July 2010 U.S. Construction: Building on Sinking Sands?

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Overall construction spending tumbled in July to the lowest level in a decade. The value of construction put in place dropped 1 percent in July, the third straight monthly decline; the fall-off was particularly noteworthy in light of revisions that showed activity during May and June was much weaker than previously reported. Private non-residential construction was the only subset of activity to post a gain in July.

"Housing is fairly weak and construction related to the stimulus is fading," Russell Price, a senior economist at Ameriprise Financial Inc. in Detroit, said before the report was issued. "Some commercial projects may have been delayed as businesses are uncertain about the outlook."

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Although the value of private construction put in place declined in July, the number of total housing starts nudged higher (1.7 percent). Even so, starts remain near the lowest levels since the Census Bureau began collecting data in 1959; also, the drop-off in permits gives little reason to expect a turnaround.

"The tax credit brought forward some demand, and now we're in the middle of the payback," said Nigel Gault, chief U.S. economist at IHS Global Insight in Lexington, Massachusetts. "We're in a deep hole right now. There's no sign that we're about to climb out of it."

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The 1.7 percent rise in total starts resulted from the jump in multi-family starts (28,000, or 32.6 percent) more than offsetting the drop in single-family starts (-19,000, or -4.2 percent). Despite the July uptick, total starts remain in negative territory on an annual percentage change basis.

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With new-home sales retreating to an all-time recorded low in July, the ratio of starts to sales remained elevated. Granted, this ratio is something of an apples-to-oranges comparison, since starts include all activity while sales include only "spec" houses (i.e., excluding homes built on contract). Nonetheless, it gives an indication of the balance (or lack of same) between supply and demand.

"The housing market's recovery has taken a big step back," said Ryan Sweet, a senior economist at Moody's Economy.com. "The improvement in the labor market is showing signs of fatigue and potential buyers are content to sit on the sidelines, which is understandable considering we have a near double-digit unemployment rate."

Mitchell Hochberg, principal at Madden Real Estate Ventures in New York, concurred with Sweet. "The [new-home sales] report shows the housing industry is still nursing a bad hangover," Hochberg wrote in an e-mail. "With shadow inventory, rising foreclosures, little job growth and more stringent access to credit, weak sales will persist and the industry's headache will linger."

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A comparison between completions and sales tells much the same story. Although completions were substantially lower in July than June, and the inventory of new homes was unchanged in absolute terms, the decline in sales pushed months of inventory back above nine months (at the July sales pace).

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July’s sales of previously owned homes were more disappointing, both in absolute and percentage terms. For comparison, new-home sales dropped by 39,000 units (SAAR), but -1.43 million for resales. The inventory of existing homes ballooned to 12.5 months at the July sales pace.

"This is a devastating reading on the U.S. housing market," said Derek Holt, an economist at Scotia Capital Inc. in Toronto. "There's such an inventory overhang, it shows there will be pressure on prices" in the months ahead.

One reason the market is hurting is that buyers and sellers are in a standoff over prices. Many sellers are reluctant to lower their prices. And buyers are hesitating because they think home prices are likely to move lower. "It really is a self-fulfilling prophecy," said Aaron Zapata, a real estate agent in Brea, CA. "If all buyers perceive that home prices are coming down, then they will stop making offers -- and home prices will come down."

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The median new home price dropped by 6 percent in July, to the lowest levels (on a nominal basis) since October 2003. Price erosion was not as great for resales, thus affordability is on par with late 2008 and mid 2009.

On average, the seasonally adjusted S&P/Case-Shiller home price composite indices exhibited very modest gains between May and June. Prices in eight metro statistical areas advanced while 11 declined.

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David Blitzer, chair of the Index Committee at Standard & Poor's, is concerned the modest upward trend in prices is set to reverse. “While [these] numbers are upbeat, other more recent data on home sales and mortgages point to fewer gains ahead,” Blitzer said. “The worry starts when you remember that the Homebuyers’ Tax Credit has expired, foreclosures are still at high levels, and July data on home sales and starts were very, very weak. The inventory of unsold homes and months’ supply data were particularly troubling. If this relative weakness in demand continues, it will likely filter through to home prices in coming months.”