As we begin the second quarter of 2018, the U.S. housing market is on track to have its best annual performance since 2006, which was just before the market crash that precipitated the 2008-2009 recession. Analysts surveyed by FactSet are predicting that 2018 starts will jump by 6.6% to 1.29 million. However, this strong performance will be followed by an easing of growth the following year according to FactSet Economic Estimates. If starts grow by just 2.3% in 2019 as predicted, this will mark the second time in this expansion that the growth rate falls below the 4.4% average growth seen in the decade leading up to the housing crisis.
What are the market factors that will drive housing over the next two years?
Housing Demand is Strong
In 2017, housing starts rose 2.6% to 1.21 million units. This was the highest level of starts in 11 years, but it was the slowest annual growth rate since 2001. While there is a lot of seasonality and regional disparity in the data, housing starts continue to trend upward. March starts were up 9.2% on a year-over-year basis (not seasonally adjusted basis), and for the first quarter saw a 7.7% increase. Meanwhile, although sales of new homes were unchanged in February from a year ago, they saw a Q4 year-over-year increase of 16%.
The underlying factors support continued strong housing construction. First of all, the current supply of new homes available for sale is low by historical standards. The months' supply indicates how long the current for-sale inventory would last given the current sales rate if no additional new houses were built. The supply of new houses for sale has fluctuated pretty evenly around its average level of 5.3 months over the last five years. This is above the average 4.1 months between 1997 and 2005, which includes the hyperactive period that characterized the housing bubble, but below the historical average of 6.1 months.
Another positive factor for housing demand is the strong rate of household formation. Monthly data on occupied housing units shows a significant increase in the last six months of 2017, with a December-over-December jump of 1.7 million units.
Headwinds Are Building
However, it is continually rising costs on the supply side that will create headwinds for the industry. To start with, home builders are facing soaring input costs, both for materials and labor. On top of that, rising interest rates will dampen consumer demand.
One of the key developments boosting the cost of construction is recently imposed tariffs. In April 2017, President Trump levied tariffs ranging from 3% to 24% on imports of Canadian lumber from five specific companies. As a result, lumber futures prices have jumped from $379.80/bft to $535.80/bft, a 41% increase, since the end of April 2017. Then in March 2018, the Trump administration announced tariffs on imported steel and aluminum products. Following this announcement, the head of the Associated General Contractors of America released a statement stating that the new tariffs would “cause significant harm to the nation’s construction industry.”
While the two tariffs will both have the effect of pushing residential construction prices higher overall, there will be different impacts depending on the market. Single family homes rely much more on lumber than steel, while the construction of multi-family housing units relies heavily on steel and aluminum. According to the National Association of Home Builders (NAHB), the overall impact of the lumber tariffs is not just higher prices; the group believes that the reduced investment as a result of the higher input costs will reduce investment in residential construction and cost American jobs. The NAHB estimates that the lumber tariff alone would reduce investment in single-family structures by $1.1 billion and investment in multifamily structures by $147 million in 2018. The industry group has not yet calculated the impact of the steel and aluminum tariffs on the housing market.
Tight labor markets
On the labor side, wages are rising, but the bigger problem is the shortage of qualified applicants to fill the number of job openings. Nearly 2.3 million jobs were lost in the construction industry alone due to the housing market crash that precipitated the 2008-2009 recession. Jobs in residential construction (residential building and residential specialty trade contractors) made up 1.5 million of those lost jobs. At this point in the recovery, 75% of total construction jobs lost have returned, but only 55% of the jobs in residential construction have come back.
Construction jobs are growing twice as fast as total employment, and jobs in residential construction are growing nearly three times faster. In March, residential construction jobs were up 4.3% from a year ago, and monthly year-over-year growth has averaged 5.5% since the beginning of 2013. This compares to March year-over-year growth in construction jobs of 3.3% and average growth of 4.2%, and total year-over-year job growth of 1.6% in March and 1.8% on average.
Even though the construction industry still has a ways to go to recover the jobs lost during the recession, job growth is slowing even as job openings continue to increase. In fact, job openings in construction are close to the highs seen in 2006 and 2007 leading up the bursting of the housing market bubble. This is a sign that many of the construction workers who lost their jobs during the recession have now left the industry, either finding work in other industries or leaving the workforce altogether.
Given the tightening in demand for construction workers, surprisingly we haven’t seen a dramatic surge in wage growth. While wage growth in construction has outpaced overall wage growth over the last four years, the difference hasn’t been remarkable. In March, the year-over-year increase in average hourly earnings in construction was 2.9%, compared with 2.7% for all private employees. That 0.2 percentage point differential is comparable to what we have seen in the annual growth rates since 2014. As pointed out above, the construction industry likely lost many experienced, highly-paid employees during the recession who never returned to construction work and now are being replaced with younger, less experienced, and cheaper workers.
Rising interest rates
Since bottoming out in the summer of 2016, mortgage rates have risen by 100 basis points, with the 30-year average mortgage rate currently hovering around 4.4%. With the Federal Reserve on a tightening path, with three or possibly even four rate hikes expected in 2018, mortgage rates should continue to move higher over the next two years.
The collapse of the housing market and the resulting credit crisis was at the epicenter of events that led to the Great Recession. The deep hit to this sector and its subsequent slow recovery helps to explain the slow overall economic recovery in this expansion. As we near the end of the ninth year of this expansion, we’re finally seeing the robust economic growth that everyone has been waiting for. But with this strong economic performance comes the risk of an overheating economy that will trigger the reactions that will signal the end of this expansion and possibly the end of this housing market rally.
VP, Associate Director, Thought Leadership and Insights
Sara Potter is responsible for developing applications that facilitate the analysis of global markets at a macro level, highlighting FactSet’s vast benchmark and economic content sets. Since joining FactSet in 1999, Ms. Potter has also managed the economic database development team, where she was responsible for the integration of third-party economic content as well as the development of FactSet Economics data. Ms. Potter received a M.A. in International Economics and Finance from Brandeis University and holds a B.A. in Economics and French from Dartmouth College. She is a CFA charterholder.