The US housing recovery: how solid are its foundations?

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October 3rd, 2013

On 19 June, before the labour market improved, Ben Bernanke reminded people of an uncomfortable truth: everything comes to an end... and the QE3 would be no exception. Nonetheless, this communication was deliberately cautious, underlying the fact that the intention was to diminish asset purchases but under no circumstances would they be sold off in the short term. However, in spite of this insistence the markets ignored the Fed's caution and the mortgage rate (fixed at 30 years) rose to 4.5% (3.4% in April). Although any increase in the future should be should be gentle and gradual, particularly as the Fed finally delayed its famous tapering in September, it still raises another question: can the recovery in the real estate sector withstand higher interest rates?

The latest figures for construction certainly call this into question: 17% fewer homes were started in July than in March, when a post-crisis peak was recorded. However, this figure should be interpreted carefully as a large portion of the reduction is due to volatility in multi-family homes that, with the crisis, have taken on a greater relative weight. In this respect, the index of the National Association of Home Builders (NAHB), which measures actual sales and their future prospects and provides a more reliable picture of the situation than the fluctuating figure of housing starts, maintained in September what it had gained in the sharp rises of July and August, placing it at pre-crisis levels (2006).

In fact, if the economic recovery continues, the housing recovery should also advance. Why? Firstly because the reduction in oversupply is a fact and this can be seen by the number of months required to sell a house (stock of housing on sale divided by monthly housing sales), which went from a maximum of 11.9 months during the darkest month of the crisis (July 2010) to 4.9 months in August 2013, in line with pre-crisis levels that are considered to be normal. Secondly demographic trends and the improvement in employment are also helping: the delay in the formation of households due to the crisis created an underlying unsatisfied demand which, with the recovery in the labour market, is now taking shape. Thirdly, if we also add the fact that construction is 40% below its normal level, we can suppose that this sector still has a lot of room for improvement and that the gradual, sustained rise in prices (17 months of consecutive increases in the Case-Shiller index) is being boosted by this better supply-demand balance.

On the other hand, the increase in interest rates could partly be offset by the better credit conditions that might be offered by banks as the economy improves and deleveraging advances. Similarly, moderately rising interest rates could spur on those buyers who thought they would remain low forever. In this respect it should be noted that, in August and with higher interest rates, the number of new mortgage loans granted to buy housing remained in line with the good figures from the beginning of 2013.

In short, provided the economy's recovery continues, the answer to our initial question should be optimistic: higher interest rates can be withstood; the contribution of housing to growth will continue to be positive and property prices will continue to increase gradually without damaging the recovery in private consumption. Paradoxically, the key lies in the same condition that will spark the Fed's change in policy, namely the recovery continuing in employment and in the economy in general.