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How is GDP affected by the housing market? Residential investment is the dollar value of construction during the year. It is part of investment in the GDP accounts (along with business investment, commercial construction, and inventory changes). Residential construction totaled $446 billion in 2001. That was about 4% of the $10.2 trillion nominal GDP. Investment in commercial structures totaled $331 billion in 2001, or 3.2% of GDP. Strong sales of existing homes mean income for the real estate industry and creates demand for home furnishings and renovations — both of which add to GDP. Housing starts gave a reasonable measure of the GDP impact in the 1990s, but in recent years residential investment has grown faster than the number of housing starts, in part due to a shift to more expensive homes. How strong is housing? Housing starts and building permits are normally sensitive to the business cycle and are a useful leading indicator. Housing starts, which include multi-family units, didn't soften in the 2001 recession. They totaled 1.6 million units in 2001, up 2% from 2000. Possible factors: the rate of employment stayed relatively high through the recession; low mortgage rates have kept houses relatively affordable, encouraging construction; and given the heavy tax burden, the value of the home-mortgage deduction is a stronger-than-ever. Yet, housing starts weren't particularly strong going into the recession. The result has been a housing picture quite different from the previous recessions in which housing starts generally dropped sharply as the recession hit. How many homes
are now selling annually? How are prices holding up? Like starts and sales, housing prices have been strong. Average prices for existing homes rose by 7.7% in 2001 to reach $192,200, a record high. Average prices for new homes rose by 9.6% to reach $228,000, also a record. This included an especially sharp rise in new-home prices in December 2001. Both new and existing home prices dipped in September and October, but finished the year strongly. What's the difference
between median and average prices? What happens to house prices during a recession and a deflation? In previous U.S. recessions, house prices often dropped during the recession, especially in inflation-adjusted terms. For example, in the 1990-91 recession, the average price for existing homes fell from $119,500 to $111,800, a 6.5% decline in nominal terms and a 9.4% decline in real terms after adjusting for the relatively high inflation rate. Compartively, in Japan's deflationary slowdown in the early 1990s, real-estate prices continued rising for nearly two years after the equity market peaked. This may have reflected an asset shift from stocks to real estate, false confidence in real estate's momentum, and the less liquid nature of the real-estate market compared to the equity market. So, by their nature, housing prices are stickier than stock-market prices. An investor or portfolio manager can sell part of her portfolio if she has concerns that the market is falling. But a homeowner cannot (in the main) sell part of a house. From 1989 until 1994, house prices rose about half the rate of the S&P 500; 4% per year for housing versus 9% for the S&P. But with the explosive rise of the S&P from 1995 to 1999 (stocks rose by 26% per year), median house prices grew only 5%. Still, for the 70% of Americans who own their own homes, housing continues to be a valued asset. So, what's the outlook? There's no reason to expect a sharp decline in U.S. house prices, but there is a difference in the pricing environment in this recession (deflation-related) versus previous ones (which were inflation-related). So there will be some downward pressure on prices due to the impact of falling prices in other parts of the economy, lower prices for construction materials and labor, and a lagged effect from the very strong dollar (which, in theory, will cause a downward adjustment in almost all prices over time). However, strong fundamental factors — including tax incentives, the relative value of houses versus other purchases, readily available financing, demographics, and the economic recovery — should help support home prices. Here's the bottom line: There will be some weakness in house prices in 2002, moderating the growth in residential investment. But there will not be enough impact on unemployment, housing-related consumption, or long-term perceptions of wealth to be a major impediment to the strength of the recovery.
— Mr.
Malpass is the Chief International Economist for Bear Stearns. |
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ousing
and residential investment are important variables in the strength of
a recovery. So the question is, how important is the housing sector going
to be to this recovery? To work out an answer, lets look at a few key
questions economists are asking today. 
