by Neil Dutta
Housing was the epicenter of the last recession. From the peak in 2005 to the end of the contraction in mid-2009, U.S. residential investment declined at an unprecedented rate of about 20 percent a year. In normal business cycles, sectors that overshoot to the downside tend to rebound sharply. Given the significant oversupply of homes and tightening of credit, housing enjoyed no such recovery. Residential investment was essentially flat for almost two years after the recession ended. Since then, a slow recovery has been underway and we suspect the housing market will pick up in the year ahead.
Although residential investment has been expanding since 2011, recent growth has been sluggish, rising just 1.1 percent over the last year, compared with about 7 percent in the two previous years. Some of this weakness can be attributed to a housing market in transition: Owner-occupied real estate is recovering as renter-occupied real estate is declining. Also, multi-family construction is ebbing as single-family building picks up. With inventories tight, home resales appear to have flattened out as new home sales take a greater share. In other words, conditions in the U.S. housing market are normalizing. That’s a good thing.
There are good reasons to expect residential investment to pick up after sluggish growth this year.
Consumer attitudes are strong, supporting housing demand. It helps that general economic conditions have improved. According to the latest University of Michigan Survey, more people say now is a good time to buy a home because of “prosperous times.” This is a notable difference from the bubble period of 2005-06 and suggests a recovery built on firmer ground.
More respondents say now is a good time to buy a home because “prices won’t come down” and because it’s a “good investment.” Price expectations matter. The improvement in household buying attitudes, helps keep user costs low. In a standard user cost of housing model, the expected value of the home offsets maintenance costs such as mortgage interest and property taxes and depreciation. No one wants to finance an asset class they believe will go down in value. Thus, it is welcome that consumers see housing as a solid investment once again.
Even as mortgage rates have picked up, lending standards have been easing fairly consistently in recent years. According to the Federal Reserve’s Senior Loan Officer Survey, a net percent of banks has been easing lending standards on residential mortgage loans for 14 consecutive quarters. Despite the ongoing easing of standards, we’d hardly describe conditions in the mortgage market as loose. After all, almost 60 percent of newly originated mortgages have gone to those with a credit score above 760; during the housing mania of the last decade, this figure ran less than 30 percent. Mortgage credit is still tight. The good news is that, at the margin, credit is expanding.
Finally, there is ample room left in the housing recovery. After all, during the 1980s and 90s -- that is, excluding the bubble period -- residential investment totaled 4.4 percent of gross domestic product. As of the third quarter, this figure stands at just 3.8 percent. The economy has been operating below this benchmark for about seven years. So, even by the most conservative of standards, there is likely upside from housing’s contribution to overall GDP growth in the quarters ahead. We’re just not building enough houses.
A popular retort to this positive outlook is that supply conditions in the housing market are constrained. There aren’t enough workers to build these homes, or so the thinking goes. Proponents of this view have a point. For example, the jobless rate in the construction industry has never been as low. Although worker shortage in the construction industry might be a problem, we think productivity is a much bigger one. Historically, we saw about four construction workers for every home start. Today, this number stands close to six. With wage growth in the construction industry finally beginning to pick up, perhaps construction workers are on the verge of repaying the favor with stronger productivity.