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Macro View

While Housing starts slipped a little in October, they were better than expected. It looks like we are finally getting a bit of positive momentum in the housing market. The best leading indicator of housing starts are Building Permits, and there was very nice news in this regard.

For the month, total permits rose 10.9% to an annual rate of 653,000 and were up 17.7% year over year. That was far above the consensus expectations for a 603,000 rate. However, September was revised down slightly from a 594,000 rate to 689,000. Single family permits were up 5.1% on the month, and up 6.6% year over year. Multifamily (5 or more units) permits rose 29.5% on the month and are up 62.9% year over year. Given that it takes over a year for an apartment building to move from permitting to people moving in, the rise is not going to have an immediate impact on supply. Meanwhile apartment vacancy rates have been falling, and as we saw in the CPI report yesterday, rents are starting to rise. That is very good news for the housing-oriented REITs like Equity Residential (EQR - Analyst Report) and Mid American Apartments (MAA - Snapshot Report).

Regionally, the all-important South region was the strongest with a 215% rise, up 30.1% year over year. The South accounted for 53.6% of all permits in October. Permits were also fairly strong out West, with a 5.4% rise for the month and up 24.5% year over year. In contrast, the Midwest was down 3.7% on the month and off 7.2% from a year ago. The Northeast, the smallest of the four regions, was down 1.6% on the month and down 3.1% year over year.

The rise in permits suggests that housing starts will rise again in November. As far as single family starts are concerned, there is a bit of ambiguity as to if a rise is good news or bad. We need less supply to help the market clear, but in the meantime, the economy is going to be stuck in limbo, unless we can find another locomotive to help pull us forward. The one we have always relied on in the past is clearly derailed. Every housing start represents a lot of economic activity, and the effects go far beyond the bottom line of the big home builders.

Housing starts are an important part of the job picture. Construction has historically been an important source of relatively high paying jobs for those without a lot of formal education. Over 30% of the jobs lost since the start of the recession have been in Construction. The conundrum is how to get these people back to work without simply adding to the existing housing glut.

Eventually, the combination of a rising population and higher household formation will absorb the excess inventory, and we will be able to once again increase housing construction. Household formation is economist speak for kids moving out of their parents houses and getting a place of their own. To do so takes a job, and one that pays enough to support having your own place. In the past, residential construction itself provided a lot of those jobs. That produced an upward spiral. This time around, the jobs have to be created in other parts of the economy to increase the household formation rate and absorb the excess inventory, which makes the process slower.

This process should probably hit the rental market first, and we are starting to see that. Most of the decline in the vacancy rate has come from the rental side of the housing market. After all, kids moving out of Mom’s basement are more likely to first move into a rental apartment than to buy a house. The decline in the rental vacancy rate is thus a positive omen for the future. However, with the unemployment rate for those 20 to 24 years old running at 14.0% in October, it’s going to be a slow process. The unemployment rate for those 25 to 34 years old is also higher than that for the country as a whole at 9.8%. That is the prime age for buying your first house.

The recent good news on initial claims for unemployment insurance also means good news on the housing front, which in turn could spark more good news on the employment front. That is the sort of cycle that recoveries are made of. Provided that we are not pulled down by a freeze up in the credit markets due to the problems in Europe, and we do not repeat the mistake of 1937 by moving towards a concretionary fiscal policy way too soon, we might just have a strong economy in 2012.

However, the odds of escaping both of those hazards, seems low at this point. Taking $1,000 out of the pocket of everyone earning $50,000 a year, and $2000 out of the pocket of everyone earning $100,000 has the potential to derail the generally positive economic momentum we have been seeing in recent reports. Unless Congress acts soon, that is exactly what will happen as the ball falls on New Years Eve. A full scale collapse of the Euro has the potential to do as much damage as the 2008 meltdown. Thus it is possible that the light at the end of the tunnel is an oncoming train.

The day will come when housing is once again a big positive contributor to economic growth. The better than expected rate for both Starts and Permits in October suggests that residential investment may be a positive contributor to GDP growth in the fourth quarter. It is not really sustainable over the long term to have total housing starts running at substantially lower levels than we saw in the 1960s. Back then the population of the country was around 200 million, now it is north of 310 million.

The graph below shows the history of building permits in total, as well as the single family and apartment sectors. Note how anemic the permits have been in this recovery relative to previous recoveries. If you want to know why this recovery has been so sluggish; look no further than this graph.

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