By Robin Anderson, Ph.D., Senior Economist, Principal Global Investors
Housing is a key leading indicator for the US economy. In fact, according to Edward Leamer's 2007 National Bureau of Economic Research Paper Housing is the Business Cycle, weak housing and consumer durables sectors have preceded eight recessions since World War II. Recently, housing data have turned down. Should we be concerned about recession, or worse, a collapse in the housing market like the period that preceded the financial crisis?
Residential investment detracted from GDP growth in the first three quarters of this year. Existing-home sales have declined for the last six months. New-home sales are down 13.2% over the last year. Building permits, which lead housing starts, have been declining since the start of the year.
Higher mortgage rates likely explain some of the weakness. According to Bankrate.com, the 30-year mortgage rate is up 90 basis points since the start of the year. Higher mortgage rates are eroding housing affordability. The National Association of Realtors housing affordability composite index has declined sharply.
However, there are still some tailwinds to housing. Homebuilder confidence remains buoyant, albeit down from its cycle high. Home prices have started to modestly decelerate, potentially boosting affordability. Inventories, which had been a constraint on sales, are picking up. New-home inventories are at the highest level since 2011, and existing-home inventories, while still very low, have moved up over the last year. Stronger wage growth could also bolster demand.
The strongest support to the housing market is probably demographics. Household formation is trending up. The homeownership rate is finally picking up too. In fact, after bottoming in 2016, 2017 was the first year since 2004 that the homeownership rate increased. And it was up for the under-35 age group.
Millennials, who according to Bloomberg are the largest home-buying generation since the baby boomers, are finally moving out of their parents' basements. That pent-up demand could support the housing market even as mortgage rates rise. Indeed, according to Smead Capital at Seeking Alpha, demographics supported the housing market during the 1970s and 1980s, a period when mortgage rates were at record highs.
Comparing this soft patch to the housing crisis is way overblown. Residential spending makes up about 3.9% of GDP versus 6.7% in 2005. So, even if housing continues to slow, its impact on overall growth will be much smaller. In fact, even as housing detracted from growth in the third quarter, GDP was still up 3.5%. There also isn't a lot of imbalance in the housing market. Housing starts are far below their mid-2005 peak. The housing vacancy rate is low as well.
Housing has stumbled into a soft patch. If mortgage rates continue to rise, that could be further near-term drag on housing. But there are plenty of supports to the housing market as well, demographics being the biggest.