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Economic Notes: Housing on the Mend

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Q. Is the housing market finally recovering and, if so, what does that mean for the general economy?

As discussed below, the housing sector is in the early stages of what appears to be a sustainable recovery.

Sales of existing homes are rising, but prices remain weak. The demand for apartments is strong, even though rents are rising. Homebuilding is up modestly, largely on solid growth in multifamily (predominantly rental) construction. If these trends persist, housing's recovery will foster faster growth in the broader economy.


Existing home sales peaked in the third quarter of 2005. Resales then went on a rollercoaster ride, plunging 54.5% during the meltdown; then surging 40.6% on homebuyer tax credits; and, when the incentives expired, dropping 12.7%. Since mid-2011, however, the three-month sales average, which smoothes monthly fluctuations, has risen consistently. And data on pending sales (i.e., pending contracts), suggests that trend will continue.

This sustained rise in transactions reflects the combination of record-low mortgage rates and sharply reduced prices, which continue to drift downward.

Although interest rates may rise somewhat over the next year, the increases are not expected to be significant and, therefore, should not impair affordability.

Prices, on the other hand, will remain soft-indeed, may decline in the near term-as the unclogging of the foreclosure pipeline adds to distressed sales (which already comprise more than one-third of all transactions).

Nationally, more than 3.3 million mortgages are seriously delinquent (i.e., 90 days in arrears or in foreclosure). Even though the number of mortgages in arrears has declined since 2009, the processing of foreclosures has been obstructed by legal and administrative issues that are nearing resolution.

As revised procedures are adopted and the share of sales consisting of foreclosed properties rises, transaction prices are expected to fall further. But since foreclosure inventory (and its price implications) is generally discoverable, prices already anticipate a surge in listings. Accordingly, the depth and duration of the actual decline may be substantially less than many commentators anticipate.

The National Association of Realtors estimates that there were about 2.4 million existing homes available for sale in February. This was down considerably from the record peak of 4.0 million in mid-2007. When adjusted for respective foreclosure inventories, however, the potential number of units available for sale is only slightly (about 7.0%) below the record high.

New Homes

New home sales, like resales, tumbled from a peak in the third quarter of 2005 and experienced a brief post-plummet blip from the temporary homebuyer tax credits.

At the outset of the housing meltdown, more than six months passed between when sales nose-dived and builders slammed the brakes on starts. As a consequence, inventories mushroomed. After three years of realigning construction and sales, builders' inventories are at a record low.

But because sales have been bottom-bouncing (2011 saw the fewest sales of any year on records from 1963), the single-family inventory/sales ratio (ISR), while down sharply, remains well above the average in the ten years prior to the downturn.

In the 34 years of recordkeeping through 1996, the single-family ISR averaged 0.521. As can be seen from the chart, it rarely dipped below 0.4 during that period.

But from the beginning of 1997 through the mid-2005 start of the single-family sales slump-a period of almost nine years-the single-family ISR never exceeded 0.4. Sales activity was fairly steady during most of that period, but even when sales soared toward the end of the bubble, the ISR remained relatively constant.

It looked as if homebuilders had achieved their equivalent of just-in-time inventory management. If so, is an ISR below 0.4 the homebuilders current target?

The single-family ISR has been below the pre-1997 rate (0.521) since October-and is trending downward. If the boom-year ISR is the homebuilders' target, they are likely to control tightly their demand for labor and other in-puts-which, in turn, will constrain the broader economy. If, however, the industry accepts a higher ratio-perhaps, because it is inflated by dead weight inventory-homebuilding's increased demand for goods, services-and workers-will stimulate growth elsewhere.

Single-family units are the predominant form of residential construction, historically accounting for slightly more than 70% of all new starts. Nevertheless, the share held by multifamily construction has expanded as the nascent housing recovery has gained momentum. Although it may be too early to declare this a trend, investor interest and leading indicators such as the Architecture Billings Index suggest that it has legs.

Implications of Housing's Recovery for the General Economy

That housing has been AWOL from the current recovery is indisputable. Its absence has been characterized by Federal Reserve Chair Ben Bernanke as "a key impediment to a faster recovery."

Homeowner equity is about one half of what it was prior to the housing meltdown; and at the lowest proportion of total value since recordkeeping began. That loss of value has eroded household confidence and constrained consumer credit, resulting in diminished consumer spending.

A sustained increase in housing prices would reverse these impacts, and bolster consumer spending. In the 10 years prior to homebuilding's recent contraction, residential construction contributed an average of 7.5% of the inflation-adjusted net gains in total output. Since the recession ended mid-2009, it has added nothing. And until there is a significant increase in homebuilding, growth in the broader economy will remain sub-par.

With the economy expected to continue expanding and interest rates to remain subdued, housing sales-both existing and new homes-should gradually accelerate, even as prices rise later this year. Under those circumstances, homebuilding-particularly multifamily construction-should add to its recent gains.

If so, by year's end the housing sector could well become a contributor-rather than a bystander-to the expansion of the American economy.

Patrick J. O'Keefe is director of economic research at J.H. Cohn.

Let Us Know What You Want to Know If you have a question about economic trends or data, email and we will try to feature a response in a future edition of Economic Notes.

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The statements, opinions, and conclusions contained herein are based solely upon the author's own studies, research, and personal experience. Neither J.H. Cohn LLP nor the author makes any representation or warranty as to the accuracy or completeness of this information. J.H. Cohn LLP and the author expressly disclaim any liability for any loss or damage which may be incurred, of any kind whatsoever, as a result of or arising from the use of any of the information contained herein or reliance on the accuracy or completeness of it.

Published date: 3/30/2012

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