Housing Permits Up 30% Over April 2009. Will Builders Stifle Recovery?

I’m starting to hear the phrase, “pent-up demand” a lot from various investors, real estate professionals, and builders. I started thinking a bit more about this and what’s in store for this spring in the housing industry, and more specifically in the new construction industry. New construction is something I have limited experience with. However, I will say that in the last 10 years, I contracted to build 4 new homes which I leased out as investments, I helped oversee the building of a duplex which I sold (we barely broke even), and I negotiated the sale of several builder closeouts. So, while my experience in new home construction is limited, I’ve at least dabbled a bit and know several home builders. I do have a penchant for numbers though, so I wanted to take a closer look at what’s been going on in the new home construction sector and how that might affect the recovery.

New Housing Permits vs. New Housing Starts

Most of the media coverage on new housing starts has been abysmal at best. In December the Commerce Department reported a 4% decline over November in housing starts, down to a seasonally adjusted rate of 557,000, capping off one of the worst years in new home construction since records have been kept. After increasing in November, the numbers fell “unexpectedly” in December. Despite this fall, the number of permits is rising. So my focus for this article is more about what the permit numbers are telling us.

Looking closely at new home permits over the last 4 years shows the huge drop in permits issued. Recent months show confidence is being restored in the marketplace and builders are prepping for a rise in demand. Let’s take a look at the New Housing Permits table below from Census.gov.

Looking at the last 4 years of data, you’ll see that December of 2009 housing permits issued are 30% of what they were in December of 2005. The good news for the builder community is that the numbers show a 31% increase over April 2009, in December. So the logical question is; why? The short answer is; builder confidence is back. Of course there is supply and demand but at the end of the day it’s the confidence that is causing them to file permits. One banker I know very well had worked closely with two of the city’s biggest builders here in Memphis, both of whom went under, but have started smaller firms and are building back up, slowly getting new financing.

Builders are seeing the inventories in the housing market being reduced. In Memphis we’ve seen an 18% decline in housing inventory over the last 12 months. That’s a pretty big absorption, thanks in part to the lack of new home construction. My only fear is with a large amount of foreclosures to still hit the market in 2010, what if the builders become overconfident (again) and prolong the slow market even further? Right not that’s probably not a severe issue because the National Home Builders Market Index recently dipped (15), but is up significantly over January 2009’s all-time low (9). Overconfidence(not just builders), after all, is what got us in this mess in the first place. A quick note just before the bust the National Home Builders confidence was 70 vs. the 15 today.

A dramatic rise in new home starts will likely be prolonged, at least for a little while, due to an unusually cold winter. This might create some “pent-up demand” very short term for the new home construction industry. My hope strategy (hope is not a strategy, however there’s little I can do about new housing starts), is that builders will take a very modest approach to starting the homes which they are approved to build. The foreclosures are still coming, unemployment is still sky high, and consumer confidence is weak at best. The last element we need is a new wave of housing from the builders (sorry guys). I’m hoping my banker friends will keep the builders in check.

Although I’d consider myself an eternal optimist, that’s not a great view from an economic standpoint. Summer could be treacherous as the real estate market will need to stand on its own with government intervention expiring. Foreclosures persist, rates will start rising in 2011, and unemployment will remain high for the foreseeable future. Let’s get our builder friends to take it slow.

Prediction: Japanese-esque “L-Shaped” recovery.

Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.