US housing has seen an uneven recovery since its collapse in 2007 and 2008. While home prices, construction, and sales are off their lows and in line with our forecasts (see US Housing Market Looking Brighter for 2012 by Blu Putnam), progress has not been smooth. Construction and new home sales, in particular, remain more than 50% below their peak levels of 2005 (Figures 1 and 2). However, there are a number of reasons to think that the housing market might be on the verge of a stronger phase of recovery over the next couple of years.
First and foremost is pent up demand: neither construction of new homes nor sales have kept up with a growing population. Taken by itself, a growing population is neither a necessary nor a sufficient pre-condition for a housing boom, but it is an important part of the mix. Indebted college graduates and others who had trouble finding jobs during the Great Recession of 2008 and 2009 and returned to their parental homes are now beginning to find jobs in large numbers. Pre-recession, there were 1.5 million new household formations per year. Post-recession, the number has been about half of that. No matter how much they love their basement lodgings, or roommates, most young people will not delay household formation forever. Many of them will become potential home buyers in the second half of this decade, or at least renters. Our focus here is that rising employment and incomes will provide an assist for new household formation, which leads to our next point.
Rising labor income might induce some individuals and families to buy a home. It will also increase the demand for rental housing construction. The early stages of the recovery from the Great Recession were painful and slow, especially in labor markets. In 2014, however, the pace of improvement in the labor market picked up considerably (Figures 3 and 4).
What matters for home demand is the total picture for labor income in the country, and too much attention on individual labor market indicators can understate the case. Average hourly earnings are growing at 2.0% year-on-year, which is a fairly modest pace of advancement. Average hours worked has grown by 0.6%, meaning that the average income of a worker has grown by 2.0% + 0.6%, or 2.6%, a more significant improvement. But it gets better. The number of workers has increased 2.4% year-on-year. This means that total labor income has risen by 2.6% + 2.4%, or 5.0%, a very significant increase. Moreover, consumer price data shows subdued inflation. In real terms (i.e., inflation adjusted) total labor income is up by over 4%, which is faster than the country’s real GDP growth and likely to provide the foundation for growth in home construction and sales.
Inventories of new and existing homes have declined dramatically. According to the Department of Commerce, there are about 218,000 unsold new homes, representing about five and half months’ worth of sales. While that is higher than the 142,000 when inventories hit bottom in 2012, supply remains fairly modest. Inventories of unsold homes peaked at over half a million in 2006; in the 1999-2001 period before the housing bubble really got underway, inventories were typically around 300,000 (Figure 5). Bear in mind as well that since 2000, the population has grown by over 10%. Bottom line: if banks boost lending and more consumers start borrowing, new homes sales will increase; and there is plenty of room for inventories of unsold new homes to grow as well before they come anywhere close to levels considered alarming.
Inventories of existing homes have also declined to nearly half since peaking in 2006-2008. Here too, the monthly-supply measure, which takes the number of unsold homes and divides them by sales per month, has returned to pre-crisis levels (Figure 6). Vacancy rates have also fallen for both rentals and properties destined for homeowners (Figure 7).
Since the end of 2008, consumer debt has fallen from around 95% of GDP to around 80% as US households have cleaned up their balance sheets.1 This improvement is reflected in housing-related statistics as well. In January 2012, 35% of home sales were distressed and about 22% of those were foreclosures.2 By January 2015, only 11% of home sales were distressed and about 8% were foreclosures (Figure 8). Delinquent mortgages have also been falling dramatically, although they are not yet down to pre-crisis levels. According to the Mortgage Bankers Association, delinquencies peaked in Q1 2010 with slightly over 10% of borrowers behind on their payments.3 As of Q4 2014, delinquencies fell to 5.7%, slightly above the pre-crisis range of 4.0%-5.5% (Figure 9). Better consumer balance sheets, fewer distressed properties and falling rates of delinquencies combined with rising consumer incomes should make mortgage lenders more willing to lend.
Households were not the only ones that spent the first half of the decade repairing their balance sheets. The banking system raised enormous amounts of capital through share offerings, reduced dividend payments/earnings retention, and by issuing relatively fewer new loans (Figure 10) in order to comply with Basel III and other requirements. In fact, the number of new mortgages issued during the past few years has been about 60% lower than it was in 2005 and 2006, and has been on par with the amount lent during the mid-1990s. Given the improvements in the balance sheets of US banks, we suspect that they will begin to loosen up the flow of credit to potential homebuyers in the next few years, making for a much brighter housing picture.
Even if banks are willing to lend, there will be no increase in mortgages if buyers are absent. One thing that could entice potential home buyers, however, is low mortgage rates. At the moment, average rates on 30-year mortgages are back below 4%. While this is not a record low, it is still very low by historical standards and the best (from a buyer’s perspective) since mid-2013 (Figure 11).
Mortgage rates are a key part of consumer affordability. Another is price. Outside of a few extremely expensive markets like New York and San Francisco, which have a strong international demand, house prices remain significantly below their peak levels from 2006. Overall, the S&P Case-Shiller Home Price Index of 20 cities is 16% below the peak levels of July 2006 in nominal terms, having recovered roughly half of the losses during the crisis. The drop is bigger in inflation adjusted terms (Figure 12). In fact, home prices are only about 40% higher in inflation adjusted terms than they were in 1987 when the Case-Shiller 10 City Index began. Given that real per capita income has risen from $34,114 in 1987 to $48,282 in 2011, according to the Federal Reserve Bank of St. Louis, the increase in inflation adjusted home prices over the same period hardly seems alarming. In some markets like Detroit and Las Vegas, home prices are below where they were even in the early 1990s in inflation adjusted terms and they are still below their inflation adjusted peaks in almost every market in the country (Figure 13). The reasonable level of prices combined with the expectation that prices might go higher given the low mortgage rates and improving labor market are indicators that potential buyers might come into the market sooner rather than later.
Like any other product, homes are made with a combination of labor and capital. Capital includes raw materials such as aluminum, copper (mainly for wiring), and lumber as well as the energy required to transport these goods to put them in place.
Aluminum prices are down more than 30% since the beginning of 2011, whereas copper and crude oil prices have fallen by 40% or more (Figure 14). Lower costs of raw materials should, at the margin, incentivize home builders to build more homes and in turn, keep costs affordable for home buyers.
The other major raw material used in building homes is lumber. Lumber prices have recently dropped below $300 per thousand board feet. While it is far from a record low, it is about 30% below record high levels achieved in occasional spikes between 1992 and 2005. Even as recently as 2013, lumber traded at over $400 per thousand board feet.
Lumber prices have, at times, tracked the National Association of Home Builders (NAHB) Housing Index rather closely (Figure 15). If housing booms in coming years, it could mean much higher lumber prices. Moreover, it could also support prices for aluminum and copper even if demand for them in China continues to slow.
There are, of course, risks to our base case scenario. The main risk points involve interest rates, energy prices, and household formation.
The Federal Reserve (Fed) may begin tightening policy (possibly as soon as June or perhaps September). We do not think a small increase in short-term rates will have much impact on the decision to buy a home, however, those with adjustable rate loans will see an increase in monthly payments, which might lead to an increase in defaults.
Energy prices are low, which is a boom to consumers and home owners. An unexpected upward move in energy prices could derail recovery in real consumer incomes.
Household formation could remain slow. The interesting issue here is the reaction of the younger generation to the Great Recession. Millenials watched the value of their parent’s homes collapse in 2007-2008, and they may be much less enthusiastic about using a home purchase as their primary path to wealth generation.
Despite these risks, we remain broadly optimistic about a US housing recovery. If housing activity expands in the manner that we think might be possible in the next few years, it will not only provide some support prices for aluminum, copper, and lumber, but also could add to GDP over the course of two to three years. We would not be surprised to see housing starts and building permits rise from their current pace of just over one million a year to around a million and a quarter or more a year within two to five years. Meanwhile, new home sales by 2016 or 2017 could move back to the 800,000 territory from its recent range of 380,000 to 480,000 units.
In the process, some of the jobs in the housing sector that disappeared during the Great Recession could come back, which would add to the positive dynamic in the US economy. The Bureau of Labor Statistics Employer Survey suggests that building-construction related employment peaked in 2007 at about 1.8 million workers. The sector then shed about 600,000 jobs, or one third, during the great housing collapse of 2007-2009. So far, only about 200,000 of these jobs have come back (Figure 16). We are optimistic that the recovery in that employment sector will continue apace, or even accelerate, creating opportunties for some of the people who have been left behind by the economic recovery thus far.
When we put it all together, we have a renewed optimism that the strength of labor markets coupled with the removal of many of the drags on home sales ranging from inventories to credit quality to bank lending will lead to an improved picture later in 2015 and into 2016. Typically in many of the economic cycles of the past in the US, the housing sector has led the country out of recession. This time around, housing led the country into the recession, so the recovery has been long, slow, and uneven. As we enter into the sixth year of growth since the Great Recession, however, the housing picture is getting brighter, promising a long-lasting economic expansion.
All examples in this report are hypothetical interpretations of situations and are used for explanation purposes only. The views in this report reflect solely those of the authors and not necessarily those of CME Group or its affiliated institutions. This report and the information herein should not be considered investment advice or the results of actual market experience.
Erik Norland is Executive Director and Senior Economist of CME Group. He is responsible for generating economic analysis on global financial markets by identifying emerging trends, evaluating economic factors and forecasting their impact on CME Group and the company’s business strategy, and upon those who trade in its various markets. He is also one of CME Group’s spokespeople on global economic, financial and geopolitical conditions.
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