Declining Housing Demand - US Economy

How a Declining House Demand Will Affect the US Economy

House prices are still going strong in the US as compared to a decade ago.

Low unemployment levels are driving up the house prices, according to Noble Prize winner economist Robert Shiller. However, the rate of increase in the housing market has declined.

In February this year, the US housing market had slowed more than unexpected. The construction of homes had dropped to an all-time low. The prices of new houses fell 8.7 percent last month. This was the largest decline in new house construction in the past eight months.

So, how will the declining house prices affect the US economy?

Understanding the Effect of the Housing Sector on the US Economy

The housing construction sector is included in the investment side of the total GDP spending. The total investment in housing sector experienced cyclical swings. Although the housing market does not directly impact the GDP, it affects the market indirectly through consumption spending.

The drivers of the housing market include housing demand, consumer income, credit availability, employment levels, interest rates, and spending levels.

With high demand in the housing market, homeowners will be more confident about spending. They can avail mortgage loans by using their existing homes as a mortgage.

Strong demand in the housing market encourages individuals to purchase and build new homes. This leads to increased activity levels in the construction sector. Consequently, the demand for construction products such as steel, cement, wood, tiles, and others increases.

In short, an increase in the housing market has a positive effect on the country’s GDP.

The rising demand in homes between 2000 and 2007 correlated with an increase in consumer spending and corporate investment. However, after the financial crisis of 2008, consumer spending and corporate spending declined significantly.

Studies have found that changes in the housing demand relate to the changes in consumption spending in developed countries.

Low house demand is affected by a number of factors. Some of the factors that affect the health of the housing market include the following.

• Interest rates
• Employment levels
• Consumer confidence in the economy
• Income levels

The rising prices of homes leads to more borrowing. On the other hand, people will focus on repaying their mortgage in the event of declining house prices.

Lackluster demand in the housing sector also affects the manufacturing sector. Due to a reduced house demand, the demand for building materials, furniture items, and appliances have also declined. This means reduced employment in the manufacturing sector.

A Dialectic Effect of House Demand on the Economy

The housing market holds back economic recovery. Due to the rise in house prices, more people are renting apartments and condos instead of buying new houses. This is particularly the case in urban areas, especially in New York, San Francisco, California, and Washington DC.

Over the past decade, most Americans have desired to own homes and everyone from the construction sector to banks have tried to make this dream a reality. This, in turn, had a positive impact on the overall economy leading to increased employment levels, income, and GDP.

However, things are changing now.

The housing market has become dialectic with the average and low-income Americans renting homes, while high-income owners building homes in luxurious areas. The price of luxury homes has outperformed the main housing market in the past few months.

The demand for houses with in-home spas, swimming pools, and outdoor kitchens is not just local, but international as well. This has led to an increase of nearly 4.7 percent in house prices during the last quarter of 2018.

Still, the international demand for luxury houses in line with the mainstream market has declined this year. This has been mainly due to the economic uncertainty caused by rising oil prices, Brexit, and slowdown of the Chinese economy.

Despite the decrease in demand, luxury house owners have decided to hold on to the inventories. This has made luxury homeowners reluctant to make new purchases.

The number of new luxury homes for sale that are priced above $2 million has decreased.

Effect of Rising Interest Rates on the Housing Sector

Looking back at the historical figures, the housing permits have an impact on the US recession. A recession results if the number of new permits has fallen by over 20 percent. At the moment, the new permits have posted small but positive growth.

The good point about the US housing market is that the structural vulnerabilities in the household sector have largely been diminished. The consumer debt levels as a percentage of GDP have reduced significantly since the crisis.

In addition, the ratio between the cost of servicing the debt and disposable income has also improved.

The rising income rates as per the Fed’s commitment to policy normalization can create a dent in the market. This will lead to an increase in the mortgage cost and decrease in the housing investments.

The big question is whether the rates will increase significantly and affect investment in the sector. If the mortgage increases to the point that it affects the repaying ability of consumers, it can have a negative impact on the housing sector and the US economy.

Since most of the mortgages are on 30-year fixed terms, higher policy rates will not have an immediate impact on the house prices. A report by Morgan Stanley has predicted that a quarter percentage point increase in the interest rate will result in four basis point increase in the house prices.

While the share of the construction sector as a percentage of GDP had decreased over the year, it does have a heavy impact on the economy. Lackluster performance in the construction sector can become a drag to the US economy.

Looking forward, housing trends point to rising prices in 2019 and beyond. In fact, this is the best year to invest in a home. Investors who buy houses today will likely be treated to above average returns in the medium and long term.


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