A Strong Start for Housing

2019 was a solid year for U.S. housing.  While still subject to modest revisions, government figures show that new residential sales increased 10.4% from an estimated 617,000 units in 2018 to 681,000 units in 2019.  Single-family housing starts advanced 1.4% to an estimated 888,200 units in 2019 from 875,700 units in 2018.

The notable difference in percentage increases between sales and starts is due almost entirely to changes in Federal Reserve interest rate policy.   In 2018, new residential sales were essentially flat, rising only 0.7% from 2017 levels.  Solid mid-single digit increases in sales recorded during the first half of the year gave way to low double-digit declines in the second half, as rising mortgage rates pushed buyers to the sidelines.  Buyers came back into the market in 2019, as the Fed reversed course and cut interest rates.  Easy year-over-year comparisons in the second half of 2019 helped new residential sales post a low double-digit gain for the year.  New residential sales in the second half of 2018 were up nearly 19% over 2018.

The percentage change in single-family housing starts reflected the response of builders to their expectations of future sales in light of the changes in Federal Reserve interest rate policy.  With the sharp drop in demand in the 2018 second half, builders were left with elevated levels of inventory going into 2019.  Consequently, they pared back houses under construction for most of 2019 and began to build back under construction inventories at the end of the year, in response to sustained strength in sales. As a result, single-family housing starts for all of 2019 were up only slightly from 2018.

Outlook for Housing Sales and Production.  Having recovered in 2019 from the slump in sales and production at the end of 2018, housing sales and production should be driven primarily by trends in the economy, interest rates and house prices.  The modest backlog of buyers that moved to the sidelines as mortgage rates rose was presumably worked off in 2019 as mortgage rates declined.  The housing market should therefore echo the expected 2% growth in the economy, with perhaps a modest boost from the recent decline in mortgage rates, which are now lower than they were a year ago.  Lower mortgage rates can help more buyers qualify for mortgage financing; but some of the benefit of lower rates may be offset by rising house prices.

Within the broader housing market, newly built homes have the potential to gain share from existing homes as homebuilders focus increasingly on entry level housing, for which there is limited supply in the existing home market.

The average rate on a 30-year mortgage, according to Freddie Mac, peaked at just under 5.00% in November 2018 and began to fall sharply after Fed Chairman Powell signaled a willingness to respond to emerging signs of weakening in the economy by reversing course on Fed Funds interest rate increases.  Mortgage rates fell sharply for most on 2019, but then began to stabilize on rumors of an impending truce in the trade war between the U.S. in China.  In recent weeks, mortgage rates have slipped again, most likely in response to fears of economic repercussions from the potential spread of the corona virus.

Other factors that are supportive of continued strength in housing include job growth and consumer confidence.

According to the Bureau of Labor Statistics, the U.S. economy added about two million jobs in 2019, 2.3 million according to its survey of non-farm establishments and 2.0 million according to household estimates from the Current Population Survey.  The estimate for total non-farm payroll jobs added for 2019 is modestly below the nine-year average of about 2.3 million, but that is still quite strong given the long duration of this economic expansion.  The consensus estimate from the Philadelphia Fed’s Survey of Professional Forecasters anticipates that the U.S. economy will add 2.0 million payroll jobs in 2020 and 1.5 million in 2021.

Along with the continued strength in job creation, average hourly earnings grew at an accelerated pace of 3.5% in 2019, up from 3.0% in 2018.  The rise in average hourly earnings has contributed to improved growth in household income, which rose 3.3% in nominal terms in 2018, according to the Census Bureau.  (Figures for 2019 are not yet available).  While impressive, the pace of household income growth, quite strong in 2016, has decelerated in recent years, due in part to a higher rate of new household formations.

The consumer has been the lynchpin in the economic recovery, maintaining spending even as industrial production activity has slowed.  Continued growth in payrolls, the recent lift in wage growth and continued low interest rates have kept consumers buoyant.  Consumer confidence, a second key pillar of support for housing demand, has hovered near record levels over the past two years.

There are clearly risks to the downside for housing– including factors which might weaken economic growth, such as trade wars, real wars (in the Middle East and elsewhere), corona virus and political turmoil and even those that would strengthen economic growth, which could lead to increases in interest rates. The consumer is holding up extremely well; but she will not be able to maintain her strength in spending indefinitely if other sectors of the economy, most notably industrial production, continue to deteriorate.

Assuming that the economy achieves forecasted growth near the consensus estimate of around 2% in 2020, I anticipate that total home sales (new and existing) will increase by a similar percentage.  Existing home sales should grow at a slightly slower pace of 1.4%, which is an improvement over recent yearly gains.  New home sales should grow at a slower pace – 6.5%, down from 10.4% in 2019.  Likewise, I project that single-family housing starts will grow at a faster pace – 8.4% vs. only 1.4% in 2019 – as builders time starts to keep pace with new home sales growth after bringing construction levels down in 2019 to better match sales.  Housing prices will continue to slow, I believe, to 4% in 2020, down from about 5% in 2019; but new home sales prices should be flat in 2020, after easing in 2019, largely on the mix shift to lower price points.

Publicly-Traded Builders Positioned to Show Continued Gains in Early 2020.  Although sales comparisons vs. the prior year will be tougher in 2020, several factors suggest that the publicly-traded homebuilders can show meaningful gains in the first half of the year and possibly beyond:  First, after strong fourth quarter sales, up 30% on average (so far, with HOV and TOL yet to report) vs. admittedly easy prior year comparisons, builders began 2020 with average unit backlogs up 14.5% and average backlog dollar value up 12.9%.  Assuming no change in backlog conversion ratios, 2020 first quarter closings should be up by comparable percentages.

That should give the builders a strong start to the year.  As comparisons get tougher during the course of 2020, percentage gains in new orders should moderate.  Overall, I currently project that new home sales will be up 6.5% in 2020.  The large public builders should post better numbers overall, due especially to their focus on entry level housing.  So, assuming no disruptions that would jeopardize the consensus 2% growth forecast for GDP, the average builder could very well report new order growth of 8%-10% in 2020.  That would be down from the 10%+ total order growth reported by builders in 2019, but still quite satisfactory, considering the tepid economic growth outlook.

February 19, 2020

Stephen P. Percoco
Lark Research
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