Construction: A Tale of Shifts and Imbalances

So what is going on with residential construction?  We hear constantly that inventories are too tight, especially at the lower price levels, new home sales keep rising, yet four years after home prices bottomed out, new residential construction is only about half what it was at the peak of the housing boom.

At the same time, private residential construction spending in July increased only 0.3 percent (much of it apparently going to home improvements) and spending on new single-family homes has fallen for each of the last five months, by 0.2 percent in July, and is now only 1.7 percent higher than a year ago. Spending on multi-family construction was also down by 0.6 percent but remains nearly 20 percent higher than last year.

In recent days Mark Vitner, senior economist and other members of the Wells Fargo (WF) Economics Group looked behind some of the construction spending numbers to determine what is causing the inconsistency of weak residential spending and strong new home sales and Reuters took an in-depth look at one factor, the lack of skilled labor, that may be contributing to lagging construction numbers.

The WF analysis points to the recent weakness in residential construction spending as "confounding" when compared to the generally positive data on new home sales and single-family homebuilding.  This may be an anomaly, the economists say, but it has gone on long enough to deserve some analysis.

Residential investment is also trending down, falling 7.7 percent on an annual basis in the second quarter and the Federal Reserve sees it falling again in the third quarter by an estimated 4.8 percent. At the same time, new home sales rose by 12.4 percent in July. Residential construction data, while continuing to disappoint, is holding up, housing starts also rose in July and have trended higher for most of the year.  But existing home sales have see-sawed and were down 3.2 percent in July. 

Again tight inventories, get much of the blame.  WF says available existing homes were, by the end of July, down "a whopping 5.8 percent" year-over-year while there was only a 4.3-month supply of new homes.  Tight inventories become a circular problem; owners hesitate to list their homes because they are uncertain they can find another home to buy.

The tight new home inventory has boosted builder confidence and encouraged new residential development which is currently running 11.6 percent ahead of the same point in 2015.  Yet still there is the dichotomy with spending, even more puzzling when one considers that employment in single-family construction has been rising steadily and posted a 10,400-job gain in August.

Digging down, the WF group finds that some of the inconsistency represents less of a downturn than a shift.  The bulk of the growth in new home sales occurred in the South, where home prices are low compared to the rest of the country and all of the increase nationally was in the $200,000 to $400,000 price tier.  "Sales of higher-priced homes declined during the month," they say, "while sales of starter homes were little changed.

Also, apartment and urban infill construction were prominent in the early years of the recovery, and much of that went into construction of high-end apartments and teardowns and rebuilding gentrifying urban markets.  Now prices are pushing single family construction out into lower cost areas and apartment development may be following suit.  Developers are also turning to building townhomes which are popular with those who want an urban lifestyle but at a lower price-point than traditional single-family homes.

And while, as WF says, the multi-family market is more than holding its own, Lawrence Yun, National Association of Realtors® Chief Economist, points to another problem; new condo construction makes up only a small sliver of that sector.  Condo sales nose-dived in July, down 12.3 percent, and condo buyers, he said, face even tighter supply constraints than those looking to purchase single-family homes.

Census figures bear this out.  The Bureau's Survey of Market Absorption shows only 3,600 condos were completed in the first quarter of this year and 3,300 in the fourth quarter of 2015.  Further, these were disproportionally high end residences.  The median asking price was $700,000 in the first quarter, up from $501,900 in the previous period.  Fifty-three percent of all completed condos in Q1 were listed at more than $700,000 and 64 percent of all condos completed that quarter sold within three months.

David Randall writes for Reuters that another aspect of new home construction is contributing to an imbalance of supply and demand as well as to decreasing affordability.  Builders can't get enough workers to get the job done.

The housing bust drove an estimated 30 percent of construction workers into new fields.  Now the work is back by the workers are not.  Randall quotes numbers from the National Association of Homebuilders (NAHB) estimating there are 200,000 unfilled construction jobs in the U.S., up 81 percent in the last two years. The Department of Labor says the ratio of job openings to hiring is the highest since 2007.

This, Randall says has a two-fold impact.  First, the lack of an adequate workforce means residential construction is trailing the demand for homes and dampening the overall economy. Second, it is pushing labor costs up so homebuilders are developing more expensive homes to maintain their margins, thus abandoning the starter home market.  Even with mortgage rates at historic lows many first-time buyers are finding themselves shut out.

Randall says private companies are having a hard time attracting workers with carpenters and electricians in the greatest demand.  Salaries are rising in response to the shortages and in some areas contractors are starting to turn away work.

NAHB says average construction costs for a single-family home have risen 13.7 percent since 2007 even though the total cost of building and selling - including land, financing, and marketing - is up only 2.9 percent.