Homebuilding - How Slow Can It Go?
Much of the recently released U.S. housing market data has been on the weaker side. For example, housing starts declined 1.4% year-over-year in July, after a 5.5% drop in June. The drop was due to double-digit declines in the Northeast and the West, with starts increasing in the South and Midwest. Housing starts data, however, tends to be very volatile from month to month and can be impacted by things such as unusual weather events. Year-to-date starts through July – which can smooth out some of the volatility – are still up 5.6% compared to the same period last year, with strong gains of 15.7% in the West and 5.8% in the South. Based on these conflicting views of the same underlying data is the homebuilding slowdown expected to last, or will it prove to be transitory?
How Large a Share of the U.S. Economy Is Homebuilding? While the housing market gets a lot of media attention – much of it because of the housing crash that precipitated the Great Recession – the component that feeds into the GDP calculation is a relatively small share of the overall U.S. economy.
After peaking at 6.7% of GDP in the third quarter of 2006, residential investment as a share of GDP declined for 14 successive quarters, reaching a nadir of 2.4% in the third quarter of 2010. After stagnating at 2.4% for the next year, residential investment began to slowly increase and reached 3.9% in the second quarter of this year. This is, however, still well below the long-run average of 4.5% from 1960 through mid-2018.
Weak residential investment growth supports the theory that home builders have been cautious since the housing downturn. This in turn has held back GDP growth since the recession ended and could be one reason why this expansion has been weak compared to prior expansions. It also suggests that home builders have scope to ramp up construction, given how supply constraints in some housing markets are driving home prices higher.
Home Prices Continue To Rise. Despite the recent weakness in the housing data – from starts to sales – home prices continue to rise, largely due to low inventory. July was the first month in three years the number of existing homes available for sale did not decrease on a year-over-year basis. Even so, median home prices managed to rise 4.5% from a year ago to $269,600. Clearly, more homebuilding and inventory building will be necessary to further cool home price growth.
Existing home prices have increased year-over-year for 77 consecutive months now. Yet home prices relative to income are still well-below the levels seen prior to the last housing downturn. The price-to-income ratio peaked at 4.8 at the end of 2005, bottomed out at 3.2 in September of 2011, and then began to rise through 2016. The ratio, however, has been stable at 4.2 since the first quarter of 2017. It is near home price-to-income ratios seen back in 2004, well-before the last housing price bubble really took off.
The Outlook. Most forecasts call for a continued gradual slowdown in the housing market, which is typical for the late stage of an economic expansion and time of year. Housing starts are projected to grow 4.1% this year and then decelerate to 1.4% in 2019 and -1.6% in 2020. Home prices, based on the Case-Shiller 20 City Index, are forecast to rise 6.5% in 2018 and then slow to 4.3% in 2019 and 3.5% in 2020. In short, the slowdown in the housing market in this cycle is expected to be far more gradual and orderly compared to the housing crash in the last decade. As a result, the spillover to the broader U.S. economy – particularly the crucial wealth effect on consumer spending – will not be as severe, especially with national home prices expected to continue rising into 2020.
To find out more, check out last week’s US Outlook Report.