Housing Starts plunged in February to a seasonally-adjusted annual rate of just 479,000 from 618,000 in January, a drop of 22.5%. As a small silver lining, the January numbers were revised higher from 596,000, so it is possible to see the decrease as 117,000, or “just” 19.6%. Relative to a year ago, they are down 20.8%.
Quite frankly, a year ago was also a pretty lousy time for the home builders, so the drop is off a pretty easy comp. If one looks at only single family houses, the picture was just plain ugly, falling to 375,000 from 425,000 in January, a drop of 11.8% and down 28.8% from a year ago. The volatile multi family (Apartment, Condo and Co-op) sector fell a massive 47.0% to an annual rate of 96,000. However, year over year multi-family starts are up 54.8%. I was not kidding when I said that part of the housing market was volatile.
The total starts number was well below consensus expectations for a 575,000 annual rate. 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 78.9% off of the peak levels. Single family starts are 80.0% below peak levels.
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.
This is no coincidence. Each new home built generates a huge amount of economic activity. It puts 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. 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 at Bob Evans (BOBE), thus creating jobs for cooks, waitresses and busboys.
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 1.3 to 1.6 million (including rental units).
The next two graphs (also from http://www.calculatedriskblog.com/) show the homeowner and rental vacancy rate over time. While it is off their peaks, they are 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.
Thus, one can argue that, in the long term, falling housing starts is 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 a 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 February starts numbers suggest that residential investment might return to being a drag on growth again in the first quarter, although given the upward revision to January, probably not a huge drag.
All four regions of the country saw declines, but there were some big differences in magnitude. The Midwest was the weakest, with total starts falling 48.6% on the month, and down 45.7% year over year. The Northeast was also weak with a 37.5% decrease, and down 23.6% year over year. The South, which is by far the largest of the four regions, accounting for 58.9% of all starts for the month; it held up the best. For the month, starts were down 6.3% and are off just 1.1% year over year. The West, on the other hand, was down 28.0% on the month and off 40.6% year over year.
It is possible that the weather played a role in the big declines in the Northeast and Midwest, but if so it was only a small contributing factor. In general the weather was just as bad, if not worse, in January as it was in February. These numbers are seasonally adjusted, so the weather in the month has to be significantly worse than the average for that month, not just it is harder to start a house in February than it is in June.
The decline in starts is discouraging and, unfortunately, is likely to continue. The best leading indicator of housing starts are Building Permits. The news was also weak here, at least from a near term economic growth point of view. (Or significantly better from a long term repair of the housing market point of view). For the month, total permits fell 8.2% to an annual rate of 517,000 and were down 20.5% year over year. That was below the consensus expectations for a 573,000 rate. January was revised up, but only slightly, from a 562,000 rate to 563,000.
The weakness was mostly in the single family part of the market. Single family permits were down 9.3% on the month and down 27.9% year over year. Multi-family permits fell 1.6% on the month but are up 13.1% year over year. In a bit of a silver lining, the permit rate is above the start rate, so we can probably look forward to at least a bit of a rebound in starts in March or April. The rebound is not likely to be all that strong, though, as the permit rate is just 7.9% above the start rate, and is also well below where the start rate was in January.
Regionally, the Northeast was the weakest, with permits down 27.8% on the month and off 32.9% year over year. The West saw permits drop 13.6% for the month and off 35.8% from a year ago. In the Midwest, permits fell 5.4% for the month and were down 17.9% from a year ago. The South, the largest of the four regions, had the smallest decline for the month, down 1.4% from January and down 10.6% from a year ago.
There is a certain level of ambiguity about whether 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 like D.R. Horton (DHI). It represents jobs for the carpenters and roofers, who will then have the money to go spend at Wal-Mart (WMT). It also represents more demand for wood from firms like Plum Creek Timber (PCL) and jobs for lumberjacks. It also represents jobs for people making plumbing fixtures at Masco (MAS). The conundrum is how to get these people back to work without simply adding to the existing housing glut.
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, given that T-note yields are in any historic perspective, low across the yield curve.
However, in the current political environment, that is not going to happen as Congress is more likely to slash existing infrastructure spending rather than increase it. This is following the absolutely daft economic theory that putting an incremental $100,000 into the after tax income of a mid level Wall Street investment banker will instill enough confidence in the economy and produce more jobs, rather than putting an unemployed construction worker back to work fixing our bridges so they don’t collapse on us. Well, who ever said that Congress is logical.
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. 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 1960s. Back then the population of the country was around 200 million, now it is north of 310 million. That day, however, is not today, or 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.
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