 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.
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?
U.S. home sales totaled 6.2 million units in 2001. That was a 2.6%
increase from 2000. About 85% of the 2001 total sales (5.3 million)
were sales of existing homes. New home sales totaled 907,000 units,
up 3% from 2000. Mortgage applications were strong in early January,
and remained at reasonably strong levels in February, pointing to
continued strength in home sales. New and existing home sales tend
to move in a similar fashion.
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?
Average prices have been rising faster than median prices, indicating
high-end home prices are rising faster than the average. This also
helps explain the strength in residential investment relative to
the number of housing starts (relatively slow growth in housing
starts, but heavily weighted toward expensive homes).
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.
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