by Calculated Risk on 4/19/2011 06:30:00 PM
Tuesday, April 19, 2011
A few thoughts looking out a few years ...
• Residential investment (RI) is the best leading indicator for the economy. This isn't perfect - nothing is - but RI is usually a strong leading indicator for the business cycle. The slump in RI helped me call the 2007 recession correctly, and the lack of a recovery in residential investment is a key reason the recovery has been sluggish and choppy so far. Note: Residential investment, according to the Bureau of Economic Analysis (BEA), includes new single family structures, multifamily structures, home improvement, broker's commissions, and a few minor categories.
• In 2011, residential investment will make a positive contribution to the economy for the first time since 2005. The five years of drag on GDP from RI (2006 through 2010) is the longest period on record, breaking the previous record of four years from 1930 to 1933 (yeah, the Great Depression). The positive contribution this year will mostly be due to a pickup in multifamily construction (apartments) and in home improvement. However single family housing starts will continue to struggle.
• This positive contribution from residential investment suggests the economy will continue to grow all year and also in 2012 (point 1: RI is best leading indicator). There are plenty of downside risks, but I expect the expansion to continue.
• A record low number of housing units will be added to the housing stock this year. With more jobs, and more household formation in 2011, the number of excess housing units will be reduced substantially this year – perhaps by 600,000 to 700,000 units (or more).
Recently economist Tom Lawler took a long look at the 2010 Census data, and estimated there were about 2 to 3 million excess vacant housing units as of April 1, 2010. With the record low number of housing units delivered last year, Lawler estimated that as of April 1, 2011 the excess “would be somewhere in the range of 1.45 to 2.45 million units – with the latter almost certainly too high”. With another record low number of units added to the housing stock this year, the excess will be in the 750 thousand to 1.7 million range next April (with the latter “certainly too high"). This suggests the excess supply will be gone sometime between early 2014 and 2016.
As the excess supply is absorbed, new residential investment will increase in some areas – and will probably return to normal sometime in 2014 - or as late as 2017 - depending on the actual number of excess vacant housing units. I'm leaning more towards 2015 or 2016.
• “Normal” for housing starts will be the rate of household formation (probably averaging around 1.1 million per year in 2015), plus the net number of 2nd homes purchased, plus the number of demolitions. I think the 2nd home markets will be slow to recover, so "normal" will probably be around 1.3 million housing starts in 2015 or 2016 or 2017 (after the excess supply is absorbed) – up sharply from the current rate of around 550 thousand. For new home sales, normal will probably be in the 800 thousand to 850 thousand range – far above the recent 250 thousand to 300 thousand range, but also far below the 1.2 to 1.3 million range in 2004 and 2005.
• Unfortunately it is hard to pin down the timing better right now because the number of excess vacant housing units is uncertain. My guess is housing starts will return to "normal" in 2015 or 2016.