Bright Spot

In the midst of convention turmoil and concerns about the economy’s growth rate, it is nice to find a bright spot in all the data we track. Recently, we received information about the current state of the housing market and the news was good. While housing usually represents 3-5% of the overall economy, one could argue there is no better measure of consumer sentiment. And, the National Association of Home Builders (NAHB) suggests that when you consider all the jobs that are needed to produce the materials to build a home, the economic contribution is much higher.

Housing Data

Tracking the number of building permits is a good way to understand how much home construction is taking place. The U.S. Census Bureau recently released some data showing that permits in June rose 1.5% over the prior month. This represented a seasonally adjusted annual rate of 1,153,000 units. Of this number, 731,000 represented single-family homes (Economists call them “units;” “homes” seems to better represent the way we think about them). The rest are multi-family units. When looking at this data as compared to last year, a cautionary note about the pace of growth can be seen. In June of 2015, the annual rate was 1,334,000 units, suggesting that the pace has moderated a bit, despite low unemployment and moderate wage growth.

While permits represent homes to be built, the Bureau also releases information about homes started. There were 1,189,000 homes started using an annualized figure. This too is down slightly from last year, but it suggests that those obtaining permits are moving through the financing process and beginning construction.

According to the NAHB, the cost of a new home is approximately $290,000. Building 1.189 million of them then adds over $344 billion to the economy.

Interest Rates and Mortgages

We know that interest rates paid on bond investments continue to decline, which isn’t great for savers. For borrowers however, that is a different story. Mortgage rates are near all-time lows and that will continue to bolster the housing market.

The current interest rate on a 30-year mortgage is approximately 3.4%. To put that rate in perspective, in July of 2000, the rate was near 8%. The low cost of borrowing should help with demand for homes and likely has. However, one thing to keep in mind is that there is the potential to have a deflationary force at work in the housing market. That is, the longer interest rates remain low and continue to decline, the more likely buyers are to put off their purchases believing that the cost of financing will be more favorable in the future.

Household Formation

One of the other important drivers for the housing market is the formation of households. As people form households they make a decision about where they want to live and ultimately that creates demand for housing. As you can see from the chart below, the annualized formation rate is 1.285 million households. While 13.8% below last year’s level, it is certainly much better than the lows we witnessed during the recession.

Formation is important because as people rent or buy a place to live they create demand for both housing stock and services. The services component represents approximately another 15% contribution to economic growth or $2.5 trillion!

You can see from the chart below that the formation rate isn’t constant but it has improved since the beginning of the year.

Housing continues to be a bright spot in our economic growth cycle. The trend isn’t straight up though and that is consistent with the modest overall growth we are experiencing. Still it is an important component representing an opportunity for future growth as it continues to improve.

Brian Andrew is Chief Investment Officer for Johnson Financial Group

© Johnson Financial Group

© Johnson Financial Group

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