(Originally published November 15, 2012)
The missing piece of the puzzle, the one thing that has made this recovery so much weaker than previous ones, may finally be falling into place: The housing market appears to be in a sustained recovery from what can only be called a depression.
So far, new home sales in 2012 are up sharply on average from 2011, while existing home sales are up, too, according to the National Association of Home Builders. Inventory has dropped substantially. And median sale prices of new and existing homes have risen by around 5% so far this year, their biggest price increases in years.
More than 100 economists polled by Pulsenomics for the real estate Web site Zillow expect the good times to roll. They foresee home price increases of around 2.3% this year, but also think residential real estate will continue recovering for the next four years.
By 2016, the economists project, the S&P/Case-Shiller U.S. National Home Prices index will have advanced by a cumulative 15.2%—a 3% annual gain during that time. Hey, if it happens, I’ll take it!
Zillow’s chief economist, Stan Humphries, said economists are more bullish on housing than at any time since mid-2010, when the government was desperately handing out tax credits to anyone who could be roped into buying a home.
Now, interest rates are still low, but the sharp drop in home prices has made homes affordable again for a large number of buyers. “Housing prices are at 2004 levels and interest rates are the lowest we’ve seen in 20 to 30 years,” Humphries told me.
Meanwhile, the U.S. home ownership rate has fallen to just above 65%, its lowest since 1997, and about four percentage points below its bubble peak of 69.2%.
And growing demand for rental housing is driving rents higher.
Plus, there could be 1 to 2 million new households that would have formed but didn’t because of the recession and housing bust. These include roommates tripling up and adult kids living in mom and dad’s basement. As the economy and housing market improve, they will start looking for a home of their own.
“We’re seeing a huge run-up now in demand for units. There is a large pent-up demand for household formation,” said Amy Crews Cutts, chief economist for credit bureau Equifax. “You add up all these things, there’s a strong demand for housing.” She doesn’t expect any new waves of foreclosures, either.
“What we’re seeing right now is driven by fundamentals,” said Humphries.
The Fed Does Its Bit to Help Housing
The Federal Reserve is doing its bit, too, said Cutts. Under the Fed’s QE3 policy, the central bank is buying $40 billion in mortgage-backed securities a month—about as much as Freddie Mac produces. “They’re buying one-third of the market every month,” she said.
“The Fed said we’re not going to get out of this until housing is fixed…There’s a long list of people who benefit when somebody buys a house,” Cutts added.
And those people—contractors, laborers, decorators, appliance salespeople—have been missing in action in the housing depression. The ripple effect has been profound.
Residential fixed investment usually accounts for around 5% of GDP each year. By the bubble year of 2005, it hit 6.1%, before plunging to 2.5% in 2011. That’s a huge gap: This time we did without the usual comeback in housing, which traditionally leads recoveries. Or as someone once said, the housing cycle is the business cycle.
According to economist David Malpass, “housing has often contributed a half to a full percentage point to GDP growth after deep slumps.” And for each percentage point increase in GDP, roughly a million jobs are created. You do the math.
A 2010 study of OECD countries from 1970 to the mid-1990s showed housing slumps last on average around 4.5 years and prices fall by 20%. Booms last five years and prices rise 40% on average.
This time, said Humphries, the housing market peaked in April 2007 and troughed late last year—a 4 1/2-year-long slump. Prices fell around 40% when adjusted for inflation. So, this decline was longer and much deeper than average.
Does that mean the recovery will be stronger and last longer? Who knows? But investors already are anticipating a good rebound.
As of early this week, the Dow Jones U.S. Home Construction index has soared 80% this year, vastly outperforming the Standard & Poor’s 500 index. Homebuilders like DR Horton (DHI) are reporting big increases in revenue and profits.
And on Tuesday, Home Depot’s (HD) earnings beat Wall Street expectations, and the company raised guidance for the rest of 2012. The stock, which did nothing for years, has been up over 50% this year, and trades at its highest price in a decade.
As a contrarian, that gives me pause. These stocks have clearly gotten ahead of themselves, discounting a couple of years of housing recovery. They’re ripe for a pullback, and all the anxieties about Europe, the “fiscal cliff,” and higher taxes gave investors a good excuse for some year-end profit-taking.
And indeed, we may see continued turbulence in the weeks—even months—ahead. But if the economists are right and this housing recovery is for real, that will be a buying opportunity not only for housing stocks, but for the market as a whole.