|
Worst of Housing Downturn to End by Mid-2007
Although they disagreed somewhat on the outlook for interest rates and the extent to which markedly slower home price appreciation will affect consumer spending, economists at NAHB’s 2006 Fall Construction Forecast Conference in Washington, D.C. on Oct. 25 shared the view that the current housing downturn is unlikely to push the nation’s economy into a recession and will begin to dissipate fairly quickly, by the middle of 2007, with the balance between housing supply and demand considerably improved.
A faster-than-anticipated decline in housing following its unsustainable boom during the past three years has become a major drag on U.S. economic growth, said David Seiders, NAHB’s chief economist, and it is likely to subtract about a full percentage point from the Gross Domestic Product during the second half of this year and half that amount during the opening quarter of 2007.
Single-family housing starts are on the path to a 25% decline from their peak in the first quarter of 2006 to an expected trough in the second quarter of 2007, falling from an average seasonally adjusted annual rate of 1.747 million to 1.3 million. (An annual production rate of 1.5 million is sustainable, Seiders said.) Much of the contraction is “already under our belts,” he said, but with a sizable inventory of unsold homes remaining to be worked off, there is still downward momentum in the marketplace.
The condominium market has been similarly afflicted, he said, with the rental component of multifamily construction picking up some of the slack as demand for rentals receives a boost from the high cost of homeownership in many parts of the country. The direction of residential remodeling, which ordinarily follows in the footsteps of the housing market, is expected to remain slightly positive, according to Seiders, because of the substantial amounts of equity accumulated by home owners during the boom.
Single-Family Inventory the Big Issue
“The single-family inventory is the big issue,” Seiders said. “Demand might stabilize before long, but there is a lot of inventory that needs to be worked down,” and the situation may be worse than portrayed by statistics from the Commerce Department, which don’t include homes that have been sold to a buyer who subsequently cancels the contract and hands the house back to the builder.
An NAHB survey of 30 large builders found that their cancellations doubled in the three months through September from the same period a year earlier. Cancellations — stemming in part from speculators who are realizing that they are unlikely to be able to resell the home for the quick profit that might have been attainable at the height of the boom — are “a big deal to big companies,” Seiders said, “but not as much of an issue for smaller companies.”
Seiders concluded that a reasonably healthy economy will be able to absorb the negative fallout from the housing slump and that consumer spending won’t falter as home prices stabilize and as borrowers of exotic mortgages find themselves with stiffer monthly payments after their loans are reset at a higher interest rate. Core inflation is also expected to recede, and all in all, housing should be “in pretty good balance” in 2008. “If it works out that way, it’s one heck of a success story,” he said.
U.S. Economy Continues to Perform Well
 David Wyss, chief economist at Standard & Poor’s, concurred that the economy and financial markets are performing fairly well, with inflation at 2.5% and poised to move down, even as growth slows from an annual pace of 3.5% to 2.5% for the next year or two, and unemployment, at 4.7%, moves up some. At the Federal Reserve, where both he and Seiders used to work in the 1970s, “we would have killed for an economy like this,” he said.
Among the plusses for the economy, oil prices have declined 25% from August, and while instability in the Middle East makes it hard to say they won’t go right back up again, oil companies are saying that they have a supply of oil they can bring in at $40 to $50 a barrel. He noted that while oil price hikes can still trigger a recession, energy efficiency has helped to blunt the impact of rising prices on the economy. In 1981, he said, American households spent an average of 8% of their incomes on energy, compared to 5.5% today, and where it used to take 4.2 tons of oil to produce $1,000 worth of GDP, today it takes half that amount, a trend that has occurred world-wide.
Like Seiders, Wyss said he believes the Fed is done tightening after 17 consecutive quarter-point increases in the federal funds interest rate since mid-2004, and that the next trend will be down around the middle of 2007 when the Fed realizes that it has overreacted on inflation, which won’t be feeling the effects of its policies until 2008, in any event.
However, Wyss does expect to see some upward movement in long-term interest rates, with some possible impact on mortgage rates, not from what the Fed does but from changes in the international financial markets.
“Long-term interest rates have been thumbing their nose” at the Fed, he said, and the rate on a 10-year bond today is the same as it was before the Fed started raising short-term rates — 4.8%. International investors have been investing heavily in U.S. bonds because they are one full percentage point higher than what is available in Europe. There will be a net capital inflow of $800 billion into the U.S. this year, he said.
But the situation is changing, with central banks in Europe and Japan responding to a shift to stronger growth and starting to raise their interest rates, reducing the one-percentage-point differential needed to maintain the current U.S. bond yield.
On the consumer front, Wyss observed that while household debt has now risen to 134% of income, “all we really care about is how much we have to pay back each month.” Average household debt service is now running at a record 18.5% of income, he said, which is “bearable,” but as adjustable-rate mortgages are reset, that will move up to more than 20%, raising the expectation that some consumers will have to slow their spending to pay off some of their debt.
Debt repayment of 16% to 20% of income is typical for all income groups, he said, with the exception of those in the top 20% income bracket, who spend half that on repaying debt. However, households in the bottom 60% of the income distribution are primarily repaying car installment loans and credit cards, while the top 40% of debt payment is for mortgages on homes that over time increase, rather than decline, in value.
Bridging the Housing Affordability Gap
Housing is roughly 20% overvalued across the country, he said, but there will be a 30% correction in the formerly hot markets on the East Coast and West Coast, compared to 10% for the rest of the country. In the most expensive cities, however, housing prices are way out of whack with incomes. At the top of the list is San Diego, where the median price of a new home is 14 times the median income.
A 5% decline in home prices overall during the current adjustment period will help bridge the housing affordability gap, he said, as will rising incomes over time and market-driven changes in the physical components of new houses, including their size and amenities, that have helped increase their cost.
Wyss said that corrections in home prices that have already occurred in Britain and Australia (where prices rose 150% and 120%, respectively, from 1997 to 2005, compared to 70% in the U.S.), have been “moderate” and “not as painful as they feared.”
Looking at housing, “most of the country is not in bad shape,” Wyss said, and most residential mortgage pools are expected to hold up fairly well. Deserving closer scrutiny will be sub-prime loans and mortgages on second homes and investment properties, as well as a relatively few markets with weak local economies.
A Sharper Turnaround in Fed Policy
 Maury Harris, chief economist for UBS Warburg Research, presented similar views as his colleagues on the outlooks for the U.S. economy and housing sector, although he said he anticipates a sharper turnaround in Fed policy next year and a more significant impact of the buyers’ market in housing on consumer spending.
“Core inflation will slow down enough next year so the Fed can focus more on the economy,” he said, and in reaction to rising unemployment, the Fed will shift to stimulative policy, bringing the federal funds rate down to 4.25% by next fall.
Although inflation this year has been running above the limits that the Fed wants to see, Harris said, the pick-up has been significantly influenced by “rents going up because fewer people can afford to buy,” and has not been broad-based. When the impact of rent is removed from measures of core inflation, prices have actually been rising at a rate of about 1.7%, within the Fed’s 1% to 2% tolerance range.
Seiders said that the owners’ equivalent rent used to gauge housing inflation is “a statistician’s imputation” that “acts like every home owner is paying more for housing, which is nonsense.” NAHB has worked to bring this problem to the Fed’s attention, and Seiders suggested that it could be “one reason the Fed is not reacting to what looks like an out-of-bounds inflation rate.”
Home equity extraction, which was in the 0% to 1% range 10 years ago and 6.5% recently, will be dropping off, affecting spending, Harris said, as home owners perceive that their wealth has stopped rising.
Photos by Morris Semiatin
|
