The Case For A Dull Housing Market

Sales data for new and existing houses delivered better-than-expected news this week, prompting some analysts to predict that the residential real estate market is again poised to come roaring back in the summer and beyond. But a closer look at the numbers suggests that the housing recovery is still sluggish at best. One good month for sales is encouraging, but it doesn’t change what still looks like a slow grind for the broad trend in this corner of the economy.

Consider how the numbers compare for the year-over-year comparison for new and existing home sales with new residential construction starts. The last year or so reveals a conspicuous deceleration in the trend. That’s normal in the sense that the sharp recovery in 2012 and 2013 following the sharp housing correction was always destined to moderate as the rebound matures.

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There’s been some improvement in April and May. New homes sales and housing starts are higher as of last month vs. year-earlier levels, although existing sales are still declining on an annual basis. The optimistic view is that the harsh winter created severe but temporary headwinds for housing but now there’s a spring recovery unfolding and the market is righting itself, as the figures for May suggest. That’s a plausible if still-tenuous narrative for several reasons.

First, the monthly data is riddled with noise. Until and if we see sustained improvement in the annual comparisons, the case for arguing that housing is set to resume its previous degree of expansion remains a work in progress.

Keep in mind too that interest rates may continue to inch higher in the months ahead and so an additional headwind for housing may be approaching. Note that the recent rise in rates (albeit a modest rise so far) has suspiciously coincided with turbulence in sales and new construction. The national average for the 30-year mortgage was priced at 3.5% in April 2013. It’s been well above 4% this year, although it’s come down a bit lately, settling at 4.3% as of last month. Is it coincidence that the housing market turned sluggish soon after mortgage rates jumped higher last year?

Don’t misunderstand: higher rates that reflect a strengthening economy is a good thing. But it’s still a tricky path for housing. Meantime, let’s not forget that if housing’s having some trouble with forward momentum with rates still close to historic lows, what will the future look like if the price of money continues to normalize? I agree with Professor Robert Shiller, who says that rising rates aren’t a death sentence for housing. But the rising cost of financing home purchases will still contribute to slower growth in the market compared with 2012-2013.

Let’s also recognize that when it comes to economic growth, new construction offers the bigger bang for the buck with regards to raising GDP vs. sales. The sight of a revival in transaction is positive, of course, but housing starts are far more valuable as an input for economic activity and business cycle analysis vs. shifting ownership of homes from one family to another.

The summer reports on housing activity may sort out the debate about the housing market. For the moment, however, I’m still of the view that we’ve seen the best of the recovery for residential real estate in terms of its contribution to economic growth. I don’t see a new downturn in housing per se, but the data suggests that we’re entering a period when growth will be relatively modest and driven less by animal spirits vs. relatively mundane metrics like the growth rates of population, household formations, and wages. By those standards, the case is weak for seeing a new bull market that roars back to life. Instead, think water utility rather than venture capital for evaluating the outlook for housing.

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