Housing is the engine of the current US economy. A conservative reading of the last 4 years of job gains indicates it is responsible for roughly 40% of job creation. Last year, housing was responsible for 44% of the increase in individual net worth. Mortgages outstanding have increased as well, replacing income gains as the primary driver of consumer spending. As a result, any slowdown in housing could have serious ramifications for the economy as a whole. Recent statistics indicate housing is slowing. While there are not signs of a “bursting”, a slowdown of this asset’s appreciation could lead to trouble in 2006.
The internal numbers of last month’s existing home sales report indicates a possible slowdown. The West (+.8%), Midwest (-3%) and Northeast(-4.1%) regions showed slight gains or losses in number of units sold. The only region to show a gain was the South (+3.7%). This gain is largely due to Katrina’s effect. However, inventory of homes available for sale remained at 4.7 months. This number has increased for 6 of the last 7 months. In addition, available inventory increased 19.6% from last year’s level. This increase in inventory is likely responsible for the drop in both median ($220,000 – $212,000) and average sales price ($269,000 – $260,000). This increase in inventory is also probably responsible for the high level of rental vacancies.
Monday, the Census Department issued its report on housing vacancies. While the actual homeownership news was very good – a record number of Americans own their home – there was a very bad side as well. The home rental vacancy rates are near 10-year highs.
The report stated that 9.9% of all houses available for rent were vacant. This number has slowly crept up for the last 5 years. The number is coming down from 10.1% earlier this year. However, the number is still very high in comparison to the last 10-years.
If people can’t sell a second property, they will be more inclined to rent in order to make-up some of the costs. However, this increase in rental vacancies indicates rentals are harder for owners to secure. In addition, a high vacancy rate depresses rental rates, making it more difficult for owners to recoup expenses.
The high level of inventory available for sale combined with the high level of rental vacancies may indicate a housing inventory glut may exist. If this is true, price will continue to drop as sellers become more interested in closing a deal than getting top dollar.
The Census Department’s housing starts showed a similar regional skew to the existing home numbers. The West (0% gain), Midwest (+1.9%) and Northeast (0%)all showed slight gains or stagnation. The South increased 6.8%, again, largely because of Katrina.
The recent declines in consumer confidence add to real estate’s problems. People are less inclined to make a major purchase. As the Conference Board reported a few weeks ago:
The Conference Board Consumer Confidence Index, which had plummeted in September, declined again in October. The Index now stands at 85.0 (1985=100), down from 87.5 in September. The Present Situation Index declined to 108.2 from 110.4. The Expectations Index decreased to 69.5 from 72.3 last month.
Many pundits blamed the drop on Katrina and high gas prices. While the effects of these two events may be waning, we are entering the winter season. Energy prices are projected to increase 50-90% due to the spike in natural gas prices. This will continue to negatively impact consumer confidence for the next few months.
Consumers already have a large amount of debt, making additional financing less probable. In 2001, consumers borrowed a total of 464.5 billion in mortgages. By the second quarter of 2004, that number was 892 billion – an increase of 80%. Total outstanding household debt has increased from 7.6 trillion in 2001 to 10 trillion in 2004 – a 63% increase and over 90% of total US GDP. At some point, the consumer will be tapped out in terms of borrowing, unable to add more debt until he pays down existing obligations.
Finally, we have the Fed’s policy of interest rate increases. Yesterday, they raised the discount rate to 4%. There is strong speculation they will continue their 25 basis point increases through the end of Greenspan’s tenure. In addition, the 10-year Treasury has broken though the technically important 4.5% trading level, closing yesterday at 4.57%. As interest rates increase, home mortgages become more expensive making borrowing more unattractive.
In summation,
1.) Sales of existing and new homes are slowing
2.) Inventories available for sale are increasing,
3.) Rental vacancies are high,
4.) The median and average home prices dropped last month,
5.) Consumer’s confidence is lower and their debt level is high, and
6.) The Federal Reserve is raising interest rates.
It appears all the pieces are now in place for a continued slowdown in housing.