Early Sectoral Weakness
Over the past few years the United States has witnessed incredible economic and financial fallout from declining home values and the vast oversupply of homes. Weakness in the housing sector has had serious implications for other parts of the economy. The repercussions from falling home prices showed up almost immediately in the mortgage market, and it did not take long for the knock-on effects to take down the global financial markets. While the financial markets received most of the attention, other housing-related sectors also began to feel the effects of a weak home market early on and many continue to struggle today. As the housing sector slowed in late 2005 and early 2006, well before the recession began, demand for building products, furniture and other durable goods—those big ticket purchases needed to build, remodel, or fill a new home—declined sharply.
The housing market is still very much in correction mode. Builders are striving to reduce inventories any way they can, and the extreme weakness in sales and massive oversupply of homes means pricing power for sellers is practically nonexistent (Figure 1). This predicament also applies to sellers of housing-related goods. While there are some tentative signs housing starts and home sales have bottomed, both are doing so at appallingly low levels, in our opinion. Moreover, home prices are still falling and are likely to continue to do so for at least another year. The continued weakness in housing means producers and purveyors of lumber, furniture, appliances and other building supplies will likely continue to struggle. Demand is no longer falling, however, which means producers should be able to better align production and inventories with sales.
Renovations and Home Improvement
During the housing boom, homeowners could be quite confident they would recoup any investment they made in their homes and a substantial portion of home equity borrowing went to additions and repairs of existing homes. The prospect of a quick payoff from home improvements meant that spending on home improvements rose faster in areas where home prices were rising rapidly, particularly Florida, California and Arizona. This assurance led to a rise in speculative buying and house flipping. Indeed, several television shows such as TLC’s Flip That House and Bravo’s Flipping Out picked up on the trend and became quite popular.
When such speculative investment strategies become a national pastime alarm bells should start ringing. Sure enough, once home prices stopped rising, residential improvements slowed dramatically. When prices started falling outright, spending for additions and alterations tumbled. Spending for residential improvements peaked at a 10 percent year-over-year pace during 2004/2005. Residential improvements slowed significantly once prices started tumbling in California and Florida and fell into negative territory once prices started falling nationwide. The latest data show spending for additions and alterations contracting more than eight percent year over year (Figure 2).
Investor purchases made the underlying demand for new homes appear to be stronger than it actually was and led to a dramatic rise in home prices. Builders responded by ratcheting up home construction. As long as sales remained robust, the month’s supply of homes stayed at a manageable four-five months, meaning the pace of sales would consume all available homes in that time period. When sales slowed, the month’s supply rose steadily, climbing to more than a one year supply, despite a collapse in new building activity.
