Building permits

What Is Building Permits?

A building permit is official authorization issued by a local government or regulatory body that allows a property owner or contractor to begin a new construction project or make significant alterations to an existing structure. Its primary purpose is to ensure that proposed building projects comply with local zoning ordinances, building codes, and safety regulations, thereby protecting public health, safety, and welfare. Building permits are a crucial component within the broader category of economic indicators, specifically serving as a bellwether for activity in the real estate and construction sectors.

History and Origin

The concept of regulating construction dates back millennia, with early examples like the Code of Hammurabi (circa 1754 BC) outlining severe penalties for builders whose structures failed. In the United States, formalized building codes and the associated permit processes began to emerge in the colonial era, primarily driven by concerns over fire safety. Early regulations often specified materials like brick and stone for construction to prevent the spread of fires. Boston, for instance, outlawed wooden chimneys and thatch roofs in 1630. Larger U.S. cities started establishing more comprehensive building codes in the early 1800s, with New Orleans being the first city to mandate inspections of public places in 1865. The development of modern building codes in the U.S. gained significant traction in the late 19th and early 20th centuries, often in response to major urban fires or natural disasters, aiming to ensure safer, healthier, and more resilient buildings. The International Conference of Building Officials (ICBO) adopted the first Uniform Building Code in 1927, which became a standard across California and other Western states.¹³

Key Takeaways

• Building permits are official governmental authorizations required before new construction or significant renovations can begin.
• They ensure compliance with local zoning laws, building codes, and safety standards.
• Building permits are considered a leading economic indicator, reflecting future activity in the construction and housing market.
• Data on building permits are collected and published monthly by the U.S. Census Bureau.
• The number of permits issued can provide insights into consumer confidence and expectations for economic growth.

Formula and Calculation

Building permits themselves do not involve a financial formula in the sense of a quantitative calculation for their issuance. Instead, the data collected from building permits are aggregated and analyzed. The primary "calculation" involves compiling the number of permits issued across various geographies and housing types, often presented as a seasonally adjusted annual rate (SAAR).

The U.S. Census Bureau, in conjunction with the Department of Housing and Urban Development (HUD), collects and reports data on privately-owned housing units authorized by building permits.¹² This data is categorized by:

• Total Units: The overall number of housing units authorized.
• Single-Family Units: Permits for detached residential homes.
• Multi-Family Units: Permits for buildings containing multiple housing units, such as apartments or condominiums.

These figures are often presented as a seasonally adjusted annual rate (SAAR), which removes predictable seasonal variations to allow for more meaningful month-over-month and year-over-year comparisons. The SAAR helps analysts gauge underlying trends in residential investment.

Interpreting Building Permits

Interpreting building permits involves understanding their role as a leading economic indicator within macroeconomics. An increase in the number of issued building permits generally signals an optimistic outlook for future construction activity and, by extension, the broader economy. This is because builders typically seek permits when they anticipate demand for new housing or commercial spaces.¹¹

Conversely, a decline in building permits can suggest a slowdown in future construction and potentially a weakening economy. Regional disparities are also important for interpretation; for instance, some areas like Arizona, Florida, and Texas have recently shown substantially more building permits per 1,000 people than the national average, which can influence regional price differences in housing markets.¹⁰ Changes in building permits can reflect shifts in supply and demand within the housing sector, as well as broader economic sentiments regarding interest rates and employment.

Hypothetical Example

Imagine a local municipality, Metroville, issues 500 residential building permits in January. In February, the number rises to 550, and in March, it reaches 600. This upward trend in building permits over three consecutive months suggests that homebuilders in Metroville are confident about the future of the local housing market. They anticipate continued strong demand, potentially driven by job growth and low interest rates, leading them to plan more new housing projects. This increase signals a likely boost in future construction activity, which could translate into more jobs in the labor market and increased economic activity in the region.

Practical Applications

Building permits are widely used by various stakeholders for strategic decision-making:

• Economists and Analysts: They closely monitor building permit data as a key leading economic indicator. An upward trend can signify future economic expansion, while a decline might forewarn of a slowdown. This data contributes to overall assessments of the nation's Gross Domestic Product (GDP) and economic health.⁹
• Investors: Those in the real estate and construction sectors use permit data to anticipate future supply and assess investment opportunities. For instance, an investor might consider increasing their stake in homebuilder stocks if building permit numbers are consistently rising.
• Policymakers: Government bodies and central banks, such as the Federal Reserve, consider building permit trends when formulating monetary policy or fiscal policy, as residential construction impacts employment and overall economic stability.
• Businesses: Suppliers of building materials, appliances, and home furnishings use building permit data to forecast demand for their products and manage inventory.
• Researchers: Academics and researchers study building permit data to understand long-term trends in urban development, population shifts, and their impact on the economy. The U.S. Census Bureau provides detailed data on permits at national, state, and local levels.⁸

Limitations and Criticisms

While building permits serve as a valuable economic indicator, they have certain limitations. One primary criticism is that a permit issuance does not guarantee that construction will actually commence. Projects can be delayed or even canceled due to various factors such as financing issues, changes in market conditions, or unforeseen complications.⁷ This can lead to a divergence between the number of permits issued and actual housing starts.

Additionally, the complexity and inefficiency of the traditional building permit process can sometimes skew the data or hinder responsiveness to market changes.⁶ The process often involves numerous stakeholders and adherence to complex regulations, which can cause significant delays. Variations in local regulations and enforcement can also make direct comparisons of permit data across different regions challenging. Furthermore, the data primarily reflects new privately-owned residential construction and may not fully capture other forms of construction or renovation activity.⁵ These factors can introduce a degree of imprecision when relying solely on building permit data to forecast the entire business cycles or assess specific market conditions.

Building Permits vs. Housing Starts

Building permits and housing starts are two closely related, yet distinct, metrics used to gauge activity in the residential construction sector. The key difference lies in their timing and definition.

Building Permits represent authorization to build. They are issued by local government agencies and must be obtained before construction can legally begin. Think of a building permit as a forward-looking indicator, signaling a builder's intent and future construction plans.

Housing Starts, on the other hand, measure when actual physical construction of a new residential unit has commenced. A housing start is typically recorded when the excavation for the foundation of a building begins.⁴ Housing starts are considered a coincident indicator, reflecting current construction activity.

Essentially, building permits precede housing starts. A rise in building permits indicates an anticipated increase in future construction, while housing starts confirm that the anticipated construction has indeed begun. While these two metrics often move in tandem, there can be a lag, especially if permits are issued late in a month or if weather conditions delay the start of excavation.³

FAQs

Why are building permits considered a leading economic indicator?

Building permits are classified as a leading economic indicator because they signal future construction activity. Builders typically apply for permits when they anticipate demand, indicating confidence in the economy. This forward-looking nature provides insights into the potential for future economic growth and job creation.

What types of construction projects require a building permit?

Generally, projects involving new construction, additions to existing structures, major structural alterations, or changes to electrical, plumbing, or mechanical systems typically require a building permit. Minor cosmetic changes like painting or replacing cabinets usually do not. Requirements can vary by local jurisdiction.²

Where can I find data on building permits?

Data on building permits are collected and published monthly by the U.S. Census Bureau. These reports provide national, regional, state, and local statistics on new privately-owned residential construction.¹ Various financial news outlets and economic data providers also compile and analyze this information.

Do building permits always lead to housing starts?

While building permits are generally a precursor to housing starts, they do not always result in immediate construction. Factors such as financing availability, changes in market conditions, or unexpected delays can cause a permit to expire or a project to be postponed or canceled. Therefore, a permit represents intent, while a start represents actual commencement of work.