The impact of rising federal funds rates and mortgage rates on our economy is enormous. The 5-unit sector in particular entered a recession in September 2023 and those permits have long been at COVID-19 recession lows. However, in the last few months, single-family permits have also declined. The turning point in every economic cycle is when construction workers lose their jobs in such numbers that it causes unemployment claims to rise.
Let's take a closer look at today's housing construction starts report.
From Census, building permits, Privately owned housing units occupied by building permits were at a seasonally adjusted annual rate of 1,386,000 in May. This is 3.8 percent below April's revised rate of 1,440,000 and 9.5 percent below the May 2023 rate of 1,532,000.
We want to keep it very simple. We have a backlog of orders that need to be completed, so this has kept workers on five-unit housing, because it takes 21 months to complete a 5-unit construction project. Once these projects are completed, there will be very little residential work for these construction workers and they will have to consider alternative options, such as government-funded projects like semiconductor fabrication plants. This is why we keep track of permit data.
We all know that 5-unit permits have been at COVID-19 recession lows for some time, but what is different now is that single-family permits are also falling. We still have a backlog of single-family homes that need to be built and purchase application data for those new homes is rising. However, once those homes are built, and if permits for new single-family homes continue to fall, it will be a problem for construction workers. Construction workers for single-family homes have already felt the blow after rates headed toward 7% in 2022.
From the census: housing starts, Privately owned housing construction starts came in at a seasonally adjusted annual rate of 1,277,000 in May. This is 5.5 percent (±9.4 percent)* below the April revised estimate of 1,352,000 and 19.3 percent (±10.0 percent) below the May 2023 rate of 1,583,000.
As we can see below, housing construction starts are at the lowest levels we saw in the COVID-19 recession. This is happening as permits for single-family homes have recently begun to decline. As more and more homes are being built, if we don't see permits increase soon, the homebuilding labor force pool will be at risk when their work is completed. Hopefully mortgage rates will fall soon, boosting builders' confidence and putting more deals in the pipeline. This was the case last year as well.
Why is this so important?
Economic cycles have similar patterns: one is that the Fed raises rates too much and is too restrictive, causing housing to go into recession first, which means the number of construction workers in the residential sector will decline first. We have been creating jobs in this sector in the past few months, but if this downward trend continues, the labor pool is at risk of declining.
Overall, this is a disappointing trend report on the housing construction data, but it has been going on for a while. The other side of this equation is that if construction workers break even, mortgage rates will fall and that will increase demand, so hopefully we can limit future production losses if that happens.
However, for now, we'll keep a close eye on this. Those who hear stories about high rates being inflationary are saying the same thing: that ultimately, restrictive policy will stifle future housing production. As I always say: “Supply is the best way to beat inflation. Destruction of demand is a short-term solution, supply wins in the long run.”