Economic Optimism in Unexpected Places
It’s easy to be pessimistic about the economy and capital markets today, especially since there is plenty of evidence, both hard and anecdotal, to support a negative view. However, after five years of decline, home prices may finally be ready to bottom out, and perhaps, begin to recover. That should also lead to improving fundamentals in the economy as a whole.
A buyer’s housing market
Based on most measures, it’s an incredible time to buy a home, whether it’s a primary residence, an investment, or a vacation property. According to the S&P/Case-Shiller Home Price Index, home prices are back to early 2003 levels. However, when you factor in current incomes and historically low financing costs, homes are now more affordable than they have been in 40 years.
We fully acknowledge the headwinds that keep many existing homeowners from upgrading, including tighter lending standards and a lack of equity. We must also consider the demographics of a workforce where job changes are more frequent and job seekers are forced to broaden their search. Couple this with the fear of buying a home that may decline in value, and it’s easy to understand why buyers are hesitant to enter the market.
In this environment, renting has great appeal. However, demand for rental units has pushed lease rates up rapidly. According to the U.S. Census Bureau, occupancy of rental units increased by roughly 900,000 last year. While new supply has been coming on the market, it has not kept up with demand. According to JPMorgan, renting is now 18 percent more expensive, on average, than owning a comparable home. This ratio only compares monthly expenses and does not factor in the equity gained over time from ownership. Buyers are now heavily incented to purchase rather than rent.
Pent-up demand for housing
Meanwhile, two factors — new household formation, which has averaged 1.35 million per year, and housing starts, which have fallen to historic lows — are resulting in significant pent-up demand for housing.
In addition, excess housing inventory has been declining steadily. These factors — declining housing stock, pent-up demand, record affordability for ownership, and higher costs to rent — when considered together, suggest that the decline in housing prices is very near an end. If we’re correct in this view, then it’s also likely that housing starts will begin to pick up. That’s where we find a beneficial economic multiplier.
According to JPMorgan and the Bureau of Economic Analysis (BEA), each 250,000 housing starts generate 1 million jobs, add $4 in earnings per share to the S&P 500, and is equal to roughly 0.75 percent of gross domestic product (GDP) growth. These remarkable numbers also shed light on the economic drag caused by the current depressed housing market.
Housing starts are currently running at a 700,000 annual rate. The long-term trend line implies an additional 800,000 starts annually. Let’s do some math using the BEA projections. If housing starts returned to long-term levels, the economic benefit implied would be:
- An additional 3 million jobs
- A reduction in the unemployment rate from 8.2 percent to 6.3 percent
- An improvement in the forward price-to-earnings ratio of the S&P 500 from 13.2x to 11.9x
- An additional 2.25 percent of GDP growth
We still hold to the view that real GDP growth for 2012 will come in around 3 percent — a disappointing performance, but better than other developed market economies. However, if we begin to see some improvements in housing starts, we will gladly move that forecast up. The capital markets would also likely be very pleasantly surprised.
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Mark A. Griffin, CIMA®
Principal, Chief Investment Officer
CliftonLarsonAllen Wealth Advisors, LLC (“CLA Wealth Advisors”)
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