May 20, 2009 (Housing Market Monitor)
False Starts? Construction Dips Again in April
By Dean Baker
May 20, 2009
Mortgage applications are near their low point for the recession.
The April data on housing starts seems to have surprised many analysts. Based on a modest uptick in the National Association of Homebuilders’ Housing Market Index, they expected the April data to show an increase in housing starts from the March level. Instead, both starts and permits plummeted to record lows.
This is not the first time that analysts have looked to find evidence of an uptick in the housing market in construction. When the February data showed a modest bounce back from January levels (levels that in actuality were depressed by the weather), many analysts took this as evidence that the housing market had bottomed out and was turning upward. The plunge in starts in the March data made this view appear less plausible.
Whatever the monthly movements in starts and permits, the expectation that an upturn in housing would first be visible in construction is fundamentally misguided. There is an enormous inventory of unsold new and existing homes. In the case of new homes, the inventory is reported at 10.7 months worth of sales, compared to a normal level of less than 6 months.
However, even this figure almost certainly understates the size of the inventory. Once a new home is placed under contract, it is counted as sold. If the contract subsequently falls through, then the home is never added back into the inventory. With builders in some areas reporting cancellation rates in the 30-40 percent range, there are undoubtedly many new homes that do not appear in the inventories.
There is also some evidence that builders are pulling homes off the market. There have been several months in which the number of homes completed was larger than the number of completed homes sold; yet the inventory of unsold homes did not increase. This pattern would be consistent with builders pulling completed homes off the market.
It is implausible that there will be an upturn in residential construction as long as there is such a large backlog of unsold homes. A recovery will require a substantial reduction in inventories before there can be a sustained increase in new construction. Until there is evidence of an uptick in sales and a decrease in inventories, there will not be a substantial increase in housing starts and it is foolish to expect one.
The April data showed a 12.8 percent fall in starts and a 3.3 percent fall in permits. In both cases the drop was due to a falloff in construction and permits in multi-family units. There was a modest increase in both starts and permits for single family homes, although it did not come close to offsetting the 42.2 percent drop in multi-family starts. Construction of single-family units may have hit bottom at a very low level, but it is not going to be bounding upward. Continued high vacancy rates in rental units may lead to further cutbacks in the construction of multi-family units.
The most recent mortgage applications data certainly provide no evidence of any turnaround. The Purchase Applications Index fell by 4.4 percent last week, pushing it near its lowest point for the recession.
Given the macro-economic situation, it is not surprising that house sales would be very weak, even with the record low mortgage rates and the inducement of a first-time buyers’ tax credit. Tens of millions of current homeowners are underwater in their mortgages or have very little equity in their homes. After selling costs, these people will have almost nothing to put up as a down payment for a new home.
The vast majority of homebuyers are families who already own a home, especially younger households who might look to buy a larger house or who may be moving to follow a job. These younger households were especially likely to see their equity wiped out by the plunge in house prices over the last three years, since most would have had little opportunity to accumulate much equity prior to the crash. Until the labor market substantially improves, these families will have great difficulty buying homes.
Dean Baker is Co-Director of the Center for Economic and Policy Research, in Washington, D.C. CEPR's Housing Market Monitor is published weekly and provides an incisive breakdown of the latest indicators and developments in the housing sector.