Construction Paradox: Why Do We Care About the Number of Single-Family Homes Being Built in the US When Permits Are Declining?

When you look at financial news today, you're likely to come across headlines about the US housing market. Specifically, there's talk about how in August, the number of single-family home starts increased, while the number of building permits issued decreased. At first glance, this might seem like dry statistics from across the ocean that don't concern you. But the opposite is true. This apparent paradox is like a mirror reflecting deeper economic trends and can impact your investment portfolio, whether you hold stocks, ETFs, or are just trying to understand the broader economic context.

Imagine a situation: builders in the US are trying to catch up with demand, which remains strong despite higher interest rates. Yet, at the same time, the number of "stamps" for future projects is decreasing. It's like having a workshop full of orders, but the authorities are limiting your access to new materials. What does this mean for home prices, housing availability, and, not least, for companies that rely on this sector?

The Story Behind the Numbers: From Boom to Uncertainty

The American housing market has experienced turbulent times in recent years. After the pandemic boom, when low interest rates and the desire for more space drove home prices to dizzying heights, a cooling-off period followed. The Federal Reserve (Fed) began aggressively raising interest rates to tame inflation, which immediately affected mortgage prices. The average rate on a 30-year fixed mortgage, which was around 3% in 2021, climbed above 7% in 2023, significantly reducing housing affordability for many Americans.

Despite this slowdown, the housing market shows interesting anomalies. In August 2023, the number of single-family home starts (housing starts) increased year-over-year by about 3.9% to a seasonally adjusted annual rate of 1.283 million units. This is a positive signal that builders are trying to catch up with the shortage of homes on the market, but at the same time, the number of building permits issued (building permits) fell by 6.9% to 1.443 million units. This decline is significant because building permits are a key indicator of future activity. It's like seeing homes under construction but knowing that not many new ones will start in the near future.

Statistics and Data: What Do Historical Trends Tell Us?

Why is this difference between housing starts and permitted projects so important? Building permits are considered a leading indicator of future developments in the real estate sector. When the number of permits decreases, it signals that developers expect lower demand in the near future or face higher costs and uncertainty, which discourages them from starting new projects.

Historically, when the number of building permits declines over the long term, it often foreshadows a slowdown in the entire real estate market, sometimes even a broader economic recession. For example, before the financial crisis in 2008, the number of building permits in the US reached annual highs of around 2.2 million units in 2005, only to fall below 500,000 units in 2009. The current decline of nearly 7% is less dramatic, but in the context of high interest rates and inflation, it's important to monitor.

On the other hand, the increase in housing starts may be due to efforts to complete already initiated projects and use existing permits before they expire or before market conditions worsen further. Developers are trying to sell homes they have under construction, even at the cost of smaller margins, to free up capital. This phenomenon is typical for the late cycle phase, where companies try to optimize their balance sheets and reduce exposure to risk. Focusing on completing and selling existing projects is logical when the costs of new projects are rising and demand is uncertain.

An interesting complement is the view of the inventory of unsold new homes. Even though construction is ongoing, the number of completed but unsold homes is around 430,000 units, which corresponds to about 8 months of supply at the current sales pace. The historical average is around 6 months. A higher inventory indicates that the market is more saturated, and buyers have more bargaining power, which can push prices down or at least slow their growth. This data suggests that despite the increase in housing starts, demand may not be strong enough to absorb all the new supply, which could lead to pressure on construction companies' margins.

Practical Framework: How to Navigate and What to Do?

For an investor, it's crucial to be able to interpret these signals. Here are some practical steps on how to do it:

1. Monitor interest rates and inflation: The level of mortgage rates is the alpha and omega of housing affordability. Any hint that the Fed will slow down or even start lowering rates can revive the housing market. Conversely, further increases can deepen the decline in permits and future construction. Also, watch inflation trends—if the Fed manages to tame inflation, it could open the door to future rate cuts.

1. Analyze regional differences and demographics: The US housing market is not homogeneous. While some regions may experience a decline, others, such as those with a large influx of residents or a strong economy (Texas, Florida, or areas with a developing tech industry), may be more resilient. Look for data at the state or metropolitan area level. Demographics are also important—aging populations, migration, and preferences of younger generations (e.g., smaller homes, city apartments) can affect demand in different market segments.

1. Diversify your portfolio across real estate segments: If you have exposure to the real estate sector (e.g., through REITs or construction company stocks), consider diversification. Instead of betting on one type of property (e.g., only single-family homes), look at commercial properties (offices, retail), industrial halls, logistics centers, or data centers, which may have a different cycle and react differently to economic changes. For example, demand for logistics centers is strongly driven by the growth of e-commerce, which can offset weakness in the residential segment.

1. Look for "value" opportunities and resilient business models: A sector downturn can reveal undervalued companies. Look for firms with strong balance sheets, low debt, and stable cash flows that can weather tough times. These could be suppliers of building materials (e.g., cement, wood), furniture makers, home appliance manufacturers, or companies providing home services (e.g., maintenance, renovation). These firms often suffer with the entire sector, but those with efficient management and diversified revenues can recover faster and offer interesting potential.

1. In QMA: Monitor sector scores and Watchlists. Our system allows filtering stocks of construction companies, material suppliers, or real estate sector firms and tracking their financial health, valuation, and momentum. You can create your own watchlists and monitor how, for example, QMA scores develop for companies like Lennar, D.R. Horton (major home builders), Home Depot (building materials retailer), or Sherwin-Williams (paints), which are directly affected by the housing market. This way, you can identify companies that are relatively strong even in a challenging environment or those facing the greatest challenges. open in QMA

Key Takeaways

1. Building permits are crucial: Monitor them as a leading indicator of the future health of the real estate market. A decline signals developer caution and potential slowdown, while an increase may indicate future recovery.
2. Interest rates move the market: Any shift in Fed policy has an immediate impact on the availability and cost of mortgages, and thus on housing demand. Be aware that rate changes manifest with some delay.
3. Look for resilient companies and diversify: In uncertain times, focus on companies with strong fundamentals that can weather economic cycles. At the same time, spread your investments across different real estate market segments or companies with diversified income sources to reduce reliance on a single cycle.
4. Analyze deeper than just headlines: Don't focus solely on one data point (e.g., housing starts). Combine it with other indicators, such as building permits, unsold home inventory, regional data, and demographic trends, to get a more comprehensive picture of the market's condition and future direction.

Sources and Further Reading

This topic has been covered by several financial media today. Factual basis and links for further reading:

• Yahoo Finance
• Seeking Alpha Market Currents
• Google News · Treasury Yields