Although the housing market is continuing to improve more slowly than hoped for, it is on the mend and getting stronger. In another two years, it should be back to normal, which means about 1.5 million housing starts per year.
The key statistic to watch is new single family home sales. Sales drive housing starts which lead to increased demand for wood products. Although the most recent total housing starts numbers were disappointing, the drop of 10% was due almost entirely to the 26% drop in the multifamily sector. Multifamily starts are historically volatile – due in large part to financing – and it goes in spurts. Single family starts, however, were down less than 1%.
Housing, the economy, and wood products are “joined at the hip.” Housing’s contribution to the gross domestic product (GDP) has historically been almost 20% of the economy when you include housing services and fixed investment, but today it is down to 15%. In reality, housing is even more important when you include purchased furniture, landscaping, general maintenance, etc. The slow housing growth is a major reason why the economic recovery has remained muted. Housing is important to wood products and other product categories too. See Chart 1.
The employment situation continues to be the biggest problem facing the housing market. There are about 23 million people who are unemployed, underemployed or have stopped looking for jobs – and they are not buying houses. Unemployment remains high and will remain relatively high for several years. It’s getting better, but slowly. Overall employment remains weak by past standards. Many jobs don’t include health care or retirement benefits because they are often part time jobs and those kinds of jobs don’t encourage people to buy houses. We need 100,000 – 150,000 net new jobs per month just to keep up with new people entering the workforce. We need 300,000 new jobs per month to bring unemployment down.
Additional headwinds facing the housing market include an economic recovery that is much slower than previous ones and mortgage rates that are trending upward as the Federal Reserve pulls back on quantitative easing and money printing. The slower recovery is the result of this recession being a financial recession, unlike previous ones which were typical economic recessions where the economy overheats and the Federal Reserve increases interest rates to cool things down. Financial recessions are more serious and take more time to heal damaged credit.
A positive trend is improving consumer confidence, which is at a five year high. Consumer spending is 70% of the U.S. economy, so improving consumer sentiment is a must for any sustained recovery. See Chart 2.
It is interesting that consumer confidence has improved even though wages are continuing a downward trend.
Another positive trend is the recent increases in house prices – up 12% year over year. This is due in large part to weak supply, but it is still good news because it will drive supply by encouraging builders to build more homes. In addition, higher prices will help slow foreclosures and enable people with negative equity to sell homes and move to better jobs and apply for refinancing. This will help turn the housing market around along with improving the economy.
But is this sustainable? Currently, the market is facing low inventories and weak new home starts. In addition, 25% of homeowners are still “underwater” and 18% have little equity in their homes. This means over 40% of homeowners are trapped in their houses. However, it is sustainable as long as the economy continues to move forward.
New household formations are a key driver for the housing recovery, and there is good news on this front. Not only is there a growing pent up demand, but formations are also improving, exceeding housing starts. Historically, household formations account for 65% of housing demand. Since 2007, the number of new households formed has been one-third the historical rate. Between 1995 and 2007, there were 1.5 million households formed per year. From 2008 to 2010, there were only 500,000 formed annually, leaving a significant shortfall. Any further improvement depends on creating a stronger economy. When the economy picks up, household formations will go back to normal. Again the key is the economy and jobs.
Looking forward, here are some key questions to consider: 1.) What will the mix be between detached single family and multifamily housing? and 2.) What are the implications for the wood products industry?
Home ownership rates have been falling for the past seven years. Traditionally, first-time buyers account for about 40% of resale market, and they made up about 50% of the market in 2009 when recession-era policies favored new home owners. But today, they account for only about 30% or less of the market. Lending standards have become stricter, which can impact first-time home buyers who usually have less cash to pay for a deposit. First-time home buyers are starting to get crowded out of the market thanks to increasing mortgage rates, higher prices and investors who can afford to pay cash for properties. Many first-time home buyers are also saddled with huge college debt too. And to date, the “housing recovery” has been mainly multifamily units. There may be a return to single family housing once the economy gets back to normal, or we could see more multifamily demand continue to be strong.
Wood product pricing should be solid for the next two years or so due to improving domestic housing market and exports, the demand for wood products outstripping supply as previous production cutbacks catch up with demand, and structural products benefiting from residential construction including new construction and remodeling. Structural products include: framing lumber, OSB, and plywood, as well as hardwood based products such as furniture, kitchen cabinets and flooring.
We are in uncharted waters right now with issues such as massive, unprecedented money printing by the U.S. Treasury Department. This move has helped prevent worsening of the short-term bad economy. But it certainly has not had the impact the Fed had hoped for in terms of jump starting the U.S. economy. Problems going forward are higher interest rates and continuing uncertainty. These are key factors holding back job creating investments by companies and investors. Housing will continue to improve, albeit more slowly than hoped for compared to previous cycles.
The bottom line is that housing is on the mend and getting stronger. Most analysts predict that housing should be back to normal by 2015. The housing market faces some strong headwinds, but we’re making good progress.
