Eye on the Economy: Housing Avoids the Fiscal Cliff — for Now


*Eye on the Economy is an NAHB newsletter that is published every two weeks and takes a larger view of recent economic and housing policy news.

One of the threats to the continuing recovery in housing was the prospect of falling off the “fiscal cliff.” Had Congress failed to extend the expiring 2001 and 2003 tax rates, the economy may have fallen back into recession, according to the Congressional Budget Office. The resulting job losses would have reduced demand for both renter and owner-occupied housing, thereby halting the expansion of residential construction that contributed significantly to economic growth in 2012.

However, Congress and the President agreed to a fiscal deal at the beginning of the new year, which is fairly positive for housing and home builders. The new law permanently extends the income tax rates paid by those with less than $450,000 in adjusted gross income (AGI) ($400,000 if single), including the rates paid for capital gains and dividend income. This is a positive development for home builders, 80% of whom are organized as pass-through entities and who pay business income taxes on individual income tax forms.

The deal also sets permanent rules for the estate tax, the AMT patch and other elements of the 2001/2003 tax cuts. On the negative side, the law reinstates the Pease itemized deduction phase-out.  This rule will reduce slightly the value of itemized deductions, such as for charitable giving and mortgage interest, for taxpayers above $300,000 in AGI ($250,000 if single), by 3 cents for every dollar above the threshold amounts. For example, a married taxpayer with an AGI of $400,000 would face a loss of $3,000 in itemized deductions and perhaps $1,000 in additional tax liability. This rule, while complicated, should have only a small effect on housing demand.

However, the reinstatement of the Pease rule suggests that policymakers are eyeing itemized deductions, like the mortgage interest deduction, as potential revenue raisers in future fiscal debates. And those debates are coming: In February, the debt ceiling will need to be raised and the now-delayed sequester on government spending must be addressed. The year 2013 may be defined by a series of mini-cliffs, the resolution of which will certainly affect home buyers and home builders.

Despite the uncertainty created by the potential of falling off the fiscal cliff, the news for the housing market continues to be generally positive. The NAHB/Wells Fargo Housing Market Index measure of single-family builder confidence rose for the eighth straight month to a level of 47 in November, the highest level since April 2006.

While total housing starts as reported by the Census Bureau fell 3% for the month, the first two months of the fourth quarter set a construction pace (an average of 875,000 starts rate) that is 13% higher than the rate of building in previous quarter. The starts rate for apartments in buildings with five or more units was up in November at a rate that is the highest since July 2008.

The share of custom homes, that is contractor- and owner-built homes, stood at 26% (on a four quarter moving average) of all single-family starts for the third quarter of 2012, down from the peak of 31.5% during the second quarter. This share will continue to decline as single-family starts continue to grow.

New and existing home sales were up in November. Sales of newly constructed homes rose 4.4% to a seasonally adjusted rate of 377,000 according to the Census Bureau, the highest monthly total since the end of the federal home buyer tax credit program in April 2010. The inventory of unsold homes increased slightly to 149,000, but the higher sales pace helped reduce supply to 4.7 months’ worth.

National Association of Realtors (NAR) data showed that existing home sales were up 5.9% for the month and are up 14.5% from November 2011. Like new homes, the inventory of existing homes has fallen significantly, with the supply down 3.8% for the month to a total of 2.03 million homes – a 4.8 month supply.

Existing home sales should continue to grow, as the NAR Pending Home Sales Index increases 1.7% in November, reaching the highest level since April 2010. Moreover, as part of the fiscal cliff deal, the extension of the tax relief for forgiven mortgage debt in 2013, should ensure short sales continue without tax consequences, thereby helping to work off the distressed inventory.

Continued growth of home sales means the period of significant price declines has ended. The Federal Housing Finance agency reported that nationally, prices were up 0.5% in September on a seasonally adjusted basis. On the other hand, both composite indexes for Case-Shiller were down slightly in October after peaking in the summer.

Continued accommodative monetary policy should help shore up housing demand. For example, in December the Federal Reserve announced explicit targets for unemployment and inflation. In particular, the Fed’s policymaking body indicated that it would not increase interest rates as long as the unemployment rate remains above 6.5% and inflation projections one to two years out are not above 2.5%.

Housing continues to outperform the economy as a whole, a role the sector usually fills during the beginning of an economic recovery. The final estimate for GDP growth in the third quarter came in at 3.1%, with home building responsible for 10% of that total – an outsized share given home building is approximately 2.7% of the economy.

Consumer prices declined slightly (0.3%), per the CPI for the month of November, the first drop since May 2012. The decline was due to a steep drop in energy prices. Similarly, producer prices, as measured by the PPI, declined 0.8% in November, lead by energy price reductions. Nonetheless, for 2012, prices for home building products were up year over year. Prices for gypsum (14%) and softwood lumber (13%) are notable examples.

Despite the soft national economy, housing demand is being supported by improving household balance sheets, accomplished in part by household deleveraging, as families pay down debts and build up savings. For example, recent data suggest mortgage and credit card debt continues to decline, while auto and student loans are on the rise.

While there has been a general trend of more positive conditions since early 2009, there have been ups and downs in this process due to stock market and other asset value fluctuations. As of the third quarter of 2012, net worth relative to disposable income measures stood above historical averages. This suggests that the process of household balance sheet repair may be coming to a close, with the end determined by how much demographic change in the United States, particularly the aging of the population, has moved the new “normal” for balance sheets from the historical average.

Although household finances are improving and taxes targeted on housing have been avoided for now, there are other headline risks on the horizon for housing, including proposed Basel III rules regarding bank capital that could raise the cost of lending to home buyers.

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