Wells Fargo Reports: December Housing Starts Headline Full of Hubris

Housing starts jumped 11.3 percent in December, ending the year at a 1.226 million unit pace. Multifamily starts surged, while single-family posted its second weak monthly reading. Permits fell during the month.

Solid December Report, but Payback Is in the Offing

Thanks to an outsized surge in the volatile multifamily component, housing starts ended 2016 on a solid note, rising to a 1.226 million unit pace in December from an upwardly revised 1.102 million unit rate in November. Although the strong reading is welcome, the level of starts looks to be bit exaggerated, especially as we are in the seasonally slow period of the year and swings in the data due to the seasonal adjustment process and weather distortions play a larger role in the headline reading. The three-month moving average shows starts are up a more moderate 5 percent in December, with single-family activity eking out a 0.6 percent gain and multifamily increasing 16 percent. Permits, which tend to be less volatile, fell 0.2 percent in December but grew 1.9 percent on a year-over-year basis.

With December now in the books, we see that the annual average for permits is running ahead of starts, pointing to a pickup in activity in the coming year. In previous publications, we have written about the shift in construction toward less expensive homes, which is a welcome sign following the dearth of activity in the lower-priced home segment as many investors converted units into rentals. We suspect some of this activity will cool as the recent spike in mortgage rates following the election curtails overall activity. December mortgage purchase applications are already showing some of the strain of higher mortgage rates, declining in December from a two-year high.

The trend in multifamily starts seems to be unrelenting; however, we expect some payback in the coming months. Starts jumped a strong 57.3 percent in December to a 431,000 unit-pace. On the other hand, permits fell 9.0 percent to a 393,000 unit-rate. With lending standards in multifamily tightening and apartment rent growth moderating, we expect the pace of multifamily building to cool in 2017.

Another seemingly hopeful sign is builder sentiment. The NAHB/Wells Fargo Housing Market Index remained at an elevated level in January, suggesting some upside risk to overall starts. Although builder sentiment is typically seen as a forward-looking indicator for starts, the 11-year high in December and still-elevated reading in January seems to be somewhat unbridled and could also reflect some election euphoria. Similar to residential borrowers, developers likely rushed to “lock-in” financing. We see the same pattern in consumer sentiment, which is now at a two-year high. That said, the builder sentiment index declined 2 points to 67 during the month, with all three components including current sales, future sales and prospective buyer traffic retreating.

Looking ahead, the underlying fundamentals and still rising credit availability suggest starts have more room to run. We expect starts to average a 1.17 million unit pace in 2017 and 1.22 million unit rate in 2018.