Housing Slowdown’s Ripple Effect
By: Troy Scroggins - Marketing/Communications Director
1/17/2007

As the new year begins, there is much discussion of the slowdown in the residential construction market in the U.S., but not as much talk about the presently healthy commercial construction landscape.  The dialogue may change as 2007 unfolds and the effects of the declining housing market begin to be felt by other industries.

U.S. manufacturing is already feeling the pain.  While 2006 started out hot for most manufacturers, slowing demand left them with bloated inventories by the end of the year.  Part of the reason for sagging demand was auto production cutbacks, but a significant portion was attributed to the slowdown in the housing market.

November 2006 statistics from the U.S. Dept. of Commerce showed a slight increase in the seasonally adjusted annual rate of housing starts compared to October; however, the 1,488,000 figure was still 25.5 percent below the same rate from a year ago.  For example, in Fort Wayne, IN, a Midwestern city of 300,000, housing starts are off 26 percent this year.  Prior to November, housing starts had experienced a three-month, annualized rate of decline of nearly 50 percent.  Using another measure, fixed residential investment fell at an 11.1 percent annual rate during the second quarter of 2006, followed by a 17.4 percent drop in the third quarter.

After a decade-long boom, the housing market appears to be adjusting for excess inventory.  Demand began to wane in many markets throughout the U.S. at the end of 2005.  Nationwide home sales had fallen by 22 percent through October 2006.  Nevertheless, residential construction continued at the “boom” pace until late in 2006, creating an “overstock” that will take some time to reduce.  This glut depresses the market value of existing homes, however; most owners refuse to drop their asking price in the short term, further stifling home sales and causing consumers to be more conservative in their spending habits.  Depending on the Federal Reserve’s policy on interest rates and consumer confidence, demand for housing may be depressed for a prolonged period of time.

While fixed real residential investment represents only five percent of the GDP, it affects other areas of the economy, such as purchases of furniture and household equipment, which constitute another five percent of growth.  It also impacts employment as evidenced by the loss of 110,000 residential construction jobs since February 2006.  An estimated 400,000 to 600,000 residential construction jobs will be lost by the middle of 2007.

Many will point to the fact that commercial construction has more than made up the difference in the declining housing market, both in employment and growth.  The question is:  Will commercial construction continue to make up the difference or will it begin to suffer from the impact of a prolonged housing downturn?

The axiom, “if you ask 10 different economists the same question, you’ll get 10 different answers,” holds true for perspectives on how declining residential construction will impact the U.S. economy.  Theories suggest that housing slowdowns tend to lead recessions rather than result from them.  In five of the last seven economic recessions in the U.S. since 1965, a weak housing market existed prior to the decline.  Others contend that declining non-residential investment precipitates a recession and recoveries are associated with residential investment.

There is no debate that a decrease in residential construction reduces demand for building materials, some durable goods (kitchen and bathroom appliances), furniture, carpet, etc.  While residential construction alone is subtracting 1.1 percentage points from U.S. growth at the present time, when combined with the materials noted above, the reduction in the GDP amounts to 2.6 percentage points.  With GDP growth averaging between 2.8 and 3 percentage points (the current estimate of the trend growth rate – sustainable and non-inflationary), the total impact of the decrease in residential construction brings the economy to the brink of the definition of a recession.

Construction equipment manufacturers believe the declining housing market will have an effect on their business.  Caterpillar Inc. stated in November that it expected 2007 sales to be flat to slightly above this year’s totals due to expectations of a continued U.S. housing slowdown and weaker demand for heavy-duty engines.  Deere & Co. also expects to be hurt by weakness in the light construction equipment market in 2007.  Bank of America’s Seth R. Weber said, “Continued growth in non-residential construction will be more than offset by a weak housing construction market and potential for pricing pressure on smaller and compact machinery.”

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