U.S. Housing: Building Strength

Even with an expected rise in interest rates, the sector should see a faster pace of growth—not enough, however, to give a major boost to the overall economy.

Housing should accelerate in coming months and quarters. Even with the extra growth, the sector will fall far short of past booms and hardly offer the general economy enough of a fillip to change the slow-growth nature of the overall recovery. But otherwise, residential real estate can look for enough additional support, even with an expected rise in interest rates, to make the frustratingly slow slog of the past few years into a slightly less frustrating slog going forward.

A Disappointing Recovery So Far
Up until now, the housing recovery has given ample cause for frustration. The last four to five months are indicative. Starts of new homes came into the year showing no growth. They fell steeply in February, by 16.7%, rose modestly in March, and surged by 22.1% in April, only to fall back to 11.1% in May. The inordinately cold winter weather might explain some of the up-and-down behavior, but this erratic pattern is little different from that of the prior five months, during which two months reported starts falling. Nor is it much different from the entire period going back to the beginning of the recovery in 2009. The net of all this misleading monthly gyration was indeed a slow slog, during which residential construction expanded at barely more than a 5% average annual rate. Sales have presented a similarly frustrating picture. Existing home sales show three down months in the last eight, plus two with barely any change. Though some months looked good enough to cause a stir, they show only a 6.1% net gain over the past 12 months.¹

To be sure, these net growth figures are faster than the overall economy’s real annual growth rate of 2.0–2.5%. On that basis, housing might look robust, but considering the hole created by the Great Recession, the performance hardly constitutes much of a comeback. Housing starts, after all, remain even now more than 50% below the peak of 2007 and 20% below the average level of home construction during the 1970s, 1980s, and the mid- to late 1990s. Sales of new homes trail past benchmarks by even more. As of last April (the most recent month for which data are available), these remain some 63% below their former peak and about 30% below the average of the 1970s, 1980s, and the mid- to late 1990s. On this basis, the recovery so far does look very much like a slow slog.²

Some Pickup to Come
Under almost any circumstances, it will be a long time before the sector comes up to its historical norms. It may in fact never get there, since, even after immigration, low birth rates in the United States have slowed the fundamental rate of new family formation. Such very long-term considerations and perspectives aside, however, at least four considerations should support some housing pickup in the period just ahead.

Increased lending is one of these. Throughout this recovery, banks and other lenders have held back lending for anything to do with residential real estate. They cut it almost 2.5% a year on average between 2010 and 2014—a major impediment to home ownership and to a faster recovery. But now they have begun to change. The year 2014 saw the first uptick in such lending. This year, banks have built on that tentative start. Lending has increased only at a 1.5% annual rate so far—hardly a flood of liquidity—but it is a major change from the last five years and a reason to except more activity in the sector, especially since, to date, a lack of available funds has been the major impediment to new sales.³

Combined with this new willingness to lend, affordability presents a second favorable consideration. The National Association of Realtors compiles an affordability index by comparing the cost of supporting a mortgage on the average home in the country to the average household income. Largely because housing prices have risen slightly faster than incomes, affordability has deteriorated some in the past couple of years, falling about 7.1% last year and about 2.1% so far this year through April (the latest month for which data are available). But because housing prices fell so precipitously during the crisis, even the losses in affordability during recent years still leave housing considerably more affordable than it was during the boom and even in the 1990s, before the great price surges. The picture suggests that housing will remain historically affordable, even as the Federal Reserve begins the modest interest-rate increases it has indicated. Indeed, affordability might even improve in the coming months, as the increased hiring rates that have developed of late add to the pace of income growth. It is noteworthy in this regard that the modest acceleration in hiring late last year and the additional income it created actually improved affordability some 16.3% during the second half of 2014.⁴

The modest improvement in labor markets might help in a third way by spurring an increase in family formation. The long-term demographics limiting the growth of family formation are one thing. More cyclically, the lack of jobs growth had an impact by forcing an increased number of young people to remain in their parental home and forgo establishing an independent residence. Between 2010 and 2014, for example, the Census Bureau reports, the percentage of people between the ages of 18 and 24 who remained in their parents’ home increased from about 58% to 60% for men and 49% to 53% for women. The percentage of people between the ages of 25 and 34 who remained in their parents’ home increased from about 16% to 18% for men and 10% to 12% for women. No data exist on 2015 yet, but it is doubtful that the improved jobs market would raise these figures meaningfully and likely that it will bring some of these young people out to form households of their own. It also is probable that some will buy, because, as a fourth consideration in this equation, rents are rising rapidly. Since 2011, rents nationally have risen almost 20%—faster than incomes and faster than the cost of supporting a mortgage.⁵

None of this suggests a housing boom. It does not even suggest that home buying and construction will re-approach historical levels anytime soon. But it does suggest a pickup in the sector from the off-again/on-again pattern exhibited so far in the recovery and the resulting sluggish pace of advance.