Inflation impacts new-home permit values

The single-family detached home construction industry in Northern Colorado is well on its way to recovery.

The number of permits pulled in March was 200, up from 125 in February and only 94 in March 2011. The March number was last seen in 2007 and is still less than one-third the peaks reached in 2004 and 2005. In other words, we still have a long way to go before we regain the exuberance of the home construction boom. But we’re much better off than the metropolitan areas that really boomed, such as Las Vegas, Southern California and many communities in Florida.

Let’s take a look at changes in the average value of permits pulled and inflation in Northern Colorado since 1988, the mid-point of the last energy boom in Colorado. I have normalized the average single-family detached-home permit value and inflation to their January 1988 levels so we can see relative changes since that month. (See accompanying graphic.)

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Homes to be constructed, represented by the average value of the permits pulled for their construction, increased 3.73 times between January 1988 and June 2007. (Average permit values have peaked to near four in the three months since June 2007, but those months are aberrations caused by a heavy mix of expensive home permits.)

As we can see from the graphic, average monthly permit values have been much more erratic since the beginning of 2009. As the number of permits being pulled each month dropped from levels around 600 to fewer than 100, the mix of their values became highly variable.

It would appear from the graphic that the bottom was reached in 2009 and definite improvement occurred in 2011.

We can also see that the increase in new-home construction permit values began its most rapid increase in the second half of 2003, lasting through the first half of 2008. This was the duration of the home construction bubble in Northern Colorado, when homeowners were pulling increased valuations out of their existing homes to construct and buy even bigger and more modern homes. This bubble burst when the increase in home values leveled off and began to decline; pushing many new homebuyers under water on their mortgages.

But the increase in permit values is deceiving because it is in nominal terms, i.e., not adjusted for the effects of inflation. To account for this effect, I have added the normalized inflation rate to the graphic. We see that the inflation rate has nearly doubled since January 1988, from a nominal value of 115.7 to a value of 230.1 this April.

If we compute the ratio of normalized permit values to the normalized inflation rate, we get an estimate of the change in the real value of new homes being constructed in Northern Colorado. We can see from the graphic that the real change in the value of new housing permits being pulled has nearly doubled since January 1988. It did double in select months and was at a mostly higher level in 2007, before dropping as low as 1.55 in some months during the Great Recession. A recovery from the low points of the Great Recession is not evident in this data.

So, the value of new homes being constructed in Northern Colorado between 1988 and 2007 increased nearly four-fold but inflation wiped out about half of that gain. Still, the value of new homes being constructed nearly doubled in real terms, suggesting that the new-home-owning segment of our population is much wealthier than in 1988. We undoubtedly have larger homes with more high-value furnishings.

But we have also learned a valuable lesson in economics as many homeowners without jobs have seen home values decline and their homes fall into foreclosure. Still, with the recovery under way, home construction activity is on the rise and that’s good news, even if it’ll be a while before we reach the levels of the mid-2000s.

John W. Green is a regional economist who compiles the Northern Colorado Business Report’s Index of Leading Economic Indicators. He can be reached at jwgreen@frii.com.