% of all starts for the month, was the only place where starts declined. For the month starts were down 3.3% and are off 12.4% year over year. The West, on the other hand, was down 28.0% on the month and off 40.6% year over year.
Building Permits
The rise in starts is encouraging, and fortunately, it is likely to continue. The best leading indicator of housing starts are Building Permits. There the news was also modestly upbeat, at least from a near-term economic growth point of view. (Or worse from a long-term repair of the housing market point of view).
For the month, total permits rose 11.2% to an annual rate of 594,000 and were down 13.3% year over year. That was above the consensus expectations for a 540,000 rate. February was revised up, from a 517,000 rate to 534,000. The strength was mostly in the multi-family part of the market while the gains in single-family permits were more modest. Single family permits were up 5.7% on the month, and down 25.3% year over year.
Multi-family permits soared 43.0% on the month and are up 28.1% year over year. The permit rate is above the start rate, so we can probably look forward to at least a bit more upward momentum in starts in April and May. The rebound is not likely to be all that strong though as the permit rate is just 8.1% above the start rate.
Regionally, the West was the strongest for the month, with permits up 37.1% on the month but off 7.6% year over year. The Midwest saw permits rise 6.9% for the month and off 20.5% from a year ago. The South, the largest of the four regions, rose 6.3% for the month but down 14.6% from a year ago. The Northeast, the smallest of the four regions, was unchanged on the month, and down 5.9% year over year.
There is a certain level of ambiguity about if a rise in starts is good news or bad. We need less supply to help the market clear, but in the meantime, the economy is going to be stuck in limbo, unless we can find another locomotive to help pull us forward. The one we have always relied on in the past is clearly derailed.
Every housing start represents a lot of economic activity, and the effects go far beyond the bottom line of the big home builders. Housing starts are an important part of the job picture, and construction has historically been an important source of relatively high paying jobs for those without a lot of formal education. The conundrum is how to get these people back to work without simply adding to the existing housing glut.
Housing & the Political Environment
Additional government spending on infrastructure would be the logical solution. After all, we have huge needs to rebuild out crumbling infrastructure. Better infrastructure would enhance our long-term economic competitiveness. The government would not be competing for resources with the private sector, it would be competing with idleness. Even with the recent rebound in interest rates, the cost of financing the infrastructure rebuild would be extremely low, give that T-note yields are in any historic perspective, low across the yield curve.
However, in the current political environment that is not gong to happen, as Congress is more likely to slash existing infrastructure spending rather than increase it. This is following the economic theory that putting an incremental $100,000 into the after-tax income of a mid-level Wall Street investment banker will instill more confidence in the economy that they will produce more jobs, than putting an unemployed construction worker back to work fixing our bridges so they don’t collapse on us. I don’t think that is the case, and that employing the unemployed would be a better route to regaining confidence.
Eventually, the combination of a rising population, and higher household formation will absorb the excess inventory, and we will be able to once again increase housing construction. Household formation is economist speak for kids moving out of their parents houses and getting a place of their own. To do so takes a job, and one that pays enough to support having your own place.
In the past, residential construction itself provided a lot of those jobs. That produced an upward spiral. This time around, the jobs have to be created in other parts of the economy to increase the household formation rate, and absorb the excess inventory, which makes the process slower. This process should probably hit the rental market first, and we are starting to see that.
Most of the decline in the vacancy rate shown above has come from the rental side of the housing market. After all, kids moving out of Mom’s basement are more likely to first move into a rental apartment than to buy a house. The decline in the rental vacancy rate is thus a positive omen for the future.
The day will come when housing is once again a big positive contributor to economic growth. It is not really sustainable over the long term to have total housing starts running at substantially lower levels than we saw in the 1960’s. Back then the population of the country was around 200 million, now it is north of 310 million.
That day, however, is neither today nor in the near future. It is possible that it might happen in the second half of 2011, but more likely in 2012. For the time being, the best we can really hope for is that it stops being a brake on the economy. That appears to be happening.
D R HORTON INC (DHI): Free Stock Analysis Report
FORTUNE BRANDS (FO): Free Stock Analysis Report
PLUM CREEK TMBR (PCL): Free Stock Analysis Report
WAL-MART STORES (WMT): Free Stock Analysis Report
Zacks Investment Research
