There has been much hoped placed on the “housing recovery story” over the last five years as it relates to the economy. With each passing month, all eyes have been glued to television headlines as the latest estimations of housing starts, completions, new and existing home sales, etc. are trumpeted as a sign of a renewed housing cycle. This is no trivial matter as real estate is seen as a bedrock to economic strength as much as it is the sign of achievement of the “American Dream.”
Note: The “American Dream” is not home ownership. Millions of immigrants did not immigrate to the United States, with only the clothes on their back and few personal possessions crammed in a knapsack, just to buy a home. No. The “American Dream” has always been the freedom to achieve success in whatever endeavor they choose which ultimately afforded them the opportunity to own a “home” when they could afford it. For more on this subject read: “The Real American Dream”
It is true that housing has previously been a large contributor to economic growth in the U.S and is perhaps one of the most cyclical sectors of the economy. As such, keeping a close eye on housing provides a valuable insight into future economic trends. However, the question remains how sustainable is the current recovery in housing? More importantly, what really drives long term economic growth is not residential investment as much as “household formation” where a couple buys a home, raises a family and continues the consumption cycle.
The same is true for automobile manufacturing. The building of homes and cars increased economic output and the multiplier effect through the economy was large. However, due to the shift in the makeup of the U.S. economy, housing is no longer the contributor to the economy it once was. The chart below shows the percentage that housing and automobile manufacturing contributes to U.S. gross domestic product.
At barely 3%, the impact of increases in residential construction is very small relative to exports, which comprises roughly 40% of corporate profits. Furthermore, Computer & Software spending has, as a percentage of GDP, has almost doubled since the turn of the century which has increased worker productivity and lowered wage growth.
At The Margin
The problem with all of the analysis each month on the transactional side of housing is that it only represents what is happening at the “margin.” Housing is more than just the relatively few number of individuals, as compared to the total population, that are actively seeking to buy, rent or sell a home each month.
In order to understand what is happening in terms of “housing” we must analyze the “housing market” as a whole rather than what is just happening at the fringes. For this analysis, we can use the data published by the U.S. Census Bureau which can be found here.
Total Housing Units
In an economy that is 70% driven by consumption it is grossly important that the working age population is, well, working. More importantly, as discussed in “The Statistical Recovery Continues.”
“The mistake is assuming that just because initial claims are declining that the economy, and specifically full-time employment, is markedly improving. In any economy, it is ONLY full-time employment that matters as it provides enough income to support household formation, increased consumption and higher levels of personal savings rate which leads to increased productive investment. Unfortunately, as shown below, full-time employment as a percentage of the working-age population remains elusive despite falling jobless claims.”
“Furthermore, the issue of “labor hoarding,” combined with the huge pool of individuals outside of the labor force, is an important phenomenon that obscures the real weakness in the underlying economy. These forces combine to reduce aggregate demand on businesses that in turn resort to productivity increases to stretch the current labor force further to protect profitability.”
To present some context for the following analysis we must first have some basis to work from. Our baseline for this analysis will be the number of total housing units which, as of Q3-2014, was 133,331,000 units. This was up from 132,843,000 in Q3-2013 for a total increase of 488,000 units which is roughly in line with annualized run rate of new one-family home sales during that period which averaged 434,000 units.
The chart below shows the historical progression of the seasonally adjusted number of housing units in the United States.
As an example, the most recent report of “existing home sales” showed that 5,170,000 homes were sold on an annualized basis in September. Since this is an annualized number, we must divide it by 12 months for the estimated seasonally adjusted number of sales for the month which was 430,833 homes. This number of home sales represents just 0.83% of the total number of homes available. This is what I mean by “activity at the margin.” When put into this frame of reference the “existing home sales” report doesn’t seem nearly as exciting.
Out of the total number of housing units some are vacant for a variety of reasons. They are second homes for some people that are occasionally used. They are being held off market for one reason or another (foreclosure, short-sell, etc.), or they are for sale or rent. The chart below shows the total number of homes, as a percentage of the total number of housing units that are currently vacant.
If a real housing recovery were underway, the vacancy rate should be falling sharply rather than rising in the latest quarter and hovering only 0.5% below it’s all-time peak levels.
Owner Occupied Housing
Another sign that a “real” housing recovery was underway would be an increase in actual home ownership. The chart below shows the number of owner occupied houses as a percentage of the total number of housing units available.
Despite the Federal Reserve flooding the system with liquidity, suppressing interest rates and the current Administration’s efforts to bailout banks and homeowners, owner occupied housing is at all-time lows. This certainly is not a sign of increasing economic activity.
The simple reality is that there has been very little actual recovery in housing, or for roughly 90% of the American population, which explains its weak contribution to economic growth. The chart of home ownership shows the overall lack of recovery the best.
At 64.4%, which is down from 65.4% in 2013, the current level of home ownership is the lowest that it has been since the early 1980’s.
“But Lance, the recent reports of sales, starts, permits, and completions have all improved in recent months.”
That is true, and those transactions must be showing up somewhere, right?
REO To Rent
While the Federal Reserve and the current Administration have tried a litany of programs to jump start the housing market nothing has worked as well as the “REO to Rent” program. With Fannie Mae/Freddie Mac, and the banks loaded with delinquent and vacant properties, the idea was to sell huge blocks of properties to institutional investors to be put out as rentals. This has worked very well.
The chart below shows the number of homes that are renter occupied versus the seasonally adjusted home ownership rate.
Do you see the potential problem here? Speculators have flooded the market purchasing properties in cash and then turning them into rentals. As this activity drives the prices of homes higher, reduces inventory and increases rental rates – it prices out “first-time homebuyers” who would become longer term home owners. The problem is that when the herd of speculative buyers turn into mass sellers – there will not be a large enough pool of qualified buyers to absorb the inventory which will lead to a sharp reversion in prices.
Maybe this is why the Federal Reserve, and the FDIC, are looking to relax the regulation put in place after the last housing bubble which required banks to have “skin in the game.” By removing that restriction banks can now go back to providing mortgages to unqualified buyers, pool them and sell them off to unwitting investors. Haven’t we watched this movie before?
While the surge in housing activity, which still remains at historically low levels as shown in the chart below, has certainly been welcome it should not be forgotten that it has taken massive bailouts, stimulus and financial supports to induce such relatively small amounts of activity.
The mistake, however, as I addressed in “Housing Recovery, What Has Been Forgotten”is that:
“There is no argument that housing has improved from the depths of the housing crash in 2010. However, while the housing market remains at very recessionary levels, recent analysis assumes that this has been a natural, and organic, recovery. Nothing could be further from the truth as analysts have somehow forgotten the trillions of dollars, and regulatory support, infused to generate that recovery.
I recently penned an article showing the $30 trillion, and counting, which has been thrown at the economy, and financial system, to keep it afloat over the last 4 years. Of that, trillions of dollars have been directly focused at the housing markets including HAMP, HARP, mortgage write-downs, delayed foreclosures, government backed settlements of ‘fraud-closure’ issues, debt forgiveness and direct buying of mortgage bonds by the Fed to drive refinancing and purchase rates lower. Of course, the Fed has also maintained its ZIRP (zero interest rate policy) during this same period with a pledge to keep it there until at least 2015.
The point here is that while the housing market has recovered – the media should be asking ‘Is that all the recovery there is?’ More importantly, why are economists, and analysts, not asking the question of ‘What happens to the housing market when the various support programs end?’ With 30-year mortgage rates below 4% we should be in the middle of the next housing bubble – not crawling along a bottoming process.”
The housing recovery is ultimately a story of the “real” unemployment situation that still shows that roughly a quarter of the home buying cohort are unemployed and living at home with their parents. The remaining members of the home buying, household formation, contingent are employed but at lower ends of the pay scale and are choosing to rent due to budgetary considerations. This explains why household formation is near its lowest levels on record despite the “housing recovery” fairytale whispered softly in the media.
While the “official” unemployment rate suggests that the U.S. is near full employment, the roughly 94 million individuals sitting outside the labor force would likely disagree. Furthermore, considering that those individuals make up 45% of the 16-54 aged members of the workforce, it is no wonder that they are being pushed to rent due to budgetary considerations and an inability to qualify for a mortgage.
The risk to the housing recovery story remains in the Fed’s ability to continue to keep interest rates suppressed. It is important to remember that individuals “buy payments” rather than houses, so each tick higher in mortgage rates reduces someone’s ability to meet the monthly mortgage payment. With wages remaining suppressed, and a large number of individuals not working or on Federal subsidies, the pool of potential buyers remains contained.
While there are many hopes pinned on the housing recovery as a “driver” of economic growth in 2014 – the lack of recovery in the home ownership data suggests otherwise.