On Friday, Haver Analytics released critical reports on the status of the US economy. These were quarterly reports on the US Gross Domestic Product (GDP) identifying growth and price changes. For reference, Gross Domestic Product represents the total value of the country’s production during the period and consists of the purchases of domestically-produced goods and services by individuals, businesses, foreigners and government entities. The chart below, illustrated by Haver Analytics, is the Real GDP Growth (adjusted for inflation) with both quarterly annual changes and yearly changes.
The Q3 2016 change from the previous four quarters is generally attributed to the rise in gas and energy prices. The “pop” reversed a slowing quarterly trend since Q3 2014, and almost on cue as the economy avoids sinking further into recession. At a tepid pace of 1.5% quarterly annualized, we witnessed a reverse of the five consecutive quarters of yearly declining trends. Since Q4 2015, the quarterly annualized changes have been well below levels during 2010 to 2014. After the yearly trend peaked in Q4 2014, it has continued to steadily erode since the Federal Reserve discontinued their multi-trillion dollar stimulus campaign.
Below is the GDP Price Index, a comprehensive indicator of inflation. It is typically lower than the consumer price index because investment goods (which are in the GDP price index but not the CPI) tend to have lower rates of inflation than consumer goods and services.
As shown, the slow rising yearly trend of prices is at a “Goldilocks” pace of not too fast or too slow inflationary trend. The Federal Reserve has been very concerned about the continual decline of yearly changes in prices since mid-2014 that could be sinking into disinflation (negative change in prices is typically a poor barometer of the economy) that has been holding just above 1% in an annualized change. Minutes from the recent Federal Open Market Committee (FOMC) meeting indicated that a minority of members voted to approve a rate hike as confidence the economy will not experience disinflation and low unemployment since 2010. Analysts fear that if inflation and other economic indicators continue to improve in the next quarter, the Federal Reserve Committee may approve a second rate hike in December (low probability given to a rate hike in November’s meeting the week of the election).
Since December 2014 when the Federal Reserve ended their multi-trillion dollar stimulus campaign, the stock market came to a screeching halt and reversed the positive GDP trend (we covered this last week). However, the asset class of residential real estate is looking more attractive every day. The FHFA House Price Index chart released last week (provided by Haver Analytics) indicates that home prices are steadily rising while sales are also increasing (refer to New Home Sales chart also released last week provided by Haver Analytics).
What is especially attractive about residential real estate is rising demand with slowing new supply. New families are being created every day while the pace of new construction continues to decline.
Several factors are contributing to the decline in construction spending that includes cautious CEO’s in the building industry, challenging lending market, and government regulations. At some point, there will not be enough houses for people to rent or buy and may become headline news. Politicians are famous for capitalizing on crises with attempts for quick remedies. The single biggest factor we experienced at Harris Bay (our real estate private equity company) and observed with other developers is financing. Banks are handcuffed, and hard money lenders want too much in fees and interest. The continual decline of new construction is partially attributed to the challenging lending environment after Dodd-Frank Legislation.
The new home construction challenges will be corrected over time but may take decades to balance out the supply and demand ratio. Getting new developments approved through city planning with environmental and financing issues is challenging and time-consuming. Our view is residential property is a must owned asset for your personal residence and investment property. Real estate is still very affordable throughout the country and even when interest rates rise will still allow opportunities for purchase. The construction and related industries have been key drivers in many former growth economies. As these issues are resolved we believe it will become the next economic growth driver and provide investors significant opportunities for investment.