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Wednesday, November 18, 2009

Housing Leads the Economy, Existing Home Sales are Irrelevant

by Calculated Risk on 11/18/2009 03:30:00 PM

After reading some of the commentary regarding the housing starts report this morning, it might be useful to reiterate these three points:

  • Residential investment is the best leading indicator for the economy.

  • Residential investment will not recover rapidly because of the large overhang of existing vacant housing units.

  • Existing home sales are largely irrelevant for the economy.

    Residential investment is reported quarterly by the Bureau of Economic Analysis (BEA) as part of the GDP report. We can also use monthly housing starts and new home sales as indicators of residential investment. I've written extensively about how residential investment is an excellent leading indicator for the economy (also see Dr. Leamer's paper: Housing and the Business Cycle)

    This morning several commentators suggested that housing starts were depressed in October because of the expiration of the tax credit (new home buyers had to close by Nov 30th to get the tax credit), and also because of the weather. Probably. But the key point is that housing starts will not increase rapidly because of the large overhang of existing vacant housing units (see 2nd graph here). And that suggests that the economy will not recover quickly either.

    Another key point is that existing home sales are largely irrelevant for the economy. This is an important point to remember next week when the NAR announces that existing home sales surged to 5.8 million units or so in October (seasonally adjusted annual rate). Some reporters and analysts will jump on the existing home sales report as evidence of a housing recovery. Others will point to it as showing that the first-time home buyer tax credit is helping the economy.

    Both points are wrong.

    The only contribution from existing home sales to the economy are some commissions and fees. That is good news for real estate agents and mortgage brokers, but not for the overall economy.

    The good news is the level of inventory for new and existing homes is declining. The bad news is the inventory of rental units is at record levels - as is the combined inventory of vacant single family homes and rental units. Residential investment will not increase significantly until this overhang is reduced.

    The key to reducing the overall inventory is new household formation (encouraging renters to become owners accomplishes nothing in reducing the overall housing inventory). And the key to new household formation is jobs. And usually the best leading indicator for jobs is residential investment. Somewhat of a circular trap.

    And that suggests the recovery will be sluggish and unemployment will stay high for some time.