Economist's Commentary: February 20, 2008

Necessary Corrections

By Lawrence Yun, Chief Economist

The latest housing starts figure continues to show exceptionally weak levels. A total of 1.01 million units were started for construction in January, which was an increase of 0.8 percent from the prior month. The increase was driven by a jump in multifamily unit starts. Single-family units continued their descent. Permits (not starts) on single-family units also fell, implying further lowering of housing starts in upcoming months.

The current new home construction activity has essentially been cut in half from the peak levels in 2005 and is at the lowest point in over 15 years. This low level of new home construction is, however, a needed adjustment. The inventory of homes on the market for both new and existing homes is very high, and the last thing that is needed is to add more inventory to the market.

Based on the latest available information, my outlook is for new single-family home construction to decline for another year-and-a-half through the second quarter of 2009.

Lower home construction cuts into economic growth. The component that goes into GDP calculation called residential construction spending fell 18.3 percent in the final quarter of 2007 over a one-year time span. As a result, GDP growth will be sub-par throughout 2008.

However, lower home construction activity is just what is needed to help stabilize the housing market. Abundant inventory is not what we want. A high number of vacant new homes will pressure home prices on existing homes to fall and that could result in a sizable loss in housing equity for a vast portion of 75 million homeowners in the U.S. Consumer spending can spiral downward fast from loss in equity and push the economy into a deep recession. So the only way to halt this scenario is for the inventory to be reduced. That will happen if builders hold back on construction and that is what they are doing. Builders currently are in a very tough spot: to build a home and lose money or not build a home and not make money. I am glad that builders are taking the latter option and this is a necessary correction in the homebuilding industry.

This is one in a series of commentaries by the Research staff of the National Association of REALTORS®.