26 March 2009

Is US Housing on the Mend?

The following was written by Peter G. Hall, Vice-President and Chief Economist, Export Development Canada.

Three cheers! US housing starts rose 22% in February, the first monthly increase since June, 2008. In a market hungry for good news, this was well-received, fuelling hopes that the industry where the global recession began is finally bottoming out. Is this leading sector on the mend?

Without question, the last 30 months have been quite a ride for US housing. Starts of new dwelling units tumbled in mid-2006, falling from 2 million units to the 1.5 million-unit level in just 5 months. At this point, it seemed that the market might stabilize. However, following a 9 month hiatus, activity dropped again, hitting the 1 million level. Following a small jump last June, markets went into freefall, bottoming out in January at a paltry 480,000 units. It is from this base that February starts surged, hitting a higher-than-expected 580,000 units. Hardly cause for a party.

You can’t blame the builders. They are simply following sales activity, which is similarly pathetic. Sales of new and existing homes have declined consistently for over three years, hitting a new low in January that is 44% below the mid-2005 peak. Prices also tell the tale. The median price of a new home fell to $200,000 in January, fully erasing the gains realized in the bubble years. Existing home prices have fallen further, notching just $170,000 in January.

Compounding the current weakness is the level of inventories. New construction may be low, but the number of units up for sale – many of them foreclosures – remains high. There is currently just under 10 months’ supply of new and existing homes on the market, well over double the “stable market” level. Put another way, there are now roughly 5.7 million excess units on the marketplace. That is down from the 7.9 million-unit peak last April, but at the current rate of work-down, the market will be well into 2010 before conditions are more balanced.

How did the excess get so high in the first place? Simply put, building levels were far higher than basic demographic requirements. The level of household formation in the US suggests that a sustainable pace of construction would be somewhere between 1.5-1.6 million units per year. The marketplace was generally in balance until 2002, when easy credit terms and a strong economy boosted sales, igniting prices and setting off a building frenzy. From 2003 through mid-2006, housing starts averaged a stunning 2 million units annually.

The good news in today’s numbers is that the huge excess is being worked off. Building activity is now well below fundamental requirements, and although levels are appallingly low, it stands that the lower the level of activity, the quicker markets will rebalance. Deep price discounting, evident in all sub-markets, should spark an even speedier return to balanced conditions. Also, recent substantial interest rate cuts and other stimulus measures will soon filter through to homebuyers. A key obstacle is the job market. Recent monthly job losses in the 600,000+ range weigh against restored balance in housing markets, and we can only hope that layoffs will abate soon.

The bottom line? It is still far too early to celebrate a turnaround in the US housing market. But we can take solace in the fact that the market has responded quickly, and is clearing. The sooner, the better, given housing’s role as a key bellwether of US, and by extension global, recovery.