Eye on the Economy
By David F. Seiders, NAHB Chief Economist
The U.S. economy still is doing well, thanks largely to housing …
We are now more than three years into the recovery and expansion phase of the current economic cycle and we’re seeing a pattern of solid growth in economic output, decent growth in payroll employment and low rates of core inflation (excluding prices of food and energy). That healthy pattern should persist for quite a while — with skillful management of economic policy and without severe shocks to the U.S. economy.
Growth of real Gross Domestic Product (GDP) now stands at a highly respectable 3.8% for the first quarter of the year, according to the “final” estimate released today by the Commerce Department. The housing production component of GDP (residential fixed investment) grew at a robust 11.5% pace and directly contributed 0.64 of a percentage point to the overall GDP growth rate (that’s a lot). Strong forward momentum of home sales and housing starts suggests that housing will be a strong component of GDP in the second quarter as well.
The ongoing strength of housing will be critical to overall economic growth as high energy costs take a toll on the U.S. and global economies ― including our manufacturing sector. Fortunately, current and expected weakness in other sectors helps hold down long-term interest rates, and that’s very good for the housing market.
The interest rate structure still reflects a variety of opposing forces …
The Federal Reserve has hiked short-term interest rates by two percentage points since mid-2004, and another quarter-point increase was enacted at the conclusion of the Federal Open Market Committee meeting on June 30.
Despite the systematic increases in short-term rates, long-term interest rates have fallen substantially over the past year. As a result, the Treasury yield curve has flattened by nearly three percentage points and the spread between the three-month T-bill and the 10-year T-bond now stands at only about 75 basis points. That’s not far from flat, flat isn’t far from inverted, and an inverted yield curve is a classic sign of trouble in the U.S. economy.
Defiantly low long-term rates are a global phenomenon, and Fed Chairman Alan Greenspan increasingly seems resigned to the Fed’s inability to get long-term rates up in the U.S. The question is, will the Fed continue to raise short-term rates and risk a yield curve inversion?
NAHB’s forecast says the Fed will not have to face that decision because long-term rates finally will move up (by about half a percentage point) during the second half of 2005 as the Fed systematically moves the federal funds rate to 4%. But that’s conventional economic thinking and the markets may not agree. One thing’s for sure — the defiantly low long-term interest rates are a windfall for the housing sector.
Home sales remain robust and house prices continue to climb …
Sales of new single-family homes climbed by 2.1% to a near-record 1.298 million units in May. Furthermore, sales were up by 4.4% on a year-to-date basis, and NAHB’s forecast shows a new annual record in 2005.
Sales of existing single-family homes and condo/co-op units inched down last month following record levels in April. But sales are up substantially on a year-to-date basis in both markets and are on pace to set new annual records in 2005.
The national median price of new homes sold in May was down from April and up only 2.5% on a year-over-year basis. However, this apparent price weakness reflected a major, and presumably temporary, shift in the regional composition of sales (primarily from the high-priced Northeast to the lower-priced Midwest) rather than price weakness in any part of the country.
In the existing-home market, the median price of single-family homes sold in May was up 12.2% on a year-over-year basis and the median condo/co-op price was up 15.2% ― similar to the robust rates of appreciation recorded earlier in the year — and prices were up substantially in all regions of the country.
These data suggest that home prices have not yet begun to decelerate, despite an avalanche of media reports about “unsustainable” house prices in many markets.
Single-family housing production steams ahead and the mood of builders brightens even further …
Total housing starts edged up in May, paced by a 4.7% surge in the single-family component to an annual rate of 1.7 million units. Issuance of single-family permits slipped by 1.3% but held near recent record levels. Indeed, both single-family starts and permits are up on a year-to-date basis and new annual production records are in the cards for 2005 despite serious supply constraints in many areas of the country.
NAHB’s Housing Market Index, based on monthly surveys of more than 500 single-family builders, moved up to 71 in June ― at the upper end of the elevated range that’s prevailed for the past year. Furthermore, all the components of the overall index moved upward, particularly the measure of builders’ sales expectations for the next six months.
Weekly surveys of lenders (Mortgage Bankers Association series) show a record pace of applications for mortgages to buy homes through the week ending June 24 (four-week moving average basis). Refinancing activity has picked up a bit as well, reflecting the recent slippage of long-term mortgage rates.
Housing inventories remain healthy despite confusing reports to the contrary …
The inventory of new homes for sale has been rising in recent years, but the inventory/sales ratio (or the months’ supply) still is historically low (4.2 at the end of May). In addition, units that have been permitted but not yet started have made up a growing share of total units for sale (20.5% in May). Despite the healthy level and structure of new-home inventories, some analysts are insisting that the elevated level of unbuilt homes for sale is a sign of an impending glut of new homes.
The rise in the number of homes that have been permitted but not yet started partly reflects efforts by builders to sell homes before construction begins, a very healthy practice. Furthermore, drawn-out regulatory processes in many local jurisdictions have encouraged builders to accumulate an unusually large supply of unused permits to be able to meet future housing demand. Once a permit is obtained, the Census Bureau classifies the home as part of the inventory “for sale,” even if the builder does not view it that way.
It’s clearly wrong to conclude that a sizeable backlog of unbuilt homes for sale suggests an impending housing “glut.” If housing demand weakens, builders can easily defer starts of homes that have been permitted. In fact, inventory management in the home building industry has been excellent for years, and the public companies know that stock analysts watch their inventories very closely. Unsold units that are completed or under construction could eventually become a problem, but unsold units that have not even been started are a relatively benign matter.
Speculation in new single-family homes remains limited …
NAHB research has uncovered a good bit of concern in the home building industry about speculative home buying, i.e., purchases driven solely by the lure of short-term capital gains. Our research also found that many builders, particularly large companies, are taking steps to discourage sales to buyers who do not intend to occupy the homes and that these efforts have helped contain speculative activity in the national new-home market.
Builders are concerned about speculative home buying because a lot of this activity can generate substantial “hidden supply” that could come back onto the market quickly if price appreciation should begin to falter. In that event, additional downward pressure would be put on market prices and sales of new units coming onto the market would be severely disrupted. Indeed, speculators could not only unload units that they own, they also could fail to close on units they have contracted to buy — a key risk in the new-home market because of typically long lags between sales contracts and closings.
Many builders also are concerned about investor-owned units standing empty in new communities they are developing. Large numbers of sold but vacant units can detract from the sense of community as well as the overall look and feel of an area under development.
From a national perspective, the amount of speculative buying in the market for new single-family homes appears to be quite limited at this time, thanks largely to the efforts of large national and regional builders and those companies in hot metro markets that recognize the dangers of speculative activity.
A comprehensive national survey of about 500 home builders conducted by NAHB in June shows that only 4% of single-family homes sold in the first half of this year were to investors (not for primary residence or vacation home), compared with 13% of multifamily condo units sold during the same period.
Some of the units sold to investors (particularly condos) are bought as long-term rental investments, of course, leaving even smaller shares for short-term speculative activity. It’s also noteworthy that only 6% of respondents to NAHB’s June survey said they were actively marketing homes (single-family or condo) to investors.
Financial regulators and rating agencies focus on risks of ‘exotic’ adjustable-rate mortgages …
Soaring house prices in many areas have encouraged the development and use of a variety of adjustable-rate mortgages (ARMs) that can stretch this affordability envelope for prospective owner-occupants, and some ARMs have provided attractive short-term financing for investors/speculators in the housing market.
Indeed, Greenspan recently cited expanding usage of “exotic” ARMs as a development of “particular concern.” At issue are ARMs with deep initial rate discounts, interest-only payment schedules, payment options that allow negative amortization (rising principal balances), and little or no documentation of borrower income, debts or assets.
The federal regulators of commercial banks and thrift institutions reportedly are working on interagency guidance addressing the credit risks associated with various types of ARMs and underwriting procedures, and a joint supervisory letter may be forthcoming before long ― modeled after the risk management guidance issued for home equity lending on May 16. Furthermore, in recent days both Standard & Poors and Fitch Ratings issued tougher rating criteria for mortgage-backed securities backed by ARMs with payment-option features that permit negative amortization.
The efforts by federal regulators and rating agencies hopefully will promote better risk-management practices by lenders and provide better information to mortgage investors on particularly “exotic” forms of ARMs. The trick is to head off potential credit problems down the line while preserving the affordability enhancements provided by ARMs in high-priced markets. Stay tuned.
NAHB Chief Economist David Seiders analyzes the economy from the point of view of the housing market every other week in the free e-newsletter, “Eye on the Economy.” The preceding is a reissue of his June 29 edition. To subcribe to “Eye on the Economy,” click here
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