Halfway through 2015 and what have we got to show for it? To be honest, I expected more by this time, but the slow start should not be interpreted as a turn, but rather a pause. There are many positive signs suggesting a better second half and beyond
Start with the economy. The first quarter turned negative, but the second quarter likely will reverse that and the second half is staged for even better growth. The first quarter of the year was pounded by a number of one-time events: Snowfall was unusually large in parts of the upper Midwest and Northeast; the work stoppage on the West Coast kept goods from moving in and out of the U.S.; and Europe, China, and many developing countries have been hit with slowing economies, thereby reducing their demand for U.S. exports. Weaker international markets also pushed the dollar up and reduced the competitiveness of U.S. goods, further weakening exports. Many of these headwinds were temporary or at least are starting to reverse. And, to be a total economist, there is something called ‘residual seasonality' in major economic data that could be reducing the estimates of first-quarter activity lower than actual fact. Together, these factors point to greater growth in future quarters.
A tepid economy also means slow job recovery and even slower wage growth. This is important to housing since a steady and at least modest-paying job is an essential ingredient to home buying. Wage growth has been particularly slow in this recovery partly because the new jobs being created are in less lucrative occupations. That has two impacts. First, fewer people have sufficient income to manage saving for a down payment and paying for a mortgage and maintenance. Second, less attractive job alternatives have pushed many into not working at all. The labor participation rate has dropped about 3 percentage points during the recovery as more workers become discouraged and stop job searching. In addition to the loss of job skills, these jobless individuals represent a shadow supply of labor that keeps wages from rising as long as there are others who can be induced to join the workforce for little additional cost. The drift downward has stabilized and real wages are showing some signs of increasing as more consistent job creation brings discouraged workers back.
The need for additional homes comes primarily from newly formed households. Existing households can move from one place to another, but that does not increase the total number of homes needed (with some exception to that rule if the change involves a move from a high- to low-vacancy market). But young people moving from their parents' homes into their own space does increase the total number of homes needed, and if they are first-time buyers, it increases the number of single-family homes needed (which is what most first-timers buy). The good news here is that for the first time in nine years, household formations have exceeded 1 million. Rising household formations mean rising housing production, especially since vacancy rates also are back down to more normal levels. As this revival in living independently evolves, many of these young adults will turn back to homeownership and increase the demand for more single-family homes.
Basic housing market conditions remain fertile for growth. Mortgage rates are low by historic standards and while they're expected to rise as the economy grows, rates will remain affordable. Access to credit has constrained home buying, but some changes have been initiated that should attract more buyers to the closing table—especially first-time buyers.
Home prices have and will continue to increase as building costs increase, but affordability indexes, such as the NAHB/Wells Fargo Housing Market index, remain well in the affordable range. The inventories of new homes are growing as builders' access to construction credit improves and more market certainty develops. Many current and potential households have been holding off on their purchase, waiting for the headwinds described above to dissipate. As improvements continue, they will return.