Housing Starts Plunged in May After Tax Credit Expired

Housing starts plunged in May, falling 10% to a 593,000-unit, seasonally adjusted annual rate, following the expiration of the federal home-buyer tax credit at the end of April. The drop was not entirely unexpected, but the key question moving forward is: How long will it take the sector to return to normal, healthy levels?

If one begins with the 1990s economic expansion median of a roughly 1.4- million-unit annualized rate -- it would be unreasonable to use the previous decade's "housing bubble" median of about 2.0 million units -- and assume a 15% increase in starts per year, it would take about five years for starts to return to normal levels near a 1.4 million rate.

Of course, housing starts, particularly when they're at a very low base as they are now, are capable of increasing 20% or even 25% in a year. If this happens, it would shorten the return time to normal levels.

Home Building: Strengthening or Meandering?

But how likely is a boom in starts given the current housing sector and U.S. economic conditions?

In addition to a reduction in inventories of new homes, the economic bulls would point to a 7.8% rise in starts since May 2009, when they totaled a 550,000-unit annualized rate, as a sign of life in the sector, after the recession's drought. Housing starts bottomed in April 2009, when they fell to a level of 477,000.

The economic bears, however, would see a more somber picture: a housing starts roller-coaster -- with starts rising up until the end of the initial home-buyer tax credit on October 30, 2009, then falling, then rising again until the end of the tax credit's extended period on April 30, 2010, then falling.

Another data point the bears would cite: building permits, which again fell substantially in May, plunging 5.9% to a 574,000 annual rate, after plummeting 10% in April. Economists monitor building permits because they are a telling gauge of future activity in the sector.

Taken together, the decline in starts and permits as the tax credit expired suggests a home-building boom is not likely in the quarter ahead. Builders are not seeing enough demand in the economy to warrant substantially increasing home-building activity. And more than likely, builders will need to see sustained, monthly job growth of 150,000 to 200,000 jobs per month -- with an increase in household income driven by that hiring expansion -- before deciding to markedly increase construction of new homes.