Wonder why the U.S. economic recovery feels so tenuous?

Blame the housing construction industry, which typically accounts for 4%-to-5% of GDP, but represents just 2% of the economy these days.

Though home prices in many markets have moved up from their 2008-2010 lows, the pace of new home construction has remained extremely low. According to the St. Louis branch of the Federal Reserve, residential construction permits are at roughly half the levels seen from 1995 through 2007. The impact: Simply returning to the long-term average would likely add around 1.5 million jobs to the economy, shaving the unemployment rate by roughly a percentage point.

Note: not all permit applications lead to actual construction, and actual new home builds are lower.

What makes the housing slump especially remarkable is that borrowing costs are quite low and bank lending standards have been gradually easing.  And if you are wondering about supply and demand, know that the U.S. population has grown by roughly 20 million since 2006.

Potential first-time homebuyers are still traumatized by the last economic downturn — many of them remain at home with their parents or are sharing apartments with friends. These are the folks responsible for “new household formation,” and the current rate of new household formation is roughly one-half of the 1.24 million annual rate seen from 2000 to 2007. If and when these first-time home buyers wade into the market in force, they portend a huge snapback in demand.

The financial press is rife with stories that many young people are carrying high levels of student loans, impeding their ability to purchase homes. But analysts at Goldman Sachs sees the issue in a positive light, noting that student loans taken out in the past decade for advanced degrees actually correlates well with eventual home purchases. Prior to the financial crisis, “young individuals with significant amounts of student loans were more likely to take out mortgages,” than those without loans, according to analysts at Goldman. As those with advanced degrees move up in the workforce, home-buying will once again become an obvious choice.

What about the notion that the housing crisis of 2008 has led many people to simply steer clear of home ownership? Well, according to Pew Research, “when renters are asked if they would like to continue to rent or if they would prefer one day to buy a home, 81% say they would like to buy.” Many of those renters are millennials, or those born between 1980 and 2000. The first wave of that group, which represents 82 million people, are now in their 30’s, which is often the time when a first home is bought. “The sheer size of the millennial cohort compensates for the challenges faced by young adults,” predict analysts at Goldman.

#-ad_banner-#To be sure, this long-awaited rebound in housing demand has become an old story, and expectations of an imminent uptick in the housing market have been falsely predicted for several years. The fact that the U.S. economy has created at least 200,000 net new jobs for six straight months hasn’t even been of much help. At least until recently.

A closer look at recent trends reveals a housing market beginning to rumble to life. The housing market index rose to 59 in early September up from 55 in August and well higher than the average reading of 48 in the first half of 2014. Analysts at UBS think the rising index means that around one million new homes will be built this year in the United States, with that figure rising to 1.25 million in 2015. Note that this figure is still well below the 1.5-to-1.6 million annual average that we saw before the housing bust. As a result, while employment trends continue to strengthen, UBS and others may be predicting a move up to 1.5 million new homes constructed by 2016. Again, such a trend wouldn’t even make a dent in the accumulated deficit in new household formations over the past six years.

To be sure, some housing data are giving mixed signals. On Monday we learned that sales of previously owned homes fell around 2% in July, ending a four-month winning streak. That’s the nature of the stop-start recovery you’ll likely see in the housing market. Still, the ingredients are in place for a more linear upturn in this all-important sector. 

The value play
Make no mistake, a rising tide would lift all boats in this sector. Yet I prefer to focus on the home builder offering the best value: MDC Holdings, Inc. (NYSE: MDC). While most other homebuilders trade for between 1.4 and 1.7 times book value, MDC is valued at just 1.1 times book. Also, the 3.8% dividend yield makes this the only meaningful income producer in this group.

Right now, MDC has roughly $700 million in cash and investments that are slowly being put into play to acquire land and build homes. Analysts expect revenues to rise around 9% this year and 19% in 2015 to an estimated $2.1 billion.  Per share profits are expected to grow a robust 29% next year to $2.15. Yet when you consider that MDC routinely exceeds profit forecasts, such a 2015 outlook may prove to be too conservative. Meanwhile, shares remain near two-year lows, discounting the slowly improving housing market.

Risks to Consider: Interest rates are quite benign right now, but a rise in rates may make mortgages less affordable for first-time home buyers. If the 10-Year Treasury interest rate moves up from a recent 2.5% to around 4.0% by the end of 2016, as consensus forecasts suggest, then mortgage rates will likely be in the 5%-to-6% range.

Action to Take –> Quarterly results in the housing sector are starting to take on a more positive tone. Homebuilder Lennar (NYSE: LEN), for example, just reported a 44% jump in fiscal third quarter profits, noting that orders for new homes jumped 23% from the year ago quarter. Homebuilders such as Lennar and MDC focus more squarely on the mid-market, which may be the industry sweet spot in coming years in light of the still-strained finances of many millennials. MDC is trading a near-52-week lows, which may present a prime opportunity to enter the market and await the potential aforementioned boom.

MDC sports a 3.8% dividend yield, which in current economic conditions is very attractive. My colleague Amy Calistri has made a name for herself by finding some or the world’s best dividend payers and teaching her readers how to collect a dividend paycheck every day of the year. She’s collected $65,000 in dividends in less than 5 years — with a portfolio that’s safer than the S&P 500. The strategy has been so successful, she’s was recently invited to reveal its secrets in front of a live audience at St. Edward’s University. Click here to watch her presentation for free, and to get access her top 3 high-yielders.