2017 in Review: A Gradually Strengthening Economy Meets Higher Construction Costs

At this same time a year ago, I wrote about an economy that was improving enough that the Federal Reserve was about to raise interest rates for the second time since 2006, followed by up to three more hikes in 2017.  However, there has also been a consequence of this growth in the form of higher costs for land, labor and materials, making it challenging for builders to build the types of affordable housing at a time when new home starts are predicted to jump sharply in 2018.

U.S. GDP growth – which averaged about two percent in both 2015 and 2016 and was just 1.2 percent in 1Q 2017 ---- surged to three percent in the second and third quarters, due mostly to increased consumer spending, inventory investments, exports and federal government outlays.  Current forecasts are suggesting this rate of growth to improve even further to 3.3 percent in the final quarter of 2017.

Job growth, which rose by 261,000 in October, averaged 169,000 per month through the first ten months of 2017 (down 12.2 percent from the same period of 2016), and would likely have been higher without the negative impacts from a particularly harsh hurricane season.  Had job growth stayed on track with the average through August, job growth through October would have been closer to 185,000 jobs per month.  Moreover, October’s official unemployment rate of 4.1 percent is the lowest reported since December 2000.

Not surprisingly, consumer confidence from both The Conference Board and the University of Michigan surveys has risen to the highest levels since the early 2000s, boosted in large part by the strengthening job market.  In turn, wages have come under increasing pressure, with average hourly earnings up 2.2 percent for the 12 months ending in October.

Still, because the Federal Reserve-preferred PCE price index rose by just 1.6 percent per year through September, it’s not clear just how many interest rate increases we’ll see in 2018.  Complicating matters further are higher inflation indicators from both the Producer Price Index and Consumer Price Index, which rose by 2.6 and 2.2 percent per year through September, respectively.

Certainly one area in which we’ve seen higher inflation is in the cost for building a new single-family home, which as of September 2017 was up by 5.2 percent year-on-year and 29.2 percent over the previous five years.  Combine that increase with tight supply in most markets, and the result has been a decline in home affordability.

As of 3Q 2017, the NAHB/Wells Fargo Housing Opportunity Index fell to 58.3 percent, for the lowest rate since the same quarter of 2008, and down sharply from the last peak of 77.5 in 1Q 2012.  Since 3Q 2008, median national home prices tracked by the same report rose by 26 percent.

Single-family new home sales, which dipped in July and August, rebounded by nearly 19 percent in September to 667,000 per year, and were up 17 percent year-over-year.  So far in 2017, new home sales have averaged 609,000 per month, up nine percent from the same period of 2016.    At current sales rates, existing inventory would take 5.0 months to sell, down slightly from 5.1 a year ago.

For existing homes, lack of inventory at the lower end of the market and rising prices have recently stunted sales, with September’s pace down 1.5 percent from a year ago and the share of first-time buyers declining to 29 percent from 34 percent.

Although September’s inventory did rise slightly to 1.90 million homes – or a timeline of 4.2 months at current sales rates -- it has fallen year-over-year for 28 consecutive months. While pending home sales in September were flat from August, they were still down 3.5 percent from a year ago, and have fallen on an annual basis in five of the past six months.

Thankfully, there does seem to relief on the horizon.  Looking ahead to 2018, FreddieMac is predicting home builders to take up much of this slack in overall housing inventory.  Annualized housing starts, which averaged 1.19 million for the first nine months of 2017, are forecast to rise by another nine percent to 1.33 million in 2018, with total single-family home sales rising by about two percent to 6.30 million units even as mortgage rates trend slowly upward.

As for potential consequences of tax reform on the housing market, given the high level of push-back from multiple interest groups, and with the Senate and House versions still far apart as of mid-November, that analysis must wait for another day.