- Some investors may be missing out on opportunities in building products because they have fresh memories of the 2007-2009 Great Recession.
- However, the segment’s fundamentals are strong: Housing starts trail the long-term average, the imbalance between supply and demand favors continued market stability, and repair and remodeling activity remains steady.
- These positive indicators, combined with moderating valuations and less competition to contend with, make it a great time for investors to get in the game.
Three Factors Contributing to Stability
- Current housing starts trail the long-term average
- The imbalance between supply and demand favors continued market stability
- Repair and remodeling activity remains steady
1. Current housing starts trail the long-term average
Source: U.S. Census Bureau
2. Imbalance between supply and demand favors continued growth and market stability
As Figure 2 illustrates, cumulative excess inventory of housing is at its lowest point in nearly 50 years—largely because housing starts have been below their long-term average over the past decade.2 “There’s a shortage of housing relative to demand, and that should keep home prices high in the medium term, assuming interest rates don’t increase significantly,” says Graham Rives, a director in the Building Products & Materials Group.
Figure 2: Current housing inventory below long-term average
Source: U.S. Census Bureau (1. 2019 Figure Represents Seasonally Adjusted October 2019 Data 2. Long-Term Straight Average from 1980-2000 3. Cumulative Housing Starts Minus Cumulative Long-Term Straight Average)
3. Repair and remodeling activity remains steady
Repair and remodeling (R&R) spend has recovered steadily since its bottom in 2010, and is now slightly above the long-term trend (Figure 3).3 The R&R market is expected to remain stable due to increasing home sales, aging housing stock, retrofits for older homeowners, and financially healthy consumers with growing disposable income.
Figure 3: Repair and remodeling spend growing steadily
Source: Home Improvement Research Institute (HIRI)
“With home prices appreciating as quickly as they have been in several large markets, many homeowners are thinking about staying in their current locations longer and remodeling instead of moving,” notes Hogan. “And owners of older houses see this as a good time to make their homes more relevant to modern living—adding bathrooms or bedrooms, expanding their kitchens, or creating more open space. All of this translates into steady demand for building products.”
Evidence for a Milder Cycle
Despite these solid fundamentals, some investors are shying away from the sector because of the length of the current recovery, believing that a downturn is coming. While the current recovery is long by historical standards, that doesn’t necessarily mean a recession is imminent. In fact, there are several reasons why the next downturn may be several years away, as well as more moderate.
“One reason is the sheer depth of the hole we had to climb out of a decade ago,” says Webb. As illustrated in Figure 4, the 2008 downturn was extraordinary from a housing starts perspective: The 73% peak-to-trough drop of housing starts was the most severe in the past 50 years by over 25%.4 As Webb explains, “With far more ground to recover, the market inherently should be expected to take longer to get back to ‘normal.’”
Figure 4: Historical housing starts
Source: U.S. Census Bureau
Closely related is the fact that housing starts have grown at a compound annual growth rate (CAGR) of 9% during the current expansion, lower than five out of the seven previous recoveries.
“In the majority of housing cycles of the past 50 years, this CAGR has exceeded double digits,” says Hogan. “It surpassed 20% in two of those cycles, both of which were severe housing cycles that saw starts drop by more than 45%.”
“And if you look at the underlying economic drivers of this recovery, annual GDP growth hasn’t broken 5% in this cycle, which it did in all prior economic recoveries,” says Webb. “So, while the current recovery is long, it has been muted in terms of growth and, therefore, the continued length of the expansion is not as surprising.”
Beyond growth rates, the total number of housing starts also suggests any near-term housing downturn would be relatively muted. Returning to Figure 4, over the past 50 years, there has not been a housing decline that began when starts were below the long-term average of 1.43 million. Today, starts stand at approximately 1.3 million—15% below the lowest peak before a downturn in the past 50 years, and 40% below the peak before the Great Recession.5
Current housing starts are only slightly above the trough average from prior downturns. This suggests that if there was a housing cycle in the near-term, it should be modest, in the mid-single-digit percentage point range. “With housing starts at the current level, a significant housing downturn in the near term would fly in the face of 50 years of history,” notes Hogan.
There also are historical reasons to believe that if a downturn does eventually happen, it’s likely to be mild. In analyzing past housing downturns, the three least severe were 1999-2000 (4%), 1968-1970 (5%), and 1994-1995 (7%), each of which featured a macroeconomic backdrop similar to today—low unemployment and moderate inflation characteristics. Additionally, peak housing starts preceding each of these downturns were 10-20% higher than they are today.6
“There’s a misconception that the length of a recovery is directly correlated to the severity of the next downturn,” Rives says. “But from a housing starts perspective, history suggests there is still room for growth, and if there is a decline, it will be notably less severe.”