Residential construction set for steady growth

After a sluggish start to the year, activity levels in the residential construction sector gained momentum in the second quarter of this year. The total number of new houses started in the United States actually declined slightly in the first quarter when compared with the same period a year earlier, but the second quarter tally from this year was almost 12 percent stronger than last year.

Adding the two quarters together gets us a year-to-date increase of 6 percent in 2014. Based on the strong gain in second quarter, we are forecasting an 8 percent gain for all of 2014. If this forecast holds, it will put the annual total for housing starts over the 1 million mark for the first time since 2007.

It is hard to overstate the importance of the trends in the data from the residential construction and real estate sectors when it comes to assessing the health and vitality of the overall U.S. economy. Economists have studied this relationship in great detail, and Federal Reserve Board Chair Janet Yellen has recently gone to unusual lengths to explain it to Congress.

Simply put, if it is a good time to build or buy a new house in America, then it is most likely a good time to make or buy almost everything else. The fact that the residential construction sector has stubbornly underperformed for the past six years (ever since the housing bubble burst in 2008) goes a long way toward explaining the sub-par growth in employment and macro-economic data during this time period.

Of course, no segment of the manufacturing sector is more acutely affected by the trends in the construction data than the extruders of pipe, profiles, siding, fencing, decking and other building materials. And as you should expect, our research indicates that overall business levels for these processors were constricted during the first quarter of this year. But demand for plastic building products improved markedly in the second quarter. We expect this upward trend to continue for the remainder of this year and throughout 2015.

The biggest segment of this group is plastics pipe, and it appears that this segment enjoyed a solid rebound in the second quarter. Our research indicates that the market for high density polyethylene pipe was affected more negatively in the first quarter than the market for PVC pipe was, but both of these segments were trending upward in the second quarter.

The divergence between the HDPE and PVC pipe data most likely reflect the differences in the trends in spending for new residential construction projects versus spending for alterations, additions and repairs to existing homes. Demand for HDPE pipe is strongest when new residential developments are being constructed, whereas demand for PVC is driven by both new construction projects as well as repairs and upgrades to existing structures.

The memories of the cold, icy weather and high energy costs that impeded construction spending last winter is likely a motivational factor for consumers to make repairs and enhance energy efficiency now that the weather is warm.

The market for siding registered a noticeable turnaround in the second quarter. Market activity for vinyl windows and doors so far this year has been steady-to-higher. Demand for fencing, decking and other types of building materials that do not lower energy costs or improve the primary functions of the structure has been slower to respond so far this year, but we expect the markets for these products to improve going forward.

So last winter is fast becoming a distant memory, and all of the indicators that measure sales and production levels for construction materials appear to either be recovered or in the process of recovering. I feel quite confident that we are now back to the trend that has prevailed since the recovery started.

Yet, as mentioned earlier, this trend has been sub-par for the last six or seven years. The housing starts total, which only this year appears poised to break the 1 million mark, needs to come in closer to 1.5 million units per year on a consistent basis before the housing market will be considered “fully recovered.”

And by now you probably realize that the main factor that drives demand for new houses is household income. Growth in incomes and wages has been frustratingly slow this recovery, but I am happy to report that there has been steady improvement in the fundamentals that generate income growth. Most notably, the employment data continues to trend higher and the pace of growth is accelerating.

As incomes rise, spending on real estate and construction projects will also rise. This will result in even more jobs and eventually more spending. Construction spending generates a lot of localized economic activity, and the result is a virtuous circle of rising incomes and stronger aggregate demand.

A silver lining of the past six years is that the subdued activity in the real estate markets and construction levels has resulted in a substantial amount of pent-up demand for new houses. Therefore, future gains in jobs and income levels will increasingly generate rising home prices, increased sales of existing homes and stronger demand for new houses.

If you factor in population gains, growth in new household formations, and the loss of units due to obsolescence or natural disaster, it is possible that the current stock of U.S. houses is underbuilt by as many as 5 million units.

I remain optimistic that this market will eventually recover and these 5 million new houses will get built. Because of the way this market works, there will be plenty of advance notice as the activity levels gain momentum. Processors who supply the residential construction sector should closely monitor the trends in the housing starts and permits data as well as the monthly employment figures and the data that measures sales of existing homes.

Existing home sales dipped during the first part of this year, but the data hit a cyclical bottom in March and have been rising ever since. They are still a bit below last year's levels, but mortgage rates are low, price appreciation is in a lull, and credit availability is gradually improving. These factors portend greater activity in this sector. This will in turn lift the data on housing starts, spending for alterations and repairs, and production of plastic building materials.