US Housing Starts Plunge in February; Challenges on the Horizon

US housing starts dropped more than expected in February. The metric was led by a plunge in the construction of multi-family housing units and increased consternation driven by recent Dow Jones Industrial Average (DJIA) volatility and a broadly slowing housing market.

Housing Starts, Permits & Completions

After a 9.7 jump in January, housing starts tumbled 7 percent to a seasonally adjusted annual rate (SAAR) of 1,236,000 units in February. Single-family starts accounted for 902,000 units, which is 2.9 percent above the revised January figure of 877,000. Starts for the volatile multi-family housing segment dropped 26.1 percent to a rate of 334,000, the lowest level since September 2017.

Privately-owned housing authorizations decreased 5.7 percent to a rate of 1,298,000 units in February. Single-family authorizations dropped to 872,000, which is 0.6 percent below the revised January figure.

Privately-owned housing completions increased to a SAAR of 1,319,000 million in January, up 7.8 percent from January’s revised estimate of 1,224,000, and 13.6 percent above February 2017. Regional performance in January was mixed, as confirmed by the US Census Bureau report. Seasonally-adjusted total housing starts by region included:

• Northeast: -3.5 percent (+45.5 percent last month)
• South: -7.3 percent (+9.3 percent last month)
• Midwest: +7.6 percent (-10.2 percent last month)
• West: -12.9 percent (+10.7 percent last month)

Seasonally-adjusted single-family housing starts by region included:

• Northeast: +6.7 percent (+34.7 percent last month)
• South: +4.1 percent (+4.5 percent last month)
• Midwest: -14.9 percent (-4.0 percent last month)
• West: +8.8 percent (-0.4 percent last month)

Mortgage Rates & Shrinking Inventories

The 30-year fixed mortgage rate increased from 4.03 to 4.33 percent in February, its highest level since January 2013. The National Association of Home Builders (NAHB)/Wells Fargo builder sentiment index dropped 2 points to 70 in March. “Builders’ optimism continues to be fueled by growing consumer demand for housing and confidence in the market,” said NAHB Chairman Randy Noel. “However, builders are reporting challenges in finding buildable lots, which could limit their ability to meet this demand.”

There is growing optimism that tightening job market conditions will translate into faster wage growth in the second half of this year. Annual wage growth has been stuck below 3.0 percent even as the unemployment rate has dropped to a 17-year low of 4.1 percent. Despite the improved unemployment numbers, homebuyers are also facing growing price and availability pressures. Sales of both new and previously-owned homes have slumped in recent months as the shortage of available inventory has caused prices to climb much faster than wages, creating an additional challenge for many first-time home buyers.

Due to these low inventories and a solid job market, builders have begun to shift their efforts to single-family houses. The millennial population is beginning to tiptoe into homeownership and the number of homes listed for sale has at the same time tapered off. Recent increased construction activity has not done much to offset the shortage, and steadily-increasing mortgage rates are not helping matters for this cohort.

"Soaring employment and faster wage growth should support the housing market, but activity is going to be constrained by higher rates," said Ian Shepherdson, chief economist at Pantheon Macroeconomics.

Existing Home Values Soar in 2017

A surge in home values in 2017 gave homeowners a net worth bump in the form of home equity, and the growth also helped more than half a million homeowners get “above water” on their mortgages—many of which have been hurting since the housing collapse of 2007. While not all real estate markets perform equally, homeowners in the Western US experienced the greatest annual equity gains since 2013.

Homeowners with a mortgage (roughly 63 percent of all properties) experienced a home equity increase of 12 percent over the course of 2017, according to data from CoreLogic. That’s an average of $15,000 per homeowner and a collective gain of $908.4 billion. As noted above, real estate markets do not necessarily perform at the same rate; for instance, homeowners in California and Washington gained an average of $44,000 and $40,000 in value, respectively, in 2017. However, in Louisiana, homeowners saw zero growth and in Oklahoma, homeowners eked out $2,000 in additional equity.

“Home-price growth has been the primary driver of home-equity wealth creation,” said Dr. Frank Nothaft, chief economist for CoreLogic. “The CoreLogic Home Price Index grew 6.2 percent during 2017, the largest calendar-year increase since 2013. Likewise, the average growth in home equity was more than $15,000 during 2017, the most in four years. Because wealth gains spur additional consumer purchases, the rise in home-equity wealth during 2017 should add more than $50 billion to U.S. consumption spending over the next two to three years.”

Caution Ahead

Although the housing market has unquestionably improved since it bottomed in the wake of the Great Recession, Clarity Financial’s Lance Roberts recently asked a valid question: “Is that all the recovery there is?” After other housing downturns prior to the Great Recession, total housing starts returned to the current long-term average of 1.435 million units within three years (range = 3 to 35 months) of bottoming. However, nearly nine years after housing bottomed in April 2009, starts have yet to reach that milestone. Roberts argues that if a “real” housing recovery were underway, vacant units held off market as a proportion of the total housing stock would be falling sharply (2000-2006 average = 4.6 percent) rather than hovering only 0.5 percentage point below 2Q2014’s peak of 5.8 percent.

Despite the tremendous gains in home prices and homeowner net worth last year, perspective is important. Home prices and consumer debt are (once again) at record highs, and the Fed has been steadily raising interest rates over the last year. The Fed is also expected to take additional action in 2018; the recent tax cuts are likely to cause inflationary issues, which will require the Fed to adjust interest rates as a responsive measure. This will likely negatively impact the housing market, potentially driving more homeowners underwater and making it even more difficult for them to pay their mortgages and other debts.

While the economy has seen some wage growth, average American households have nearly 7 percent less spending power than they did a decade ago—before the Great Recession. The combination of these elements—increasing interest rates and home prices, and decreasing inventory and individual buying power—is creating an unsustainable environment. Households can either shoulder more debt to temporarily maintain living standards, or they can significantly reduce their spending. Either way, something has to give.