Nearly a century ago, economist and Maryland congressman Clarence Long recognized the significance of the building industry in shaping economic booms and depressions. Since then, economists have been striving to understand the complex relationship between housing markets and the overall economy. Building permits serve as a valuable indicator of investors' beliefs about the local economy, acting as a link between Main Street and Wall Street.

Building Permits: A Signal of Investor Beliefs

A flurry of housing activity often precedes economic downturns, as evidenced from the Roaring '20s to the 2008 Global Financial Crisis. Real estate prices and sales volume typically reach a climax a few months before the stock market peaks in economic expansions. However, the lack of comprehensive, long-run data on local housing market activity has hindered a deeper understanding of this relationship. LaPoint and Cortes set out to address this issue by constructing a new dataset of U.S. historical local building permits from 1919 to 2019.They found that periods of rapid increases in building permits followed by quick declines predict subsequent booms and busts in both stock and bond markets. "Building permits give you a nice signal of investors' beliefs about the local economy," LaPoint explains. "They reflect one's thinking that having the option to build is valuable." Across 100 years of data and 20 recessionary periods, these movements in local building permit activity consistently predict fluctuations in stock and bond markets.To build their dataset, the researchers spent two years hand-collecting and digitizing data using deep-learning optical character recognition techniques. They pulled historical building permit data from various sources, including Dun's Statistical Review, the U.S. Census Bureau's Building Permit Survey, HathiTrust Digital Library, and the Federal Depository Library Program. Despite inevitable scanning errors, they wrote custom code in Excel to fix them.Building permit activity was more volatile in cities and states with more elastic housing supply, such as Atlanta compared to San Francisco. In Florida, for example, when building permit activity became 10% more volatile, stock market volatility increased by 0.2 percentage points and bond market volatility by 0.7 percentage points a year later. This predictive power was not found in heavily regulated states like Connecticut.In the data leading up to the Great Depression, total permits issued in Miami peaked in 1925 during a Florida land boom and then plummeted before the 1928 Okeechobee Hurricane. Building permits in Florida also peaked five months before the 1973 OPEC recession and almost two years before the Great Recession of 2007-2009. Las Vegas, another city with elastic housing supply, saw downturns in 2006.From 1989 on, the researchers were able to examine the connection between local permit activity and movements in individual companies' stock prices. They found that companies with operations in areas experiencing volatile building permit activity saw more volatility in their own stock prices. This implies that investors could use increases in building permits to design trading strategies to hedge against firms' exposure to real estate markets facing a glut of new residential development.Currently, LaPoint and Cortes are working to fill a gap in their dataset from 1957 to 1959 and plan to post raw data online once completed. They are also building a website with interactive graphs featuring key data. The research has far-reaching implications for investors, housing policy, and the housing affordability crisis. Permits-to-population ratios are at historic lows in high-regulation states, and data patterns could help consumers predict price peaks.For financial regulators, volatile building permit activity in certain regions could serve as an early warning for broader financial market instability. "This could help regulators identify when and where to focus attention to curb potential developer enthusiasm and overbuilding risks," LaPoint says.