According to “Navigating Volatility in the U.S. Residential New Construction Sector,” a recent collaboration by Wells Fargo Securities’ Building Products and Homebuilding Investment Banking practice and L.E.K. Consulting, pent-up demand from a new generation of first-time home buyers and a low supply of single-family housing should drive long-term residential new construction growth. Concerns of a 2019 downturn in housing screen as overblown, with housing starts likely to show steady growth in the intermediate term.
As interest rates climbed higher over the course of 2018, declines in housing affordability combined with economic cycle concerns sparked worries for the residential new construction sector. However, as the expected pace of rate hikes has slowed in early 2019, affordability and homebuyer sentiment is improving. These factors coupled with historically low levels of inventory should help moderate declines in new residential construction should a broader economic slowdown occur. Considerably low supply and emerging demand driven by millennial household formation should further support long-term growth.
“The industry may face near-term turbulence, but strong tailwinds will help sweep through it with a new generation of homebuyers driving longer-term growth,” says Lucas Pain, Managing Director and Head of Americas Building Products and Materials practice at L.E.K. Consulting.
The study examines several key industry factors ― including housing starts, housing inventory, housing affordability and household formation― in order to forecast performance.
Among the study’s key findings:
- Single-family housing is in short supply ― supporting potential for future growth. The 2008 recession that weighed on demand and kept millennials out of the market also kept builders and lenders from committing to new single-family construction. The result is an undersupply of single-family homes with single-family housing starts still 22 percent below the long-term (1980-2000) average.
- The slow recovery in housing starts since the Great Recession creates a positive backdrop for the current cycle. The depth and duration of housing downturns are heavily influenced by housing starts levels relative to the long-term average when a downturn begins. On that score, the news is good ― November 2018 (SAAR) housing starts of 1.256 million are 13 percent below the long-term (1980-2000) average of 1.438 million. For housing starts to peak at this level would be unprecedented ― since 1970, there has been no instance of housing starts turning negative before they reached the long-term average.
- Housing affordability had trended down but forecasts are improving. Notable declines in housing affordability captured headlines in 2018, but the U.S. economy and labor market remains healthy. In early 2019, as expectations for rate hikes subside, affordability metrics are improving with a most recent Housing Affordability Index reading of 144 in November of 2018. This compares favorable against the June 2018 low of 138, with our analysis indicating the index should remain above its long-term average of 130 through 2019.
- Millennials are set to (finally!) enter the housing market in a meaningful way. Millennials’ delayed household formation has led to a 2.2 million household gap relative to what the historical headship rate levels of their Gen X counterparts would imply. We attribute this to the weak labor market following the 2008 recession and a student debt overhang. However, aging millennials are set to close the headship rate gap with prior generations – likely driving steady long-term growth in residential new construction.
“An economic recession may seem overdue, given historical trends,” says Harry Shaw, managing director and co-head of the Basic Industries sector in the Industrials Investment Banking Group at Wells Fargo Securities. “But given our industry specific observations on supply, demand and the level of key economic indicators, we expect the impact of any slowdown on residential new construction activity to be muted. The outlook for residential construction in 2019 is improving versus late 2018, and there are sufficient tailwinds to carry the industry through any near-term economic turbulence.”
Kevin Price, Host of the nationally syndicated Price of Business Show and Editor at Large at TDB weighed in on the topic. “I think it takes a great deal of optimism to think that the Millennials can ‘rescue” the building industry. Millennials have very different values than previous generations. They stayed home much longer than earlier generations and are not as enamored with the trappings of affluence that was pervasive in earlier generations. They read about 3-D houses that can be built for $4,000 as a way to help those impoverished and wonder how they can get one for themselves,” Price said. “Do they have pent up demand? Certainly, but they have sensibilities that are more like the children of the Great Depression than their parents. This will change the way construction is pursued for decades to come.”
Given the healthy longer-term outlook, industry participants should consider investment in both capabilities and capacity, especially in single-family housing, the study suggests. “A modest pullback could create attractive valuations and entry points for those willing and able to make opportunistic investments,” adds Casey Rentch, managing director, Industrials Investment Banking at Wells Fargo Securities.