by | Dec 31, 2015 | Real Estate

Last Updated: December 31, 2015

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One of the biggest tenets of investing is to go where the money is and where it is growing – and right now that happens to be housing. Here is what you need to know about housing starts and how to play them for your investment portfolio.

Housing Starts

Image via Flickr by woodleywonderworks

Understanding Housing Starts

New housing starts are a strong economic indicator. They look at how many new housing units were started in a given period. Beyond permits, this data looks at the actual construction of these homes and looks solely at privately-owned homes – so “HUD” homes or mobile homes are excluded. On the surface, this economic indicator looks at the demand for homes that are newly constructed, but it means much more. When housing starts are high, consumer confidence and the economy well-being of the economy is usually pretty high too.

Current Housing Starts

Right now, consumer confidence and strong economy seem to be the case, or, at least, it was last month. On December 16, 2015, the U.S. Census Bureau reported on new residential construction in November 2015. “Privately-owned housing starts in November were at a seasonally adjusted annual rate of 1,173,000,” said the report. “This is 10.5 percent (±8.6%) above the revised October estimate of 1,062,000 and is 16.5 percent (±10.3%) above the November 2014 rate of 1,007,000.”

According to Bloomberg, “Work began on the most stand-alone houses since January 2008, and permits for similar projects reached an eight-year high.” All in all, an impressive increase – but the bigger question is whether it is relevant.

Seasonality in Housing

There is a chance that some of the increase seen in November could be attributed to seasonality and possibly a delayed cycle. For example, the Wall Street Journal reported that multistage builders lagged in September and started to rebound in October, whereas usually the fall season is strong. One builder, Cottage Advisors, quipped “It’s like the fall season just got started a little late this year.” Of course, it could also be a blip.

October was slow for home sales. According to Redfin, sales rose by only 0.3 percent in October 2015 compared to October 2014, which is “an abrupt slowdown from September’s double-digit growth.” Further, the Seattle-based real estate company said that 27 of the metropolitan areas it tracks posted slower sales than the previous year for October and compared to September, sales in every metro area declined, except four (San Francisco, Buffalo, Allentown, and Miami).

Going Forward

As strong as housing starts in November were, it is easy to improve on depressed numbers. “The housing market has been building momentum this year after a lackluster performance in the early years of the recovery,” explained the Wall Street Journal in November. “Still, construction activity is well below its pre-recession levels, which economists suggest may be holding back sales of new homes, constraining the supply of homes on the market and, in turn, pushing up prices.” Starts have been steadily improving and demand is healthy, but there are also labor shortages and, now the cost of borrowing just went up.

The Fed and the Bear Case

November’s housing starts may sound encouraging, and they are, but a lot has changed since then. Namely, the Federal Reserve has started to raise rates. As the cost for borrowing goes up, the number of individuals and developers looking to initiate new construction could falter. Wage growth will have to keep pace with the higher cost of borrowing if the momentum in the housing industry is to continue. Steady job growth has helped but, if the cost of borrowing keeps climbing, the improvement in the housing industry could be somewhat cancelled out.

Make no mistake, one of the functions of the Federal Reserve is to curb growth so that the economy does not venture into deflation, and raising interest rates has a direct effect. According to Moody’s Analytics in USA Today, “A 1 percentage point increase in the Fed’s rate over the next year could curtail economic growth the following year by 0.15 percentage points and monthly job gains by 30,000.” The Fed increasing rates by a quarter of a percentage point is unlikely to have much of an effect; the markets were expecting that and already priced for the increase. However, the higher interest rates could deter buyers or change what they buy, especially if the increase is not gradual.

Playing Housing Starts

Higher rates may mean the demand for cheaper housing goes up, but it does not mean demand goes away, at least not for moderately priced homes, but there may be a decline in new builds. “History shows homes starts have tended toward a decline, which will inevitably hurt homebuilders,” writes Business Insider. “When rates get higher, building new homes is usually a less attractive prospect.” Also, rising interest rates can signal to investors and speculators that the U.S. economy is strong. A slightly higher cost of borrowing will not likely deter many construction projects at this point, and some developers may want to initiate projects sooner while rates are still low. In addition, foreign investment in real estate could increase because of the impression of a stronger domestic economy.

Renee Ann Breiten

Renee Ann Breiten is a freelance finance writer and former management consultant with over 15 years of experience in business management and strategy. She earned an MBA in financial management from Exeter in 2007 and has enjoyed a variety of international business experiences, working primarily in England and Australia. Breiten's work is centered on technology, consumer trends, and investing strategies. Her writing has appeared on TheStreet, Marketwatch, Insider Monkey, Seeking Alpha and Motley Fool.