Graphic2.jpg (11074 bytes)







BankRI, Lardaro on the Economy Series
February 2004


Once upon a time, housing was cyclical. Predictably, activity in this sector rose during recoveries and fell during recessions. This was especially true for new home construction, which is measured in terms of the number of single-unit housing permits. Typically, it surged during the early stages of recoveries, based on improving job gains and consumer confidence along with falling interest rates. During recessions, new home construction often fell sharply as job loss mounted, unemployment rose, and consumer confidence continued to deteriorate.
More recently, several structural changes have begun to affect new home construction here. Primary among these are permit restrictions, demographic changes in our population, and the fact that fewer but larger and more elaborate houses are being built. And, of course, weather has always been a consideration. So, at present, changes in new home construction are the result of the interplay of these cyclical, structural, and weather-related factors.

An examination of new home construction data for Rhode Island reveals several unexpected results. The chart below contrasts new home construction during the 1980s and 1990s recoveries. Approximately four

years (50 months) into these recoveries, permits were falling during the 1990s to around 2,000 annual units, while in the 1980s, they had soared to more than 5,000 annual units. Chart 2 shows permits since the 1990s recovery. Note that new home construction actually rose during the last recession (shaded area)! This has raised the question of

whether new home construction is cyclical any more. Finally, permits fell sharply during the early stages of this recovery before returning to (ironically) recession levels.

What accounts for these observations? During the 1980s recovery, Rhode Island was still a manufacturing-based economy, where cyclical forces dominated and the structural factors did not come into play. Since the 1990s, structural factors have played a significant role, offsetting some of the cyclical momentum experienced. Why did permits drop early in this recovery? It was due to the weather (unfrozen ground in early 2002 but frozen ground this year).

Did you ever wonder why it is impossible to buy even a “fixer-upper” house in Rhode Island for less than $200,000 today? This is the result of healthy housing demand coupled with a limited supply of housing that is a direct result of the recent low levels of new home construction.  As Chart 3 shows, existing home prices have risen much faster here than they have nationally since the late 1990s.

The good news, for home owners at least, is that with such limited supply, don’t expect home prices here to drop sharply unless demand decreases dramatically.



by Leonard Lardaro

  bott2.jpg (7892 bytes)