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There's A Strong Recovery Ahead in Housing
By: Dr. Charles Lieberman
Date: 8/24/2009
Many investors still fear that housing has another leg down, with prices falling for a year or two, despite recent data suggesting an upturn. It is our judgment that housing has already bottomed and that a strong rebound lies ahead. Housing will be a contributor to economic expansion this year, probably as soon as the third quarter, with this rebound already baked into the cake. Once job growth resumes, even slightly, housing activity will rise sharply.
Pessimists on the housing market point to the high rate of defaults, foreclosures, and mortgage resets that they expect to depress housing demand and prices for an extended period into the future. Much of this data they cite is backward looking. Year-over-year declines in home prices include the historical collapse in housing that occurred in the fourth quarter of 2008, which is now old news and that data won't wash out of the year-over-year comparisons until late this year. In the meantime, every monthly measure of home prices shows a rise in values over the past six months. This week's Case-Shiller index should fit this pattern, down somewhat less year-over-year, but likely up for the latest month.
Defaults and repossessions are running at high levels, but home sales are also picking up, as households and investors seek to take advantage of the bargains. Significantly, there's been something of a change in the nature of defaults. A large fraction of the defaults in 2007 and early 2008 resulted from badly underwritten sub-prime and Alt-A mortgages. More recently, mortgage defaults reflect the recessionary economy. So any economic recovery should also curtail the influx of defaulted homes into the market. Indeed, with housing values rising over the past six months, fewer households will be upside down in their mortgages and so are less likely to default.
Even with the influx of defaulted homes into the marketplace, housing inventories have come down, most notably for new construction. As of June 2009, unsold inventories have declined for 27 consecutive months to 281,000 units -- one of the lowest levels in 40 years! This decline in inventories is in sharp contrast with the growth in population that is now about 50% larger, suggesting that inventories are now very lean. July data on inventories will be released this week on August 26 and is very likely to show yet another decline. Existing home inventories are down to 4.09 million as of July 2009, roughly 11% below its peak a year ago. When considering the impact on GDP, only new construction is material, so the fact that second quarter starts are about 2.5% higher than in the first quarter ensures that residential construction will be a positive in GDP no later than the fourth quarter. In the second quarter, housing declined at a nearly 30% annual rate, contributing to weakness in GDP. Its impact this quarter should be minor, which is a dramatic turnaround within such a short time period.
The full potential for housing to contribute to growth is still being restrained by the recession, since a weak economy tends to reduce household formation. Longer-term household formation trends suggest a need for about 1.5 million units of new construction annually, nearly three times the current rate of construction. Actual household formation is likely running below 1 million, more than enough to continue absorbing housing inventory. But once an economic recovery starts and young people find work, they will move out of their parent's homes as quickly as they can afford to do so, adding incrementally to housing demand and meaningfully to the existing imbalance between new construction and demographic housing needs. So, rather than expecting a weak housing market for the next few years, we anticipate that housing will rise quite sharply, even accelerating over the next year or two, and becoming a strong contributor to GDP and job growth over the visible horizon.
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