Pent-up housing demand means construction growth ahead

Market demand for building materials made from PVC is expected to remain in the same gradual but steady uptrend during the second half of 2017 that has prevailed for the past few years. The only wrinkle to this forecast is that this year's annual growth rates for PVC products will decelerate a bit from the relatively strong gains we enjoyed in 2016.

Indicators from the first half of this year suggest fencing and decking products are the fastest-growing segments, but they still represent a small fraction of the overall market. The largest segment of the PVC market is still the pipe sector, and the growth rate there should be solid for the remainder of this year and into 2018.

This outlook is based on the current trends in the residential construction data and also the underlying economic fundamentals that drive demand for housing such as employment levels, interest rates and new household formations. My forecast for housing starts calls for a gain of 5 percent in 2017 to a level of just over 1.2 million total units. This breaks down to roughly 800,000 single-family units and 400,000 multifamily units.

If this forecast sounds familiar, that's because it has not changed very much recently. In fact, my analyses of the residential construction sector and the market for plastics building materials in recent years have given me a whole new appreciation of the Yogi Berra-ism, "It's like déjà vu all over again."

The current phase of expansion in the U.S. economy marked its eighth anniversary in the second quarter of 2017. That makes it one of the longest periods of economic expansion in our lifetimes. But what really distinguishes the current expansion from all of the others I have ever experienced is its consistency. The economy's cruise control is pegged at a growth rate of 2 percent per year, and with few exceptions, that is what we have experienced quarter after quarter for the past eight years.

One other unusual fact about this particular recovery is that it did not start out in the typical manner.

Most all of the recoveries since World War II have been led by a strong rebound in housing starts, and until eight years ago, I would have told you that the housing starts data were the pre-eminent leading indicator of an economic expansion in this country.

As it turned out this time, the data for housing starts did not start to recover until about two years after the Great Recession ended. (That means the recovery in the market for PVC building materials is only six years old.) And despite the fact that the residential construction data has enjoyed six straight years of positive growth, the number of new houses started in 2017 will still be 40 percent below the peak that we hit in 2005.

These two factors, the consistent yet moderate rate of growth in the overall economy and the timing of the recovery in the housing starts data, are important elements in my outlook for plastics building materials. I believe that the residential construction sector is still playing catch-up to the overall economy. That means there is pent-up demand.

Mark Zandi, chief economist for Moody's Analytics, posited in a recent article that the United States needs an average of 1.2 million new single-family homes each year in order to keep up with new household formations, the demand for second and vacation homes, and to replace houses lost due to obsolescence and disasters like fires and floods. This year, we will build about 800,000 new single-family houses. If Zandi's calculations are accurate, the market will undersupplied by 400,000 units this year alone.

If you multiply the number of units the market is undersupplied on average by the number of years in this recovery in which the supply has been too low, you get a pretty good idea of what I mean by pent-up demand. The actual number is probably in the range of 1 million to 2 million and growing.

Now it is true that there are a number of factors that are impeding the construction of new houses such as labor shortages, permitting restrictions and issues with loans for some buyers in certain parts of the country. But market demand is a powerful thing, and one way or another, more houses will be built. All of these impediments can and will be overcome, it will just take time.

This recovery, in both the overall economy and in the residential construction sector, still has legs. The fact that this important sector is still performing well below its peak output is not only a contributing factor to the consistent but moderate pace of overall economic growth, it also suggests to me that a pace of 2 percent annual growth can persist for several more years.

The biggest problem with this forecast is that an increasing number of people are growing impatient with an economy that is expanding at a rate of 2 percent. In an attempt to woo voters, politicians tell us this country needs 3 percent growth if we are ever going to pay for all of our entitlement programs and at the same time provide higher-paying jobs to all of our workers.

And if that is how they set up their budget, and the voters go along with it, then I cannot argue with their logic.

But for plastics processors that supply the residential construction sector, a pace of 2 percent growth over an extended period of time can work. Not only will it keep a floor under the demand for housing, but also it will tend to keep financing costs low for a longer period of time because there is less incentive for the market to push interest rates higher. In addition, this pace of growth has the added benefit of keeping resins prices stable because there are fewer competitive pressures for the raw materials of crude oil and natural gas to go into energy production.