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How Much Can Housing Help the Economy?

Jason Stipp
Robert Johnson, CFA

Jason Stipp: I'm Jason Stipp for Morningstar. One bright spot for the U.S. economy has been the housing market, which has seen an upturn in 2012, but how much can a better housing market really help the economy. Here to offer some insights is Morningstar's Bob Johnson, our director of economic analysis.

Thanks for being here, Bob.

Bob Johnson: Great to be here.

Stipp: Before we talk about some of the broader issues with the housing market and the broader economy, we did get some more pieces of housing data this week. One of them continued a positive trend and that was builder sentiment. It looked pretty good. What's your take on that?

Johnson: The number made a new recovery high at 47%, and again that means 47% [of homebuilders] thought things were getting better. That number had gotten as low as 9% or 10% at one point at the depths of the recession. That number has made a huge recovery even from a year-ago level. So, builders are definitely more confident.

Stipp: We also got housing-starts data this week, and it seemed a little soft. Can you give some context around that number? Is that something to worry about?

Johnson: We had a huge jump in the previous two months in the housing-starts data, and we got up close to 900,000 units. And now actually as some of it got revised back, so it looks like 888,000 was where we were in a peak. And now we drift back a little bit this month as kind of expected. We had a huge stair-step up and now we step back just part of the way. So, most economists had been expecting a pretty big downturn in this month's number and sure enough we got it. Now the single-family [building starts] wasn't quite as sharp as the apartment [building stars]. But again they were down and I'll acknowledge that. But on the other hand, I will say that permits were up and that means good news for the months ahead.

Stipp: So, bottom line, when you're looking at all the recent housing data, would you say that housing is still definitely in a recovery mode?

Johnson: It is still in a recovery mode. I think we made a big stair-step up in a lot of the housing economy, and we’ve maintained most of those levels for many months, including here in the fall season when we usually dip back. I keep on expecting these numbers to kind of fall apart and have to explain to people, "Well, keep in mind, it’s this time of the year and this usually happens and weather has more of an influence." I haven't had to make up any excuses.

Stipp: So, housing definitely is a bright spot for U.S. economy, but let's talk about how bright it is and kind of put it in context. How much of the economy is housing? How much could it help us out here? So housing is looking really good, but if it's a little piece of the economy, it's only going to get you so far. What's the story?

Johnson: Right at the base, housing investment--that is new houses, even including mobile homes, all your remodeling--that type of activity amounted to, at the bottom, about 2.4% of gross domestic product, and at its peak in the 2000s, we were up over 7% of GDP. And the long-term average is just a shade under 5%, and like I said, right now, we're at 2.7%. So, we could certainly see room for doubling.

And by the way, the 7% that I mentioned we saw, yes, was larger than usual in the 2000 gap. But boy, I went back and looked at the data for all of the recoveries since World War II, and we’ve almost always gotten to 6%. And then like I say, the long-term average is something a little bit under 5%, so we’ve still got a long ways to go there.

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Stipp: There are some other things about thinking about the impact of the housing market on the economy that are important to keep in mind. There are some sorts of knock-on effects or some other factors you should remember about housing.

Johnson: There are a couple of things. First of all, let me hit on a fact that direct housing, which everybody kind of remembers this as a small number. Yes, it is. It's only 2.5% of the economy. Remember, it's a number that can swing; it can double. I mean, we will probably be double off the bottom. In 2013 we'll go from 500,000 housing starts at the very bottom to over 1 million starts next year. So, yes, it's 2.5% of GDP, but when you start doubling a number even as a small percentage, it's a big adder to GDP despite what some people are claiming.

The other way it sneaks in is kind of the back door. There is a measure in GDP that actually asks, "What's the value of living in your own home?" It's called owner-equivalent rent. And the more units of housing you have, the bigger your owner-equivalent rent. Well, for a while we weren't adding many houses to that base. Now, I'm talking about adding 1 million new houses in 2013 on a base of 110 million. So it's going to move that portion of consumption, which by the way that owner-equivalent rent and rents amount to about 12% of GDP. So that's a bigger number, but it typically runs 14%. So we've got room to improve on that front, as well.

Stipp: Also if you are buying a new house or you are moving, there are other expenditures that you make as part of that?

Johnson: That's right and people kind of pick up a little less on those. It's already started to help the furniture account a little bit. We've talked about the retail sales report for a couple months now that it's actually been acting a little better, but that's one that will definitely move with housing starts and existing-home sales. So, I am optimistic on that. It moves things like paint, it moves painters, people that do remodeling, all times people move or buy a house, they want to come in and fix it up or they need new landscaping in front, those are all things that happen that we talked about eroded so badly in the recession and I think those are going to come back, and they've come back a little bit more slowly. Starts is the first thing to come back and now I think as we see some of the things moving and existing and so forth, you are going to begin to see some of these auxiliary categories move up.

Stipp: So there are at least a few different ways that housing can help the economy, but there are a couple of other things that I've noticed that would suggest that we're not getting the full benefits of housing yet. And I think the most apparent one is the employment market. We haven't seen the housing market help the construction market yet. So, is that going to hold us back at getting the full effect of what we would normally see from a housing recovery?

Johnson: That is a great question. It's been one of the mysteries, and I think I've got at least part of the answer [this week]. I think that one of the things that's happened is housing starts, you look at the numbers, we're up 30% year over year even with [this week's] data, 30%. The residential construction workers category in the labor market is almost flat year over year; almost no growth. How do you reconcile those two? Well I'm beginning to hear some stories that what's happening is a lot of people as they build houses, it's now taking instead of three, four, five months, [it's now] six, seven, eight months to build a home because there aren't enough workers.

Many people who have left the industry have said, "I don't need this frustration of an industry that goes up and down like this. I'm out of here. I'm doing something else." So, that's kind of happening. Now the length of time that a home remains in the building process is stretched out. That's why it hasn't absorbed quite as many workers as I would hope, and then also maybe a few of them gone into temporary work categories, as well. But I think we're beginning to see some of the construction-in-progress numbers and the completions numbers all pick up a little bit, and I think employment will follow suit.

Stipp: So it will become a bit like a pressure cooker. As there's more demand, eventually people will be attracted to come back to that market who maybe left after all the volatility that we had there.

What about prices, Bob? [Is the fact that prices are] going up a good thing for the housing market or a bad thing for the housing market?

Johnson: Well, it's mixed. It certainly makes homes just a little bit less affordable, and that's not probably a wonderful thing. On the other hand all these people couldn't refinance. We've got these great low mortgage rates, but because their house couldn't appraise at a high enough level, they couldn't go to the bank and refinance. So as home prices come up, we've seen a mini boom in mortgage applications here for refis because people can now suddenly refinance. So, that's certainly one of the big positives that we've seen from higher prices, and it certainly makes a sales transaction easier to happen.

Stipp: Might it be that if we see a little bit of price inflation in housing and prices going up that some people would be spurred to go ahead and make a purchase decision before they go any higher?

Johnson: Sure. I think we actually heard some talk even within our office--we have a number of young people here at Morningstar--and I think a lot of them are kind of saying "I've been kind of sitting around waiting." And now we're seeing prices move, and they are saying, "Maybe I should really get off the fence here." And we're seeing quite a few of those in our own office, and you can see it in the data, too.

Stipp: What about lending and the credit worthiness of folks who do want to buy? Is that a headwind? Is it still hard to get a loan for a house?

Johnson: It's still very hard to get a loan for house. I mean, the paperwork that you have to go through is a nightmare. The number of pay stubs, income tax forms, and asset verifications you have to provide are probably higher than they've ever been. And they look back over people's track records, and generally--again, I'm no banker--but they tend to look back five to seven years, And that kind of encompasses the period of the Great Recession when a lot of people were unemployed, to no fault of their own, and that hurt some people's credit ratings. So, that makes it a little bit harder for people to get loans, as well.

On the plus side, the price issue that you mentioned makes appraisers a little bit more willing to be flexible, and I think that's been a huge help already. But we still got those very tight lending standards. So, we are not going in a boom.

Stipp: One of the keys, I think, to the housing market as well is that new household formation. So folks who want to head out on their own or who had been living with family members during the lean times are ready to move out now. Are we seeing some trends where new household formation is picking up, and that folks who were maybe living in a big house together are now going out and looking for their own residence?

Johnson: Absolutely. That is what is happening right now, and I'm even seeing the trend in our neighborhood, where the people have maybe even moved home with their parents until they got established are now moving out. They didn't make a permanent condition. We're not seeing this go like "OK, the average guy stays home a year or two years or three years and [that number] keeps going up, up, up."

I think that we've reached a point now where people are moving out, and I think it's not a comfortable situation to put that many people in one household. And you're beginning to see that flow, and again, house formation was cut in half during the recession because so many people moved back home. And now that's going to begin to reverse itself and provide a real tailwind for the real estate and rental market.

Stipp: So, it sounds like we have some headwinds and some tailwinds in the housing market. When you look at this and kind of wrap it up, does it look like we might have a longer housing recovery that's more moderate, sort of like you're seeing in the economy at large? Or are we going to hit something here where housing really hits its stride and moves up much faster than what we've been seeing already? And it's been pretty quick already, even given some of those headwinds.

Johnson: Yes, we've had some headwinds, and like I say, starts has been the one [statistic] that's really been pretty dramatic. The existing-home sales have been a little bit slower yet with some lack of inventory, and people don't want to sell at one price and people don't want to buy at that price. So, we've had some issues with that, and we haven't got much inventory on the market for that reason. So, that's certainly been something that's held us back.

But you put it altogether, I think the housing market is in really good shape. I mean we had I call it seven years of famine from kind of 2005 to 2012; that kind of followed probably seven years of boom from 1999 to 2005. So, I think they've kind of equaled each other out right now, and I think we're probably due for some decent times. But for the reasons we talked about, I don't think it's going to be a straight-up boom, but it's going to be something that maybe is lasting, sustainable, and affordable.

Stipp: All right, Bob. Housing is a very important part of the recovery here in the U.S. Thanks for offering your insights on the housing market today.

Johnson: Thank you.

Stipp: For Morningstar. I'm Jason Stipp. Thanks for watching.