Millennials Will Drive Long-Term Residential New Construction, Easing Downturn Fears

Boston, Massachusetts (Feb. 19, 2019)—According to “Navigating Volatility in the United States Residential New Construction Sector,” a recent collaboration by Wells Fargo Securities’ Building Products and Homebuilding Investment Banking practice and L.E.K. Consulting, pent-up demand from a new generation of first-time home buyers and a low supply of single-family housing should drive long-term residential new construction growth. Concerns of a 2019 downturn in housing screen as overblown, with housing starts likely to show steady growth in the intermediate term.

As interest rates climbed higher over the course of 2018, declines in housing affordability, combined with economic cycle concerns, sparked worries for the residential new construction sector. However, as the expected pace of rate hikes has slowed in early 2019, affordability and homebuyer sentiment are improving. These factors, coupled with historically low levels of inventory, should help moderate declines in new residential construction if a broader economic slowdown occurs. Considerably low supply and emerging demand driven by millennial household formation should further support long-term growth.

The study examines several key industry factors—including housing starts, housing inventory, housing affordability and household formation—to forecast performance. Among the study’s key findings are:

• Single-family housing is in short supply, supporting potential for future growth. The 2008 recession that weighed on demand and kept Millennials out of the market also kept builders and lenders from committing to new single-family construction. The result is an undersupply of single-family homes, with single-family housing starts still 22 percent below the 1980-2000 average. 
• The slow recovery in housing starts since the Great Recession creates a positive backdrop for the current cycle. The depth and duration of housing downturns are heavily influenced by housing starts levels relative to the long-term average when a downturn begins. So, the news is good: November 2018 housing starts of 1.256 million are 13 percent below the long-term (1980-2000) average of 1.438 million. For housing starts to peak at this level would be unprecedented. Since 1970, there has been no instance of housing starts turning negative before they reached the long-term average. 
• Housing affordability had trended down, but forecasts are improving. Notable declines in housing affordability captured headlines in 2018, but the U.S. economy and labor market remains healthy. In early 2019, as expectations for rate hikes subside, affordability metrics are improving with a most recent Housing Affordability Index reading of 144 in November of 2018. This compares favorably against the June 2018 low of 138, with analysis indicating the index should remain above its long-term average of 130 through 2019. 
• Millennials are set to enter the housing market in a meaningful way. Millennials’ delayed household formation has led to a 2.2 million household gap relative to what the historical headship rate levels of their Gen X counterparts would imply. The study attributes this to the weak labor market following the 2008 recession and a student debt overhang. However, aging millennials are set to close the headship rate gap with prior generations, likely driving steady long-term growth in residential new construction.

Given the findings of a healthy long-term outlook, industry participants should consider investment in both capabilities and capacity, especially in single-family housing. “A modest pullback could create attractive valuations and entry points for those willing and able to make opportunistic investments,” said Casey Rentch, managing director, Industrials Investment Banking at Wells Fargo Securities. For more information, visit lek.com.