In my view, one of the most obvious secular growth stories is the rebound in single family home construction. Although single family housing starts increased off of exceptionally depressed levels in 2011, they have stopped growing over the past year and remain less than half of past cyclical peaks.
This has resulted in a lot of bearish commentary predicting a ‘new normal’ for housing where starts will never again rise to its historical average. I believe the stagnation in home construction over the past year can be attributed to rapidly rising interest rates and home prices.
Interest rates surged last summer causing the 30 year fixed rate to rise from 3.35% to 4.5% in just 2 months. This resulted in anyone taking out a $300,000 mortgage having to pay roughly an additional $200 a month.
Economists at Goldman Sachs have found that “the effect of monetary policy shocks on [building] permits persists for 3-4 quarters.” Now that interest rates have stabilized and the market has had over a year to digest 4%+ rates, its negative effect should wane.
In addition, home prices were increasing at an unsustainable double digit rate last year which was certain to inevitably cool off demand. This year, however, home price gains are moderating and should continue to slow down leading to more demand.
The National Association of Realtors’ Housing Affordability Index, despite sharply dropping last year, is still at a historically high level. There is room for home prices and interest rates to rise some more without jeopardizing affordability.
While many housing bears cite tight mortgage lending standards as a reason home sales will struggle to rise, going forward credit can only loosen. In fact, there is evidence that banks are easing credit standards. According to the July 2014 Fed survey on bank lending practices: “a moderate net fraction of domestic banks reported having eased their standards on prime residential mortgages, on net.”
The US population has been growing by 3 million people a year. This population growth would require 1.2 million additional housing units per year. Given that 250,000 homes are demolished each year, roughly 1.5 million homes need to be constructed annually. Instead housing starts have averaged approximately 850,000 per year as household formation rates have collapsed.
As the economy normalizes, there is huge pent up demand for new housing. I expect single family housing starts to return to its historical average of 1.2 million by the end of this decade.