In this episode of the REconomy Podcast™ from First American, Chief Economist Mark Fleming and Deputy Chief Economist Odeta Kushi discuss how to define the term ‘housing recession’ and try to determine whether or not the U.S. housing market is currently in a housing recession.
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“This is a fundamentally different housing market than the market that defined the housing bust of the mid-2000s. Lots of equity, tighter lending conditions this cycle, very little distressed selling, low debt-to-income burdens, and price changes are actually so lagging, it's hard to say if this should be in the 'for recession' column right now, because prices follow all these other indicators by so much time.” – Mark Fleming, chief economist at First American
Odeta Kushi - Hello and welcome to episode 59 of the REconomy podcast, where we discuss economic issues that impact real estate, housing and affordability. I am Odeta Kushi, deputy chief economist at First American and here with me is Mark Fleming, chief economist at First American. Hey Mark. In today's episode, we're going to try to define an economic and housing phenomenon that real estate professionals regularly reference and whose definition is inherently assumed but has never been definitively established. Can you guess what I'm referring to?
Mark Fleming - Hi, Odeta. Starting out the episode with a puzzle for me to solve. Let's see. How about 'balanced market' or 'sellers'' and 'buyers'' markets? They're not very well defined. Am I close?
Odeta Kushi - Not quite. I will give you a clue, though. Many think that we're in one of these right now.
Mark Fleming - Now, that's easy. A housing recession.
Odeta Kushi - Exactly. If you've read the news these days, you've probably seen the term 'housing recession' floating around quite a bit. But, much like a regular recession, there isn't a straightforward definition.
Mark Fleming - That's right. And we talk all about defining economy-wide recessions in Episode 44 of the REconomy podcast, but I think a refresher is in order here. In 1974, in a New York Times article, economist Julius Siskin, came up with a few rules of thumb to define a recession, the most popular was two consecutive quarters of declining GDP.
Odeta Kushi - A healthy economy expands over time. So two quarters in a row of contracting output suggests that there are serious underlying problems, according to Siskin. This definition of recession became the common standard over the years. But, as with all rules of thumb, it was imperfect.
Mark Fleming - I would say. So, by that criterion, then the spring of 2020 was not a recession, we didn't have two full quarters of economic decline. In fact, it was more like two months before the economy began to rebound. Not to mention swings in GDP can be driven by different factors that don't necessarily imply that the American economy is worse off. Fluctuations in net exports, for example, the difference between what the U.S. exports and what it imports, otherwise known as the trade deficit, don't necessarily mean the American economy is worse off. If other countries buy less of our exports, our GDP goes down, which says little about the health of the actual domestic economy.
Odeta Kushi - In fact, the recent strength of the U.S. dollar relative to other currencies is making our exports more expensive and has reduced our export demand. Alright, so if it's not two quarters of GDP, then how is a recession defined?
Mark Fleming - Well, the National Bureau of Economic Research Business Cycle Dating Committee, the N.B.E.R.B.C.D.C., which I think that's our acronym on those last four letters there, is the official authority on recession starts and end dates, and they have a more flexible definition of a recession.
Odeta Kushi - N.B.E.R.B.C.D.C. sounds like the name of a band, by the way, but go on.
Mark Fleming - Wait, you're right. B.C.D.C., I'm gonna have to go there, Highway to Hell, anyone? Anyone.
Odeta Kushi - I do know this one, by the way.
Mark Fleming - Livin' easy, livin' free, going down, party time. That seems actually quite analogous to the Fed's punchbowl that's been taken away.
Odeta Kushi - This is now a music podcast everyone. There's been a change of plans.
Mark Fleming - Paid my dues in a podcast band. Get it? All right. Okay. The committee says a recession involves a significant decline in economic activity that is spread across the economy and lasts more than a few months. And they use three criteria depth, diffusion and duration. They look at measures ranging from real personal income less transfers, that means they're just taking out Social Security payments and welfare payments, non-farm payroll employment, or employment as measured in the household survey, and many more.
Odeta Kushi - Interesting. So, is there an H.C.D.C., a Housing Cycle Dating Committee to officially call housing recessions?
Mark Fleming - I can't help myself here. I'm thunderstruck. Anyone?
Odeta Kushi - Oh gosh.
Mark Fleming - Anyone? No, with regard to the H.C.D.C., shockingly. Get it? Get it? Okay. No, what constitutes a housing recession is up for debate, just like the economic one, but some rules of thumb exist in housing as well. For example, six consecutive months of home sales declines may constitute a recession, according to some.
Odeta Kushi - All right, well, just like with the GDP heuristic, that makes sense. We definitely had at least six months of declining total home sales in 2008, which was a tough period for the housing market. But can we get a little bit more specific?
Mark Fleming - We will attempt to do exactly that. While we won't be able to fully define what makes a housing recession in today's episode, it would be a long episode, we'll aim to define it over several. And the way we will do that is by following a similar approach to the B.C.D.C.
Odeta Kushi - Well, that means we have to identify and analyze lots and lots of different relevant metrics. It's a lofty task. Perhaps that's why it hasn't been done, as far as we know. But let's get started by discussing how housing-related activities contribute to the GDP, since we did start the episode with a discussion of GDP. And the first way is residential fixed investment and the second is housing services. Mark, care to explain residential fixed investment, otherwise known as RFI?
Mark Fleming - Sure, think of RFI as the homebuilding contribution to GDP and it includes construction of new single-family and multifamily structures, residential remodeling, production and manufacture of homes, and brokers' fees. RFI is quite cyclical, makes up anywhere from 3.5% to 5% of GDP on average. And, in the last quarter, it was just about 4% of total GDP.
Odeta Kushi - And the second component is housing services, which includes gross rents, including utilities paid by renters, and owners imputed rent, or an estimate of how much it would cost to rent owner-occupied units, and utility payments for housing services on average is roughly 12 to 13% of GDP. And in the latest Q4 2022 data, it was nearly 12% of GDP.
Mark Fleming - So residential fixed investment is about the manufacturing of housing, and housing services is about the utility we gained from using it. How have those housing-related activities fared in 2022?
Odeta Kushi - Well, housing services has actually been increasing, whereas RFI has been declining on a quarter-over-quarter basis for three consecutive quarters. That's not surprising, given that homebuilding has slowed in response to reduced demand from higher mortgage rates.
Mark Fleming - So, one part of housing GDP is going up, and the other one is going down. But, if we put the two together and call it our housing GDP estimate, it turns out that thanks to rising housing services, housing GDP, the combination of the two, has been increasing quarterly throughout 2022.
Odeta Kushi - So, by the Siskinian rule of thumb - that's even harder - Siskinian rule of thumb, no recession in housing. I'm not sure I'm convinced, though. I think we need more data. And, since we're on the topic of homebuilding, let's see how the construction labor market is doing, so we're starting with labor here.
Mark Fleming - The number of construction workers is actually holding up quite well, even in the face of a housing slowdown. In the latest January jobs report, residential building jobs were up nearly 12% compared to the pre-pandemic level, while non-residential building jobs, that's sort of commercial real estate, just surpassed its pre-pandemic level in January.
Odeta Kushi - Not only that, but wage growth is also up in the sector. Average hourly earnings in construction were up approximately 6.2% on a year-over-year basis, significantly above the pre-pandemic average pace of about 2.8%. And, in the December JOLTS report, the ratio of construction hires per job opening, which is a measure of how easily employers can turn job openings into new employees decreased, indicating it's more difficult to hire.
Mark Fleming - So, more workers, more pay, and can't find enough of them. Well, that doesn't seem very recessionary. Was that the case in 2008, and 2009?
Odeta Kushi - Quite the opposite. Actually, the ratio of construction hires per job opening hit a historic peak in 2009. And there were a record number of unemployed per job opening. So some aspects of the construction labor market pointed to trouble during the housing crash. But, today, not so much. Even though single-family housing permits and starts are down, the construction labor market is doing well. Now, there might be an explanation for that. Remember that recessions come in all shapes and sizes and, of course, it is likely similar in housing as well. But the construction labor market has faced a shortage of skilled construction workers since the end of the Great Financial Crisis. So employers today are not likely to let skilled workers go. And there is still a large backlog of single-family homes under construction, hampered by supply-side headwinds from labor shortages and high construction material costs. The pandemic just made all of that a lot worse. So, even if groundbreaking on new homes is slowing, you still need more hammers at work to complete those homes that are in the process of being built.
Mark Fleming - That's a great point. But, of course, construction is just one piece of the housing labor market. There's so much more.
Odeta Kushi - You mean like the other, almost 90% of the housing market, existing homes.
Mark Fleming - Well, indeed there is that part. There's also mortgage brokers, real estate agents, the furniture salesperson, the home improvement store, and so on, and so on.
Odeta Kushi - Yeah, I get the point. A lot to cover in one episode, I think. But generally the labor market remains tight. And, as we just explained, so does the construction labor market. So maybe those metrics don't necessarily point to a housing recession today. But what about when we look at sales, prices and affordability?
Mark Fleming - That's definitely when things seem to get a little bit gloomy here. Let's talk first about sales.
Odeta Kushi - All right, well, existing-home sales fell for the 12th straight month in January to the lowest level since 2010. That's even lower than the pace of sales at the worst of the pandemic. And new-home sales also declined to the slowest pace since 2016 in the summer of last year. Home builder confidence declined for the 12th consecutive month in December, with more builders viewing sales conditions as poor than good.
Mark Fleming - Alright, so sales probably does point to a recessionary housing market. Though I should mention that there are signs that the housing market, in terms of sales, seems to be approaching a floor. So, maybe the worst is over with regard to that one particular perspective.
Odeta Kushi - That's a good point. Several metrics have moved up in recent months. Pending home sales, builder confidence, mortgage applications, recently new-home sales, but a meaningful demand recovery is heavily dependent on the outlook for mortgage rates. But I digress. We're talking about recessions here. So let's move to affordability. That's another metric that points to a recessionary housing market. Now the way we measure affordability is using our Real House Price Index, otherwise known as the RHPI. Lots of acronyms in this episode. The RHPI adjusts prices for purchasing power by considering how income levels and interest rates influence the amount one can borrow.
Mark Fleming - And, understatement of the moment here, affordability has been declining for some time now.
Odeta Kushi - It sure has. In fact, affordability hit a near historic low in October of last year. And it's not much better today. In our latest December 2022 report, affordability was down 48% compared to one year ago. This decline in affordability was driven by primarily two factors, a nearly 6% annual increase in nominal house prices, and a more than three percentage point increase in the average 30-year, fixed mortgage rate compared with one year ago.
Mark Fleming - But affordability was also pretty bad in 2006. So, big if here, were measuring housing recession by just looking at affordability metrics, it would seem a lot like we're in one today, like we were back in 2006 or just after that. Add that to the sales indicator in the 'for recession' column. We've got a couple now.
Odeta Kushi - But, what about prices? While prices are declining from peak levels today, it's nothing like what happened in the housing bust of the mid-2000s.
Mark Fleming - That's right. As we've said before, this is a fundamentally different housing market than the market that defined the housing bust of the mid-2000s. Lots of equity, tighter lending conditions this cycle, very little distressed selling, low debt-to-income burdens, and prices are actually so lagging, it's hard to say if this should be in the 'for recession' column right now, because prices follow all these other indicators by so much time.
Odeta Kushi - That's a good point. So let's do a little recap on the measures we've outlined so far. The metrics that point to a housing market in recession are affordability, sales and the homebuilding component of GDP. While housing services and the labor market is pointing to a still strong market. Have we come to any conclusions yet?
Mark Fleming - I certainly don't think we've reached any definitive conclusion at this point. That's why we will be covering this topic in multiple episodes. Just think about it this way. Housing has a multiplier effect on the economy, a decline in housing demand, can depress that demand in other areas, such as commodities, durable goods, a whole host of different housing services.
Odeta Kushi - So other metrics we could analyze to help us to find a housing recession could include more than just the construction segment of the labor market. Furniture retail sales, for example.
Mark Fleming - Well, since you did bring it up, how are furniture sales holding up these days?
Odeta Kushi - Pretty well, actually. According to January retail sales data, sales from furniture and home furnishing stores are well above pre-pandemic levels.
Mark Fleming - So I think that's another point in the 'against' column for the housing recession thesis.
Odeta Kushi - If you're keeping score, yeah, I think it is. That is another point. But I think this is a good time to mention that, even when we've made our way through and aggregated lots of different data, the decision to call a recession is still at the discretion of the researchers. Even the B.C.D.C. says, quote, there is no fixed rule about what measures contribute information to the process or how they are weighted in our decisions, end quote.
Mark Fleming - Wait, wait, who's on this H.C.D.C. of ours? And are they required to know lots of 80s heavy metal music to be a member? I think it should be a requirement. Well, at least we can start by framing the debate with data.
Odeta Kushi - I think I vote for you to be president of the H.C.D.C., by the way. Because you do know the heavy metal, and you have the housing background. Well, framing the debate with data is what we do best. And I think we'll end the episode there. We've already covered a lot of different indices and more to come on this topic. Tune into future episodes for more about defining a housing recession. All right. Well, that's it for today. Thank you for joining us on this episode of the REconomy podcast. If you have an economics-related question you'd like us to feature on a future episode, you can email us at economics@firstam.com. We love to hear from our listeners. And, as always, if you can't wait for the next episode, you can follow us on Twitter. It's @OdetaKushi for me and @MFlemingEcon for Mark. Until next time.
This transcript has been edited for clarity.