Having collapsed in April, housing starts in both the US and Canada have rebounded sharply with Canadian starts now at a year-high and US starts re-approaching the post-Global Financial Crisis highs reached around the turn of the year. As opposed to 2007-2008, when housing was at the epicenter of the crisis, it appears to be a stabilizing force in the broader economy today. Albeit being challenging in the short term, COVID-19 may also lastingly alter consumer preferences in favor of home ownership.
In May we had highlighted the sharp rebound in US mortgage applications as an early signal that the housing sector was shaping up to be a leader in the post-shutdown recovery phase. We also identified the homebuilder industry as a potential beneficiary as the economy started re-opening. Three months later, there is abundant further evidence that establishes housing as a recovery leader not just in the US economy but also in Canada. The strength of housing today stands in sharp contrast not only to the more muted recoveries in other sectors (particularly leisure, hospitality and air travel) but also to the Great Recession experience. Whereas housing was then at the epicenter of the crisis, it is now a stabilizing force in the broader economy. Perhaps there is no better representation of this extraordinary contrast than the performance of the National Association of Home Builders (NAHB) Housing Market Index (HMI) in the United States (US) (Figure 1).
The index measures homebuilder sentiment and is a very good indicator of the health of the housing market. During the Great Recession, it underwent a very arduous recovery, dipping below 40 in mid-2006 and taking more than six years to reclaim that level. During the current COVID crisis, the collapse and the subsequent rebound were much swifter. In fact, just two months after remaining below 40, the index hit a record high in August. Prospective buyer traffic hit a new record, present sales matched the December 2019 high and future sales expectations touched near historical record levels.
This optimism reflects much improved home sales. Both existing and new home sales have soared far above expectations over the past two months such that both reached their highest levels since December 2006 in July 2020. Truly, the US housing market seems to be on fire! Not to be left behind, the Canadian market has done quite well, too. According to the Canadian Real Estate Association, the Canadian housing market set multiple records in July as sales topped historical records while inventories declined to 16-year lows.
The same tight inventory story is playing out in the US as well. July inventory levels sales worth 3.1 months were within a hair’s breadth of record lows. By contrast, during the 2008-2011 market lows, inventories at times surged to over 11 months and almost touched 12 months during the summer of 2010. Given this, it is unsurprising that homebuilders have resumed construction in earnest. Having collapsed in April, housing starts in both the US and Canada rebounded sharply with Canadian starts now at a year-high and US starts re-approaching the post-Global Financial Crisis (GFC) highs reached around the turn of the year (Figure 2).
Mixed Fortunes for Construction Employment Across Geographies
Construction employment has exhibited a more mixed cross-country performance during the recovery phase. In the US, it has greatly outperformed services, being closely aligned with manufacturing. This confirms our initial intuition regarding construction’s relative resilience to COVID-19 compared with service industries due to the nature of construction work that demands lesser worker proximity to each other.
In Canada, however, construction employment has actually underperformed services during the time of the pandemic. This divergent performance likely speaks to the fact that construction employment in Canada entered the COVID crisis at record levels, whereas construction employment in the US had not even fully reclaimed the pre-GFC peak (Figure 3). Differences in the broader construction industry composition may also play a role as construction entails infrastructure and non-residential building activities as well.
Investors have taken notice of these positive trends. ETFs targeting the homebuilding industry have attracted US$973 million in inflows – 77% of their asset base at the end of March1. Since the market bottom, SPDR® S&P® Homebuilders ETF (XHB), which includes not only homebuilders and building products but also home improvement related stocks, has outperformed the S&P 500 by 62%2. Figure 4 shows performance strength across all subindustries thanks to a strong rebound in housing market activities and increased spending on home improvement.
US Mortgage Delinquency Ratio a Worrying Sign
So far so good then for the housing market and for homebuilders. But can this resilience persist in light of high unemployment and uncertainty over future household incomes? In a worrying sign, the US mortgage delinquency rate spiked in the second quarter with Federal Housing Administration (FHA) and Veterans Affairs (VA) loans faring especially poorly (Figure 5).
Nevertheless, this largely reflects increased use of forbearance options under the provisions of the Coronavirus Aid, Relief and Economic Security Act (CARES), which allow borrowers to defer payments for an initial six months (with an option to extend it by another six months) without suffering a negative credit report impact. Thus, it is hard to tell how much of this is a genuine inability to pay versus a possible opportunistic decision to leverage the option to boost emergency savings or free up cash for other spending. Separate data from the Mortgage Bankers Association shows that 7.2% of loans were in forbearance during the week ending 9 August 2020. Notably, this marked the ninth straight week of decline, which is encouraging and likely reflects a combination of people returning to work, generous unemployment insurance benefits and stimulus checks.
However, make no mistake: homeowners’ future mortgage servicing ability will hinge critically on how long the COVID-19 crisis persists. While the personal savings rate at nearly 20% speaks favorably of consumers’ financial cushion, there remain over 9 million out-of-work individuals who describe themselves as on temporary furloughs. Absent an effective medical solution to the pandemic, many of these (and perhaps plenty others) could find themselves outright unemployed. This is precisely the “relay race” nature of the recovery that we discuss in our mid-year market outlook: the persistent risk of relapse/failure despite having done quite well so far.
The housing sector is not immune to these risks, but there are several factors, both structural and COVID-related, that offer support. First and foremost, the sector has been “lean” for many years, having worked off the excesses leading to the GFC. Low credit risk borrowers have for years made up the bulk of new mortgage originations in the US, minimizing repayment risk (Figure 6).
These homeowners also have untapped home equity as outstanding home equity lines of credit during the second quarter stood at only a little over half of where they were back in 2009. In other words, homeowners have no incentive to default since they are not “underwater” on their mortgages. Another positive structural factor is that in the US residential segment, construction had only meaningfully picked up over the past couple of years. Even at the recent January peak, housing starts were only back to 2007 levels. Meanwhile, the US population had risen by over 27 million people.
Finally, the COVID crisis presents an interesting question in respect to its lasting impact on housing. While challenging in the shorter term via income losses and labor market concerns, the crisis may also lastingly alter consumer preferences in favor of home ownership. It is indeed notable that the building materials category in the July 2020 US retail sales data exhibited the third-highest YoY growth rate, following online sales and sporting goods. Apparently, more time spent at home is spurring a burst of home improvement activity!
The authors would like to thank Rebecca Chesworth for contributing to this article.