Can We Call a Bottom in Housing?

Why is housing so central to the U.S. economy, as opposed to other industries? Why does it hold the key to the economy booming or busting? Because it is exquisitely sensitive to interest rates -- or at least it was, before the avalanche of houses in foreclosure simply swamped the housing market. The key reason that the Fed tries to lower interest rates when the economy weakens is to jump start residential investment.

This time around, even record-low mortgage interest rates don’t seem to be moving the needle. The simple fact is that during the housing bubble we built far too many homes, and we now have a glut of empty homes around the country. Most estimates put the excess vacancies at between 1.0 to 1.3 million (including rental units).

The graph below (from http://www.calculatedriskblog.com/) shows the homeowner vacancy rate over time through the third quarter. While it is off its peak, it is still far above normal. In such a situation, it seems economic folly to simply build more houses and add to the glut. But if we don’t build houses, the economy remains stuck in a rut.

From a strict “allocation of resources” point of view, we would want to see slow housing starts until the vacancy rate fell back to more normal levels (say, under 4.0%). Unfortunately, the graph only goes through the end of 2010. However, based on other data it looks like the vacancy rate has continued to fall so far this year, particularly in the apartment sector. Thus the rise in multi-family starts is less of a problem.

One can argue that in the long term, low housing starts are a good thing, as it means fewer new homes adding to the glut. That however, is extremely cold comfort to the millions of construction workers without a job. It is also going to be very difficult to create a sustained growing economy if home building continues to be a drag.

For the month, regionally the results were mixed in magnitude, but all were up. The Northeast was by far the strongest on a month to month basis, with starts up 53.8%, but it is by far the smallest of the four regions when it comes to housing.

Year over year, starts were up 28.2%. The year-over-year growth crown goes to the West, up 66.3%. It was not too shabby on a month-to-month basis either, up 22.6%. The Midwest saw a 18.2% rise on the month and was up 16.7%. The South, by far the largest and thus most important of the regions, lagged far behind, up just 4.1% on the mongh and up 24.3% year over year.

Today's Housing Starts report far exceeded expectations. Yet my enthusiasm is tempered by it being so concentrated in the multi-family sector, but given the inventory and vacancy situation, perhaps that is for the best in the long run.

Yesterday the National Association of Homebuilders index rose to 21, its highest level since the meltdown, so it looks like the homebuilders are getting somewhat more optimistic. However, that is a magic 50 index, so being more optimistic just means they are no longer suicidal, but still very much curled up in the fetal position.

It does take workers to build apartments and condos, so this bounce in starts could help explain the sharp drop in initial unemployment claims we have seen over the last two weeks. It is probably too early to call THE bottom in housing, but it sure looks like we are getting close. If so, that will be a huge boost to the economy, and has to rank as one of the most significant upside risks to the economy in 2012.