The prospect of Federal Reserve (Fed) rate hikes has brought out much concern about the durability of the housing recovery. It is understandable. Any increase in rates threatens to raise the cost of supporting a mortgage, and the housing recovery, though far from following a powerful trend, has added to the admittedly tepid general recovery.
Still, it would be easy to exaggerate the impact of planned Fed actions. To begin with, policy makers intend to raise rates only slowly and cautiously. They will remain sensitive to the economy’s reaction, including housing. For another, housing remains historically affordable so that any rate hikes, especially the modest ones that this Fed contemplates, are not likely to shut down buying as dramatically as some seem to fear. Finally, other factors, most especially the willingness of banks to extend credit for real estate, will likely improve during the time before the Fed makes its rate moves. The housing recovery will, then, likely proceed, albeit slowly as it has to date, even after the Fed begins its promised rate increases.
From the lows of 2009, housing has made an uneven but on balance a substantive recovery. It remains substandard, however, in two crucial respects, relative to past cyclical recoveries and especially compared to the precipitous drop that preceded it. Sales of new houses fell some 81 percent during the great recession, from a high of about 1.4 million units a year in 2005 to about 400,000 in spring 2009, when the general economic recovery began. The recessionary pressure in the sector was so powerful that even as the general recovery proceeded sales of new homes actually fell an additional 32.5 percent to lows of 270,000 in spring 2011. Only then, fully two years into the general economic recovery, did they begin their upturn. This growth proceeded in fits and starts, averaging about 17 percent a year, impressive in a vacuum perhaps but leaving housing nowhere near to recovering the ground it had lost. As of September this year, the most recent period for which data are available, sales of new homes stood at a yearly rate of 467,000, fully 66 percent below their former highs from before the bust of the great recession.
New construction has followed a similar pattern. Housing starts peaked at an annual rate of 2.2 million units in fall 2005 and fell almost 78 percent during the great recession to a low of 478,000, at an annual pace. They began a modest recovery in spring 2009 along with the overall economic recovery. But two years later, in spring 2011, when new home sales at last began to grow again, starts were only some 25 percent above their recession lows, a miniscule recovery given the steepness of the previous slide. The pace of recovery has picked up since, but in October 2014, the most recent period for which data are available, starts averaged barely above 1.0 million a year, still almost 55 percent below their pre-recession highs.
Though hardly impressive in light of the previous downturn, these gains have contributed to the economy’s overall growth path, though most of that help has emerged only recently. Early in the recovery, the housing growth was so slight that, according to the Bureau of Economic analysis at the Commerce Department, residential construction actually detracted from the pace of overall growth in 2010. Housing added a miniscule 0.02 percentage points a year to overall growth in the real gross domestic product (GDP) in 2011 and 2012. In 2013 and 2014 so far, it has added a still small 0.17 percentage points a year to overall growth. It’s contribution to employment gains has been only slightly better. Construction jobs accounted for only some 5.9 percent of total jobs created in the recovery since 2009, though during the past couple of years they has averaged a modestly higher 8.5 percent of the total.
The biggest help for housing so far has come from increased levels of affordability. The precipitous drop in real estate prices during the great recession and the even more precipitous drop in mortgage rates have lessened the burden of the average mortgage on the average family’s income. Here, the figures are striking. Between 2008 and 2011, when new home purchases finally turned up again, the median price of a single-family house in this country had fallen by more than 20 percent, according to the National Association of Realtors (NAR). The rate on the average fixed mortgage had dropped more than 200 basis points or by more than 30 percent, according to the Federal Reserve. The rate on a variable mortgage fell even more dramatically. Though the median family income actually fell during this time, these price and rate declines improved those families’ ability to support a mortgage. Affordability, to use the NAR’s term, improved more than 70 percent.
Two impediments held back the pace of recovery, however. One was the loss of confidence in the household sector. Concerns and insecurities engendered by the pain of the great recession dissuaded many from stretching, as they might have previously, for the house of their dreams. The second impediment to recovery was the decline in confidence among lenders. The huge mistakes of the housing boom and the subsequent losses during the great recession prompted banks and other mortgage lenders to tighten credit standards in general and especially where residential real estate was concerned. Even as the overall recovery progressed, bank lending for real estate fell 5.5 percent in 2010, 3.8 percent in 2011, 1.1 percent in 2012, and 1.0 percent in 2013. It only just began to turn up this year and then at less than a 3.0 percent average annual rate. As affordable as housing had become, borrowers simply could not get the necessary credit. Anecdotal evidence suggests that a great many of the purchases that did occur were made for cash, and by business or well-heeled buyers who planned to rent the properties rather than live in them.
This balance of forces seems poised to change, though it should still support a modest recovery going forward. On the negative side, already rising real estate prices have begun to erode the superior affordability comparisons. The prospect of Fed rate hikes promises further erosion on this score. No doubt, actions on both fronts will tend to squeeze out the marginal buyer and so tend to slow the housing recovery. But that should not halt growth altogether.
Even the prospective deterioration in affordability could hardly be described as intense. Housing, after all, remains historically affordable. Both real estate prices and mortgage rates are well below their former highs. Affordability, as calculated by the NAR, though down from its 2011 highs, remains 60 percent better than before the housing bust began and, remarkably, some 25 percent better than it averaged throughout the 1990s. Even if mortgage rates were to rise by 100 basis points and real estate prices were to accelerate their recent rising trend, it would still take until 2016 before affordability deteriorated to its state in the 1990s and early 2000, and much longer still to reach the kind of severe constraints that could create a downturn. And since the Fed has made clear its intentions to raise rates cautiously along a gentle path, it will no doubt take a good deal longer than this for it to add those 100 basis points to mortgage rates.
If a gradual deterioration in affordability will tend to slow but not stop the housing expansion, other impediments, those holding housing back thus far, promise to improve. Homebuyers’ confidence and aggressiveness are admittedly hard to quantify, but signs of improvement are evident in the 11.5 percent rise during the past year in the University of Michigan’s consumer sentiment index. Mortgage lenders have also begun to ease their former reluctance to extend credit for real estate. The Federal Reserve’s survey of senior lending offices describes an easing in requirements generally, a change that no doubt explains the real estate lending growth described earlier. These positives will no doubt develop only gradually. But at the margin, their turn should relieve the former drag on home buying and so promote the general recovery in the area.
The pace of housing sales and construction might even quicken slightly under the changing mix of influences. A more conservative expectation would look for this changing mix of influences to sustain the housing recovery on the moderate path it has already established. Whatever record the precise statistics eventually show, investors can rest secure that, barring some presently unforeseen shock, a recovery will continue in one form or another for quite some time to come, despite plans at the Fed.
Thirty Tomorrows 