Residential Investment
Every major measure of housing activity dropped sharply during 2006, and the drop in real residential construction was steeper than anticipated in last year's Report. New home sales fell 27 percent from a peak in October 2005 through July 2006, a period when rates on conventional mortgages moved up about 70 basis points. (A basis point is one one-hundredth of a percentage point.) Sales then edged up during the 5 months from August through December, when mortgage rates dipped lower. Builders reacted sharply to the early-2006 drop in sales so that housing starts, which peaked at an annual rate of 2.27 million units in the beginning of the year, fell to slightly more than 1.6 million units by the end of the year. The drop in home construction activity subtracted roughly 0.7 percentage point from the annual rate of real GDP growth in the second quarter, and 1.2 percentage points in the second half of the year. Furthermore, even if housing starts level off at their current pace, normal lags between the beginning and completion of a construction project imply that residential investment will subtract from GDP growth during the first half of 2007.
During 2006, employment in residential construction fell, as did production of construction materials and products associated with new home sales (such as furniture, large appliances, and carpeting). Yet despite these housing sector declines, the overall economy continued to expand.
In addition to incomes and mortgage rates, the number of homes built is underpinned by demographics. Homebuilding during 2004 and 2005 averaged about 2.0 million units per year, in excess of the roughly 1.8-to-1.9-million unit annual pace of starts that is consistent with the pace of household formation implied by demographic models. As a result, the pace of homebuilding will tend to be drawn below this level for long enough so that the above-trend production of 2004 and 2005 will be offset by belowtrend production. The construction of new homes has fallen rapidly, however, and this offset may well be complete sometime during 2007. Looking further ahead, the residential sector is not expected to make noticeable positive contributions to real GDP growth until 2008 and beyond.