Monday, January 03, 2011

Question #2 for 2011: Residential Investment

by Bill McBride on 1/03/2011 12:42:00 PM

This is the last in a series of "Ten Economic Questions for 2011". These posts included some thoughts and few predictions on these questions.

Of course no one has a crystal ball, but my general view is economic and employment growth will improve in 2011 as compared to 2010, but growth will still be sluggish relative to the slack in the system. By "sluggish" I mean I don't expect anything like the 7.2% real GDP growth we saw in 1984 coming out of the early '80s severe recession. This recession was different - caused by the bursting of the housing and credit bubbles - and recoveries from financial crisis tend to be slow.

And there are downside risks from falling house prices, Europe, and state and local government budget cuts. And unfortunately I think the unemployment rate will still be around 9% at the end of 2011.

The good news is residential investment will probably make a positive contribution to GDP growth for the first time since 2005. And residential construction employment will probably increase in 2011.

Residential Investment and Construction Employment
This graph shows the annual change in real residential investment, and the change in residential construction employment since 2004. The economy has lost about 1.3 million residential construction jobs over the last 5 years, and only a small portion of those jobs will return in 2011.

We still need to work down the excess inventory of housing units. It is good news that completions in 2011 will be at or near a record low. And with improved employment growth, we should see a pickup in household formation. The combination of a low number of new units added to the housing stock, and more household formation, should lead to a meaningful decline in the number of excess housing units this year.

That brings up the question: if there are still excess vacant housing units, why will residential investment increase in 2011? There are a few reasons: for multi-family units it takes over a year on a average to complete, and apartment owners are seeing falling vacancy rates - and some have started to plan for 2012 and will be breaking ground in 2011. We can this in reports from architects.

And for single family homes, not all areas are the same (and most housing can't be moved). Also, as the economy improves, I expect some increase in homes built for owners (not built for sale). This will probably mean something like a 15% increase in residential investment in 2011.

As I've noted before, one of the key reasons for the sluggish recovery has been the ongoing problems in housing. Usually residential investment is a major contributor to GDP growth in the early stages of a recovery, but not this time because of the huge overhang of existing vacant homes.

Residential Investment Percent of GDP Click on graph for larger image in graphics gallery.

This graph shows RI and investment in single family structures as a percent of GDP. Usually RI rebounds strongly at the beginning of a recovery, but this time RI has continued to decline.

RI as a percent of GDP is at a post WWII low of 2.22%, and investment in single family structures is near the all-time low.

Even though I expect a pickup this year, I think residential investment as a percent of GDP will still be very low.

Ten Questions:
Question #1 for 2011: House Prices
Question #2 for 2011: Residential Investment
Question #3 for 2011: Delinquencies and Distressed house sales
Question #4 for 2011: U.S. Economic Growth
Question #5 for 2011: Employment
Question #6 for 2011: Unemployment Rate
Question #7 for 2011: State and Local Governments
Question #8 for 2011: Europe and the Euro
Question #9 for 2011: Inflation
Question #10 for 2011: Monetary Policy