Housing Is Already in a Slump. So It (Probably) Can’t Cause a Recession.
The United States has had 11 recessions since the end of World War II. All but two were preceded by a big decline in the housing market.
Inside that bit of trivia lie some fundamental insights into housing’s outsize role in the business cycle, along with clues to suggest that the economy is on firmer footing than the increasingly pessimistic forecasts make it seem. The gist is this: The United States may or may not enter a recession this year, but if it does, housing is unlikely to be the cause, because it never really recovered in the first place.
“Housing is not in a position to lead this thing down,” said Edward Leamer, an economics professor at the University of California, Los Angeles.
How much it can help prolong the overall recovery is another matter. Home sales and prices have been sluggish in the face of rising interest rates. Still, the pace of construction, combined with pent-up demand from young adults, suggests that the sector should at least remain stable in the face of uncertainty elsewhere.
Why is housing so often a focus of anxiety as economic expansions run their course? Here are a few reasons.
Housing is more volatile than bigger sectors
Even though housing does not account for all that much of the economy, its role in recessions is huge, because it is highly cyclical and sensitive to interest rates. Think of expansions and recessions as the cycle of things that go up and down a lot. Housing is a big determinant of where that cycle is headed because, unlike many other sectors, it has wide swings.
The housing sector accounts for as little as 3 percent of economic output during recessions and about twice that during booms. Other pieces of the economy are much bigger, but they don’t change nearly as much from boom to bust. Government spending, for instance, has hovered between 17 percent and 20 percent of the economy for decades. The three-percentage-point swing is about the same in each case, but government accounts for much more of the economy. Translation: Housing punches way above its weight.
As a result, while housing has never accounted for more than 7 percent of total output, it has on average accounted for about a quarter of the weakness in recessions since World War II, according to a 2007 paper by Mr. Leamer titled “Housing IS the Business Cycle.”
After housing, the sector that has historically been second most important to recessions is consumer durables, or expensive purchases like cars, furniture and appliances. Those are often connected to the housing market’s prosperity because people usually buy other things when they purchase a home.
Sometimes downturns have other causes, but they only underscore housing’s role in economic cycles. The 1953 recession followed a decline in government spending after the Korean War, and the 2001 recession was driven by a decline in business spending after the dot-com bubble popped. Both were relatively brief and shallow — the 2001 recession was the least severe since World War II — in part because housing investment remained stable.
The most recent recession, from 2007 to 2009, offered one of the more exaggerated examples of housing’s guiding role in downturns. A recent report from the Federal Reserve Bank of St. Louis found that the construction sector accounted for a little over a third of the decline in output in the past recession, and about half of the job losses (a figure that includes laid-off construction workers and job losses in connected industries).
How does housing look now? Mixed, but mixed in such a way that the things most important to economic growth are the most stable.
Prices have been discouraging buyers
Measured in sales and prices, the housing sector appears to be in a precarious position. Existing-home sales were down about 10 percent in December from a year earlier, according to the National Association of Realtors. The group blamed rising prices and interest rates, and a lack of supply that has left buyers underwhelmed by their choices.
Much of the problem is that while job growth has been strong, home prices have gone up faster than incomes.
Prices have gone up so far so fast that even markets previously considered affordable are beyond the reach of many buyers. Home prices have risen by about 50 percent since 2012, according to Zillow, and many of the more affordable markets have shot up even faster. In Phoenix, home values have doubled since 2012, not adjusted for inflation. The Denver market is up 90 percent, Atlanta 84 percent, Nashville 78 percent and Dallas 76 percent. If people can’t afford a home in Texas, where can they?
The sticker shock of rising prices, combined with rising interest rates that make monthly payments more expensive, scared off many buyers toward the end of last year. Some of that demand seemed to come back at the start of the year, after interest rates fell to roughly where they were a year ago.
Nevertheless, homes are sitting on the market longer, price cuts are becoming more common, and a number of homebuilders have had layoffs. Before a recent speech to 1,000 people from the housing industry, John Burns, founder of John Burns Real Estate Consulting, asked the members of the audience to forecast the year ahead. They were evenly split between those seeing sales and price declines and those seeing growth.
“Everybody is being really cautious right now,” Mr. Burns said in an interview.
This all sounds very bad, but for anyone who isn’t trying to sell a home or in the business of selling homes, it’s not as bad as it seems.
Builders are less bullish than in the past
When economists talk about a recession in housing, they largely refer to construction, not home prices. Most of the industry’s contribution to annual gross domestic product lies in residential fixed investment, a category composed almost entirely of the building of single-family homes and apartment and condominium buildings (along with a small amount of home improvements and renovations).
Rising home prices help the economy in small but important ways, like making people feel richer and building up home equity that owners can tap and spend elsewhere. But increased spending from people feeling richer is not nearly as important as the pace of home sales and the volume of construction, since both of those create many jobs — for people like real estate agents and mortgage brokers on the sales side, and the architects, construction workers, electricians, plumbers and others who design and build new homes.
Home buying is weak and getting weaker, so that could be a concern. But construction is bordering on moribund. Total housing starts grew at an annual rate of 1.2 million a year in January, more than double the recession-era low of less than 500,000, but still well below an average of 1.5 million from 1990 to the start of the housing bust — despite an expanding population.
Clearly the need for housing is there, so why aren’t builders building more? That is a confounding question.
During conference calls to announce their earnings, publicly traded builders like D.R. Horton and PulteGroup have said much the same thing as real estate agents, which is that buyers are put off by higher prices and creeping interest rates. Many builders also cite local regulations that make it harder to build homes in denser areas closer to jobs, and higher labor costs in a tight job market.
The overall message is that builders cannot build homes at the prices people want in the places people want them, so they aren’t building much at all.
The largest demand for housing is at the lower end of the market, the hardest to serve profitably, although in conference calls a number of builders said they were shifting some of their building and land buying toward cheaper, smaller homes. This may or may not improve the pace of building.
The result is that the housing sector — the residential construction components of G.D.P., taken together — accounted for only 3.9 percent of the economy in the third quarter, and has helped drag down overall economic output for three quarters.
In other words: Housing is in recession already. It might not get better soon, but it probably won’t get worse.