Running head: THE EFFECTS OF THE RECESSION ON THE HOME BUILDING INDUSTRY The Effects of the Recession on the Home Building Industry September 04, 2009 The Effects of the Recession on the Home Building Industry Introduction Similar to other industries, home building industry is seriously affected by recession. The industry continues to face various economic challenges that become especially threatening, when taking into consideration the boom times that took place in the recent years. The recession has led to serious economic costs for the nation, industries, businesses and customers. The vast majority of home building organizations report at least some level of fiscal stress, while approximately 60% of the businesses related to home building industry consider the stress to be severe or very severe. The companies reported declining revenues, increased costs, and decreased cash flow in result of government payment delays and restricted credit. At the same time, significant majorities of the companies operating in home building industry expect continuing declines in revenue and consider that recession has near to devastating impact on the home building industry. The research paper examines the effects of recession on the home building industry and provides overview of the industrys price elasticity of supply and demand, researches negative and positive externalities the industry produces, researches how wage inequality is measured and if it is present in the industry and, finally, researches monetary and/or fiscal policies that have affected the industry.
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The Impact of Recession on Home Building Industry Since August 2007 home building industry along with the real estate market was affected by recession. Although there were assumptions that the market will recover by the middle of 2008, it is still negatively influenced by economic downturn. According to the representatives of home building industry, current market conditions are even worse than the conditions during the last recession (1991-1992).
Sales in the house building industry has fell significantly to the slowest pace in twelve years, while the median price has also fell drastically. According to the researchers, the median price of new homes has declined by 7.5 percent, accounting for the sharpest annual drop in the last 37 years. Global economic downturn has negatively influenced the confidence level of buyers, leading to significant losses. Home Building Industry In order to answer what is home building industrys price elasticity of supply and demand, it is important to gain better understanding of this concept. Basically, the price elasticity of supply and demand is an elasticity measuring the degree and the nature of the relationship between changes in price and changes in quantity demanded of the products involved. It can be concluded that home building industry is cyclical.
It depends on a number of factors. Home building industry can influence businesses, in case the industry is falling (for example, during the recession) or booming; which in turn, affects jobs and home sales, correspondingly (The Financial Crisis and the Recession: What is Happening and What the Government Should Do).
Homebuilding industry is elastic in terms of price elasticity. Not all consumers can become owners of homes, so some part of them will rent homes. In turn, it causes decline in demand for home building, and at the same time, the supply will be increased. While examining the factors contributing to the increased demand for home building industry, it should be mentioned that tax lending by the banks was one of the most significant factors influencing the industry.
The banks were lending companies operating in home building industry loans with relatively light regulations and restrictions; these loans were easy to obtain. In turn, this situation resulted in speculations in the market, as many people were buying multiple homes in order to sell it for future profit instead of buying homes with the purpose of living in them. The companies working in home building industry became the part of this artificial boom. Homebuilders also tried to sell their newly built homes for profit. In such a way, the demand was mostly artificial as the vast majority of homes were purchased with an objective of them appreciating in value. This could happen only if the buyers could get easy credits. According to the representatives in the home building industry, with mortgage rates at their lowest level in 30 years and an investor shift toward real estate as an alternative to stocks, demand for homes has remained strong.
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(The homebuilding industry versus the recession) Yet, nowadays the level of demand has declined drastically, and it can be concluded that the demand was mostly artificial (How We All Will End The Recession – Forbes.com).
It turn, it led to mass selling of purchased homes, and, in turn, in oversupply in the market. Also, many individuals and businesses who were speculating exited the business; many of them got foreclosed on. What concerns home building companies, many of them filed bankruptcy and some of them will became bankrupts in the future, as they will continue to lose revenue due to economic downturn. As there is a surplus of homes in the market, home building industry faces lack of demand (Builders say economy has affected home construction).
While researching home building industry and examining the effects of recession on the industry, it should be mentioned that home building is interrelated with other industries and businesses. For example, home building companies usually need many other services that include but are not limited to real estate brokers, lawyers, contractors, lenders, companies that sell fixtures and furniture, to mention a few.
Similar to home building companies, these businesses are also negatively affected by the recession, thus decreasing the number of employees which, in turn, leads to higher unemployment rate in the market. The contractors will also experience decrease in demand, as less homes are built or renovated. Real estate brokers will also experience decrease in demand, as most of them will have little or no sales during the recession. Similar to them, home lenders will also be in less demand and will incur financial losses as they will have non performing loans on books that in turn contribute to higher rates and less credits. The lawyers in home building industry will be also affected by the recession, if their activity is focused on home building and real estate industries. Finally, as recession will result in less home owners, less sales for such products like home appliances, fixtures, furniture and other home owner related items. In turn, this will affect business companies who manufacture and sell these items.
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At the same time, although economic downturn has many negative impacts on home building industry, some businesses and individuals will benefit. For example, landlords will experience an increase in clients (renters), which, in turn, may lead to an increase in rental prices. As far as most of foreclosed homes should be cleaned, the businesses and individuals in this business will experience an increase in demand and income. The banks will also need to hire more asset managers to manage new properties, which in turn will give a lot of listings for top brokers. Other investors who deal with rental properties will also be in higher demand, compared to the home building companies, thus creating new opportunities for others. Next, while examining the home building industry, it becomes obvious that there is a wage inequality in the industry.
This is mostly explained by high immigrants employment rates, as the vast majority of home building companies prefer employing immigrants as they can pay lower wages, compared to the professionals. Home builders preferred to hire unqualified immigrants who needed a job as they could pay them low wages. In turn, this created inequality between the immigrants and professionals. Many home building companies paid immigrants under the table (they paid workers cash, with no tax paying).
There are wage inequalities as far as while some home building companies paid the employees fair price for their work, most of the companies did not pay the market price. Also, the competition in the home building industry was quite high, as home builders wanted to get more profits but encouraging employees to compete to obtain a job.
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Due to housing boom, a significant number of immigrants lost their jobs and started looking for jobs in other companies, thus further suppressing the wages. Due to recession, the situation became even worse as more people had to compete for jobs, thus causing the wages to decrease in the home building related areas due to oversupply of employment. The monetary and fiscal policies had also great impact on the home building industry. As Washington manipulates taxes and government spending to encourage or slow down growth, this influences the total demand for services and products. This method is called fiscal policy. In order to understand how fiscal policy affects home building industry, it is important to examine it in relation to home building businesses stagnation and high unemployment rate.
Due to economic downturn, the United States has suffered the period of high unemployment and business stagnation. The companies operating in the house building industry claimed that construction spending in January recorded its sharpest decline in 14 years while a closely watched indicator of manufacturing activity dropped last month to its lowest level in five years. (The Economy) According to them, spending also went down 3.3% from a year earlier and recession has hit both commercial and government projects in home building industry. Until January 2008, spending on nonresidential home building had been strong enough to compensate for a rapid decline in home building, keeping the construction sector roughly flat for the last year however, the recession along with the decreased availability of commercial loans and decreased demand had great impact on the industry (The Economy).
At the same, the government needed to undertake specific measures to revive home building industry and to create more new jobs as the government injected billions of dollars into the countrys economy. These measures included but were not limited to cutting taxes (thus leaving businesses and individuals with more money to spend), by making direct payments to individuals (for example, unemployment insurance, social security, etc.), by purchasing products and services, to mention a few. This policy aimed to increase demand, or the total products and services businesses and/or individuals could afford themselves to purchase. At the same time, the increase in demand allowed home building companies and related businesses to manufacture more products, to build more homes, to hire additional employees, and to make investments in new machinery and buildings, thus encouraging trade and commerce (How the Economy is Challenging Home Builders).
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It should be, however, mentioned that government spending had a so-called multiplier effect. The governments dollars that were allocated to various public projects went into the pockets of home building businesses and employees, truck drivers, steelworkers, carpenters, builders, bricklayers, and other employees who started to spend their money on clothing, food, medical care, recreation, automobiles, to mention a few. The workers employed in these industries also spend money on additional services and products. This effect holds for all kinds of budget transactions (in form of direct payments, tax cuts, actual purchases, to mention a few).
At the same time, demand exceeded supply, leading to increase in prices, and inflation (the prices increase while the value of money decreases).
As this took place, the government wanted to stop it by raising taxes or cutting spending.
In result, the consumers and businesses had less money in their pockets, thus leading to lower aggregate demand, which in turn, causes prices to level off. Fiscal policy was used to manipulate the federal budget to keep enough demand to make people working but not too much to cause inflation. This mix of fiscal policy and interest rate was aimed to help manage a U.S. economy that will experience slower growth during the first half of 2008. (Bernanke Urges Mix of Fiscal and Monetary Policy) As the government tried to adjust taxation and spending, these measures were undertaken to maintain stable prices and relatively high levels of employment. Finally, the monetary policies of the federal government as well as the governments encouragement led to excessive borrowing. In turn, these factors affected the home building industry.
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Some home building companies built more new homes despite the oversupply in the market. The people who purchased these new homes claimed that they would increase in price significantly, speculating and creating an artificial demand, as these homes were bought with the speculative purposes and there was no intention for the buyers to live in these homes (Home builders’ foundations shift with shaky market).
The policies of relatively easy borrowing encouraged individual to purchase homes and to take high risks. As the growth has declined drastically, the prices of homes reflect this decline. Now, the prices will come down and will be corrected to the point of equilibrium, as most homes are priced now to the extent of what the buyer can afford now. Taking into consideration current economic downturn and home building industry in particular, it becomes obvious that home building industry will continue to be negatively affected by the recession.
Home building companies will incur financial losses as a consequence, as they will be forced to reduce prices to attract more buyers. Also, due to the monetary policy of cheap money, it has caused inflation in many services and products (such as materials to build homes).
The materials have increased in dollar amounts thus hurting the bottom lines of the companies operating in the home building industry. Many home builders consider it is senseless to build new homes as the profit margin is too low. In turn, this leads to slowdown in home building industry, as it becomes less expensive to purchase the home for sale than to build the new one. References Bernanke Urges Mix of Fiscal and Monetary Policy.
Retrieved September 5, 2009, from //www.builderonline.com/mortgages-and-banking /bernanke-urges-mix-of-fiscal-and-monetary-policy. aspx Builders say economy has affected home construction. (n.d.).
Retrieved September 5, 2009, from //www.sj-r.com/archive//Builders-say-economy- has-affected-home-construction Home builders’ foundations shift with shaky market. (n.d.).
Retrieved September 5, 2009, from //www.usatoday.com/money/economy/housing/2007 -10-08-home-builders-downturn_N.htm How the Economy is Challenging Home Builders. (n.d.).
Retrieved September 5, 2009, from //rismedia.com/2007-06-25/how-the-economy-is- challenging-home-builders/ How We All Will End The Recession – Forbes.com. (n.d.).
Retrieved September 5, 2009, from //www.forbes.com/2008/12/15/recession-catalys t-recovery-oped-cx_bw_rs_1216wesburystein.html The Economy. (n.d.).
Retrieved September 05, 2009, from //www.allbusiness.com/economy-economic-indica tors/economic-indicators/11860179-1.html The Financial Crisis and the Recession: What is Happening and What the Government Should Do. (n.d.).
Retrieved September 5, 2009, from //woodwardhall.files.wordpress.com/2008/12/th e_financial_crisis_and_the_recession2.pdf The homebuilding industry versus the recession. (n.d.).
Retrieved September 5, 2009, from //www.allbusiness.com/buying-selling-business es/purchasing-a-business-valuation/1166075-1.html.