Housing Expected to Improve as the Year Progresses
It’s only a matter of time before housing begins to recover from its first major downturn in about 15 years, industry economists said two weeks ago at the International Builders’ Show in Orlando, Fla., and fundamental improvements in the marketplace could already be taking hold by this year’s second quarter.
“We knew we were in a correction process a year ago, and it was an inevitable occurrence” following the unsustainable boom years of 2004 and 2005 when stimulative financing conditions and speculation from escalating home prices resulted in a “grossly overheating market,” said NAHB Chief Economist David Seiders. Indeed, “the downward movements in sales and starts were even deeper in 2006 than expected.”
Total housing starts dropped 12.3% last year, to 1.819 million units, and single-family production was down 14% to 1.478 million homes. Even though Seiders said that he expects starts to begin a “gradual recovery” following further erosion during this year’s first quarter, total housing production for 2007 is projected to slip a further 14.2% to 1.560 million and single-family starts for the year are expected to decline 15% to 1.256 million.
“We lopped the top off the mountain,” he said, and housing starts for 2007 will be back to the levels seen early this decade.
New single-family home sales were down 16.4% in 2006 but apparently stabilized by the end of the year. Sales are projected by NAHB to decline only 1.3% in 2007 as activity rises gradually during the year.
Supporting an upward turn in new home sales, Seiders said, is today’s “Goldilocks economy,” which appears poised to sustain healthy levels of growth in Gross Domestic Product, jobs and income while core inflation recedes from levels that have been worrisome for the Federal Reserve Board. “The interest rate structure should be supportive of housing throughout this year,” he said.
While housing should be moving up before long, Seiders cautioned that it will be a couple of years before the industry reaches the 2 million annual construction pace (including 150,000 manufactured homes) that is sustainable over the long haul, the result of serious overbuilding during 2004 to 2005.
Agreeing that the housing market probably has seen the worst of the current slump in starts and sales, David Berson, chief economist of Fannie Mae, and Frank Nothaft, chief economist of Freddie Mac, said that they don’t expect to see the beginning of an upturn materialize until a quarter or two behind Seiders’ forecast, with gradual improvement likely in this year’s second half.
Investors Expected to Retreat Further
The housing affordability woes that reduced housing demand last year now seem to be bottoming out as incomes rise, home prices moderate and mortgage interest rates remain at favorable levels, said Berson, and he further noted that housing demand won’t be a negative for the industry this year, and could be a small positive.
However, how quickly conditions stabilize will depend on how quickly investors pull out of the market, he said. Although investor demand for housing peaked in early 2006, “it didn’t fall that much last year and is still relatively high.” The housing decline will be centered on those areas where investor activity was high, he added.
Berson calculated that the market was overbuilt by 600,000 to 650,000 units over the three-year duration of the boom, and the current inventory overhang of unsold homes — higher than actually reported because cancelled sales are not included in those numbers — is causing price weakness.
Housing prices were down in last year’s fourth quarter, though still up for the entire year but not by the double digits that were typical during the boom, Berson said. Price declines have started showing up in a growing number of places, including Boston, California and Northern Virginia, he said, and he predicted that the OFHEO Home Price Index is likely to show a decline in housing prices in 2007 for the first time in its 32-year history. He said that a decline of about 1% for the year was possible.
When adjusted for inflation, housing price gains will likely be on the negative side for the next couple of years, he forecast.
“We have to run through the inventory for prices to stabilize,” he said. In December, “it was not good news that starts were up and we need a period of time of sales exceeding starts.”
A Bit of a Rocky Road Ahead
“There is still a bit of a rocky road and bumps ahead of us,” said Nothaft, but builders “are seeing some light at the end of the tunnel.” High housing prices have become the decisive factor behind the slowdown, he said, and “it will take time for affordability to improve.”
Nothaft added that national data have obscured local trends and there are some markets where home sales and price appreciation are “holding up well,” particularly in much of the South. On the other hand, some markets — such as California, Florida and Massachusetts — have seen their business erode by 30%.
While single-family activity will improve as the year progresses and into 2008, “we won’t see a recovery in areas where the local economy is in recession,” Nothaft said, such as Detroit and parts of the Midwest.
In the multifamily sector, he said, condo sales are “way down,” but the apartment rental market is doing well, with rents on the rise and vacancy levels tightening.
One area to be watched, Nothaft indicated, is the rising number of mortgages entering foreclosure, driven largely by sub-prime loans. Half of the loans going into foreclosure in the fourth quarter of 2006 were sub-prime, which account for only 14% of all loans outstanding.
While sub-prime loans play a constructive role in “providing credit to consumers who wouldn’t be able to be home owners otherwise,” said Nothaft, the “underwriting of sub-prime loans may have deteriorated, raising concerns for the coming year.”
There were 200,000 loans entering foreclosure during the third quarter of 2006, he said, although research by Freddie Mac has shown that only 30% of their prime loans in foreclosure actually go all the way back to the bank.
Nothaft predicted that the 30-year, fixed-rate mortgage would average 6.4% for the year, and the housing analysts expect the Fed to hold its federal funds rate at the current 5.25% for some time, with the chance of a move to ease slightly toward year’s end.
For background materials on the presentations by the three housing economists, click here.