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Housing Market Contributions to U.S. Economic Growth

Wells Fargo Investment Institute - June 21, 2017

Analysis and outlook for the global economy

  • As housing inventory remains lean and housing demand maintains its growth, U.S. home prices have continued to rise, helping to fuel positive sentiment amongst homebuilders.
  • Housing-related activity contributes to approximately 17-18 percent of U.S. gross domestic product (GDP), but the impact may be even higher when considering household durable good expenditures.

What it may mean for investors

  • We expect the U.S housing sector to continue supporting U.S. economic growth in the remainder of 2017, helping to support equity prices in related industries.

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Housing Market Contributions to U.S. Economic Growth
As we move from the spring season into the summer season, we believe that the U.S. housing market will stay its course through the remainder of the year. It is well known that the housing market is a key driver of U.S. economic activity, but to what extent? In this week’s report, we identify where we are in the housing cycle today, describe several sources of housing-driven economic growth, and outline what these factors currently suggest for the future of this housing cycle.
Where We Are in the Housing Cycle
According to the housing-market index from the National Association of Home Builders and Wells Fargo (NAHB/WF HMI), demand for single-family housing in the U.S. is strong, and homebuilder sentiment remains positive. Despite declining three points in April after reaching an all-time (post-recovery) high in March, the index advanced again in May (see Chart 1, Figure A). This index reflects sentiment among homebuilders, specifically around current sales, expected sales over the next six months and current prospective-buyer traffic. This sentiment coincides strongly with housing activity as it tracks housing starts and building permits closely. It also displays an inverse relationship to inventory levels. We believe that the NAHB/WF HMI remains an important proxy to measure the current health of the U.S. housing sector and to help signal the probable course of the housing market in the near term.
As we have discussed in our previous housing-industry reports, an imbalance between housing supply and demand continues to dominate U.S. home-price trends. Current and prospective homebuyers are experiencing one of the toughest markets we have seen in more than a decade, due to the shortage of housing supply. The unsold inventory of existing homes is at a 4.2-month supply today. This is down from a 4.6-month supply a year ago and well below historical averages.
On the other hand, national home prices continue to advance. According to the S&P Case Schiller U.S. Composite National Index, housing prices climbed 5.7 percent in April 2017 from the previous year. This was the largest increase in more than two years (see Chart 1, Figure B).

Chart 1. Overall, the U.S. Housing Market Remains Healthy as Prices Rise and Inventories Are Lean

Chart 1. Overall, the U.S. Housing Market Remains Healthy as Prices Rise and Inventories Are Lean

With these factors at play, current home sellers have little reason to reduce asking prices. As prices continue to rise, they may generate a positive wealth effect for existing homeowners, who may eventually be prompted to spend more. In addition, homebuilders might be encouraged to fill the inventory void by constructing more properties. New homes for sale are rising, but this new housing is coming online slowly, and the pace is still not enough to ease the inventory constraint.
Sources of Housing-Driven Economic Growth
According to the National Association of Home Builders (NAHB), housing represents an average of 17–18 percent of U.S. GDP. This is divided between roughly five percentage points of investment (construction, remodeling, etc.) and 12–13 percentage points for housing services (rents, owner-equivalent rents, and utilities).  This does not include consumers’ purchases of durable goods, such as furniture and appliances, which are needed to furnish a home. As a result, the overall impact to the economy is likely even greater.
According to the latest personal consumption expenditures (PCE) report from the U.S. Census Bureau, residential construction, household consumption expenditures (for services) and durable goods orders (furniture and household equipment) continue to grow on a year-over-year basis (see Chart 2). These three indicators move in sync with the housing cycle, so continued growth in all three should continue to benefit U.S. GDP growth in the near term. Higher growth rates from residential construction are expected at this stage in the U.S. housing cycle due to the supply and demand imbalances present in the housing market. Real household consumption for services and durable goods are more sensitive to other factors in the economy, such as job prospects, wage increases, inflation and consumer sentiment. Yet, these areas still have managed to grow at a pace that is above or near their average post-crisis rates.

Chart 2. Residential Investment and Household Consumption of Services and Goods

Chart 2. Residential Investment and Household Consumption of Services and Goods

Looking Ahead
We believe that the U.S. housing sector will continue to expand in the coming months, despite some affordability headwinds as mortgage rates increase and prices continue to climb higher. Still, homebuilders should feel encouraged to increase the pace of construction in order to appease the strong demand. Additionally, households’ home-related services expenditures, along with household durable-goods orders, should continue to expand, albeit at a slower pace. We expect all of these factors to continue contributing positively toward U.S. economic growth for the remainder of 2017.
It is worth mentioning that the transition period between the spring and summer is usually a popular season for home remodeling. Frequently, these projects continue well into the fall.
According to the Joint Center for Housing Studies of Harvard University, “homeowners are continuing to spend more on improvements as house prices strengthen in most parts of the country.”  While the growth rate in remodeling is beginning to trend down, according to the Leading Indicator of Remodeling Activity (LIRA), national remodeling expenditures by homeowners are projected to reach almost $320 billion by early next year— an increase of 6.1 percent from the first quarter of this year. Also, we expect construction, and residential remodeling, to continue to have a positive influence on retail sales in the building materials, garden equipment and supplies stores category.
In summary, there are several indicators pointing toward continued residential housing investment (both construction and remodeling) in the months ahead. The NAHB/WF HMI (housing market index) is showing positive sentiment among builders. Housing demand remains strong, while inventories are lean— causing home prices to continue advancing in many cities. The combination of these factors support our fundamental housing-driven rationale for believing that the housing sector’s corporate earnings potentially will continue to increase and help to support equity markets, while housing demand should gradually help to fuel rising borrowing costs and coincide with rising yields.