As Housing Starts Go, So Goes The Economy

Keep your eye on residential construction if you want to know whether the recession is about to bottom out. A leading indicator of business activity, housing starts have never lagged behind a recovery and have turned up prior to the economy in six of the eight postwar recessions.

Judging by the latest numbers, then, the outlook for a near-term economic revival and for the housing sector itself remains grim. Housing starts continued to weaken in December, plunging 12%, to an annual rate of just 987,000, bringing last year's total to 1.19 million, the lowest level since 1982.

The old adage that it's always darkest before the dawn may well apply to the current housing situation, however. At least that's the way Wall Street appears to see it. Housing analyst Barbara Allen of Kidder, Peabody & Co. notes that homebuilding stocks led the market in the fourth quarter and are still outperforming the broad indexes. "If mortgage rates continue to decline, as I expect them to," she says, "we could see a surprisingly strong comeback in housing demand in the spring."

Economist David Hale of Kemper Financial Services Inc. thinks the public has been so obsessed with the Persian Gulf, the deepening recession, and rumors of collapsing housing prices that it has failed to appreciate positive developments such as declining interest rates and inflation. He points out that while respondents to the University of Michigan's latest monthly consumer survey show a growing awareness that good housing buys at low prices are now available, they continue to complain of tight credit and high interest rates even though mortgage rates have been coming down. "Once the Persian Gulf crisis is resolved," he says, "potential home buyers are likely to realize just how much mortgage rates have fallen."

One indicator that bodes well for sales of both new and existing homes is the National Association of Realtors' affordability index, which uses interest rates, housing prices, and household income trends to measure how affordable homes are to average families. With mortgage rates falling and home prices soft, that index has been strengthening sharply recently and in November hit its highest level since 1977 (chart).

While that implies an appreciable pickup in demand, neither Hale nor Allen expects the kind of sharp rise in residential construction itself that characterized earlier recoveries. For one thing, the overbuilt multifamily sector is likely to remain depressed for some time. For another, the financial woes of banks and thrifts will severely reduce credit availability for the thousands of small private builders who traditionally account for 90% to 95% of single-family starts.

"The coming demand pickup," says Allen, "will mainly benefit the large publicly held builders with access to credit." It should also benefit sales and prices of existing homes. "The biggest initial plus for the economy," says Hale, "may well be the tonic effect of stabilizing asset prices on consumer confidence."

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