The housing slump is not (yet) a recession
Higher mortgage rates, slowing demand will make it harder for sellers and buyers
Source: MarketWatch, by Howard Gold
While Wall Street has focused on trade, interest rates, and the midterm elections, a potentially bigger risk to the markets has gone almost unnoticed: Housing starts have slid, prices in some high-profile markets have weakened, and share prices of publicly traded homebuilders have plummeted.
That could eventually mean big trouble for an economy in which consumer spending comprises 70% of GDP. Last year, residential and commercial construction contributed $1.34 trillion, or 7%, to GDP.
Home purchases have a multiplier effect on consumer spending, since they often generate further sales of furniture, appliances, electronics, and marble or granite kitchen counters.
So, a slowdown in housing can be a very, very big deal, and a slowdown is apparently what we’re experiencing now:
• Since January, when the total of new privately owned housing units started hit an 11-year high of 1,334,000 units (annualized), housing starts have fallen to 1.2 million annually in September, according to the U.S. Bureau of the Census. That’s a 10% decline and nearly a three-year low.
• According to Redfin, sellers of more than one in four U.S. homes cut their asking price in the four weeks ending Sept. 16, the highest percentage since 2010. Once-scorching markets like Seattle and San Jose saw some of the biggest increases in price cuts, Redfin reported. Other hot markets like Boston and San Francisco are seeing prices level off. And in New York, a glut of luxury condominium and rental towers has led to big drops in rents and sale prices.
• The SPDR Homebuilders ETF XHB, +0.00% plunged as much as 31% from its January all-time high before bouncing back a little in the recent rally. That’s a bear market by anyone’s definition and three times as big a sell-off as the Dow Jones Industrial Average’s DJIA, +0.26% 9% decline and the S&P 500 index’sSPX, -0.05% 9.8% fall from their October all-time highs, before last week’s recovery.
• One measure of 30-year fixed-rate mortgages, from Bankrate.com, has topped 5% for the first time since 2010. From July through October 2016, the 30-year mortgage was less than 3.5%. For prospective homebuyers who haven’t been in the market long, that’s a big jump, and maybe a key psychological barrier.
How big a deal is all this? I contacted Ed Leamer, an economist at UCLA Anderson, who published a notable paper on housing in the summer of 2007 — just before all the you-know-what hit the fan.
That paper, while not explicitly predicting the financial crisis or Great Recession, nonetheless warned of how extensive the impact of a housing decline can be. Entitled “Housing IS the Business Cycle,” Leamer’s paper said: “Of the components of GDP, residential investment offers by far the best early warning sign of an oncoming recession… Residential investment consistently and substantially contributes to weakness before the recessions… and the recovery for residences begins earlier and is complete earlier...”
Of the 11 recessions since World War II, nine have been preceded by “substantial problems in housing and consumer durables,” wrote Leamer.
The housing bubble and bust was a once-in-a-century phenomenon: Housing starts peaked near 2.3 million in January 2006, then plunged, bottoming out under 500,000 in January 2009. They’ve slowly worked their way back up to January’s 1.3 million, but Leamer says that still may not be the peak.
“Based on historical standards, we’re still at levels that are sustainable,” he told me. “I could see 1.2 million being a ‘new normal’ based on the aging of the U.S. population.” Slower population growth, he pointed out, creates less demand for new housing units.
“If you look back to 1994 or so, you’ll see a period of time where it was pretty flat around 1.4 million units, up and down a little bit, but it was sustained for a long period of time at that level,” he continued. “If it got over 1.4 [million annually] you’ve got to start worrying about it” because it would be a sign of too much froth.
And on the downside? “When we say downturn, we imagine it going from 1.2 million down to 800,000 [starts a year,]” he said. “For recession, you typically are getting a dip of at least 400,000-500,000 homes. So it’s got to be big enough so it matters for GDP.”
Recession or no, homeowners and prospective buyers have entered a much tougher environment. “There’s no question in my mind that the housing sector’s going to be difficult over the next couple of years,” said Leamer. “The price appreciation is going to be a thing of the past. The higher interest rates are going to be a problem, and the change in the tax codes that affects several states is yet another source of problems.”
So, no housing-induced recession is on the horizon, but for those smart or lucky enough to have bought property after the housing bust, the easy money already has been made.
Howard R. Gold is a MarketWatch columnist and founder and editor of GoldenEgg Investing, which offers exclusive market commentary and simple, low-cost, low-risk retirement investing plans. Follow him on Twitter @howardrgold