Eye on the Economy: Home Prices Fall, But Not Dramatically
As expected, economic growth rebounded nicely in the second quarter following the near stall-out in the first quarter of the year.
Real gross domestic product (GDP) grew at an annual rate of 3.4% in the second quarter, according to the “advance” estimate released on July 27 by the Commerce Department — bringing the average for the first half of 2007 to a reasonably solid 2.0% pace and leaving earlier fears of economic recession behind.
The economy got through the first half of 2007 in reasonably good shape despite continuation of the dramatic housing downswing that began early last year.
The contraction in real residential fixed investment (RFI) was most dramatic in the second half of 2006, but RFI contracted at an average annual rate of 12.8% in the first half of this year and lopped 0.71 of a percentage point off the first-half GDP growth rate.
Home Sales Continue to Trail Downward From Unsustainable Highs
Home sales still are trending downward from the record levels posted during the third quarter of 2005.
Sales of new single-family homes (based on signed contracts) fell by 6.6% in June to a level that’s 40% below its 2005 peak. Sales of existing single-family homes (based on closings) fell by 3.5% in June to a level that’s 20% below its 2005 peak. “Pending” sales of existing homes (based on contracts signed) were up by 5% in June but down on a three-month moving average basis.
Indeed, the second quarter as a whole was down by nearly 7% from the first quarter average, pointing toward further declines in closings in the third quarter.
The Commerce Department’s series on new-home sales (signed contracts) does not recognize cancelled contracts. There is no estimate of net sales (contracts signed less contracts cancelled), resales of homes taken back by builders due to cancellations are not recorded in the sales series, and there is no estimate of new-home sales closed.
NAHB’s proprietary survey of 32 large builders (accounting for more than one-fourth of all for-sale housing in the U.S.) overcomes all of these conceptual deficiencies. The June readings (seasonally adjusted by NAHB) show gross sales 31% below the July 2005 peak, net sales 43% below their peak in July 2005 and closings 38% below their recent peak in March 2006.
Although NAHB’s large-builder data system showed some tentative signs of stabilization as the second quarter drew to a close, public statements by many of the public companies suggest that there’s still downward momentum in the single-family market.
Indeed, NAHB’s broad-based single-family Housing Market Index points in that direction. The HMI fell to a cyclical low of 24 in July, down from the cyclical peak of 72 in June 2005 and the lowest level since January 1991 — near the bottom of the 1990 to 1991 economic recession.
Homeownership Rates Move Lower as More Households Decide to Rent
Historically low levels of home buying affordability (exacerbated by the subprime mortgage mess), along with an apparently pervasive wait-and-see attitude among prospective buyers, has encouraged many U.S. households to rent rather than own — presumably a temporary phenomenon but one that’s shaping housing markets for now.
The U.S. homeownership rate slipped to 68.4% in the second quarter of this year (seasonally adjusted), a full percentage point below the record high three years earlier and a half-point lower than a year earlier. The absolute number of home owners has shown virtually no change during the past year, while the number of renter households has surged by an estimated 835,000.
The erosion of homeownership rates has been broad-based, although the declines during the past year are particularly striking for the 35 to 44 age range, black households and families with below-median incomes.
It’s likely that the subprime mortgage debacle, including an unhealthy dose of fraud and abuse, is at least partly responsible for these patterns.
Vacant Housing Units on the Market Remain Near Record Highs at Mid-2007
Conceptual limitations in estimates of unsold inventories of both new and existing homes have encouraged us to focus on Census Bureau estimates of vacant year-round homes for sale that are produced on a quarterly basis. These estimates include unsold completed new homes in the hands of builders along with vacant existing ― previously owned ― homes for sale.
There were nearly 5.8 million year-round housing units on the market at mid-2007, down from a record 6.1 million three months earlier but higher than any previous number on record. Both the for-sale and for-rent components of this total were down from their first-quarter records, but both remained historically high.
The for-sale measure remained in the stratosphere at mid-2007, reflecting massive increases recorded in both single-family and multifamily (condo) markets since mid-2005. Total for-sale vacancies were 2.0 million at mid-2007; about four-fifths of these (1.6 million) were single-family homes, and nearly nine-tenths of single-family vacancies were in the existing-home market — a legacy of the investor/speculator buying binge during the boom years.
Home Prices Continue to Fall, Although the Adjustments Are Not Dramatic
Available measures of single-family home prices show systematic deceleration and some erosion during the past year, although the downward adjustments pale in comparison to the explosive growth that had prevailed during the previous three years. The “true” price adjustments undoubtedly are larger than shown by transactions prices, since nonprice sales incentives support the latter measure, but it’s fair to say that home prices (measured or true) have not yet approached market-clearing levels in most places.
The S&P/Case-Shiller 20-city composite home price index (based on a repeat-sales methodology that minimizes compositional distortions) was down by 2.8% in May on a year-over-year basis, moving more deeply into the negative range that emerged in January. On a sequential seasonally-adjusted basis, this measure actually entered the negative range in June of last year and contracted at an annualized rate of 7% in May.
The median price of existing single-family homes sold ticked up in June (year-over-year basis) following 10 consecutive months of decline. However, this series has no controls for compositional shifts, and the uptick in June undoubtedly reflects a shift in the composition of homes sold toward higher-priced units — because of the relatively heavy impact of subprime-related credit tightening on sales of lower-priced homes.
Housing and Mortgage Finance Problems Spark Financial Market Turmoil
Financial markets turned turbulent late last month. A spate of bad news on the housing market prompted concerns about downside risks to the economic expansion, and ongoing problems in markets for subprime mortgages and related securities structures prompted investors to reevaluate historically narrow risk spreads in other components of the credit/securities markets.
In the midst of the turmoil, yield spreads for investment-grade corporate bonds over comparable-maturity Treasuries widened by about 20 basis points, while spreads for lower-quality corporate bonds jumped by about 75 basis points. The broad-based shift away from risky assets also hit equities, dealing the major stock price indexes heavy losses.
The generalized flight to quality provoked a strong rally in the Treasury market, a dynamic that was reinforced as investors marked down their expectations for the path of the federal funds rate. Unfortunately, the decline in the 10-year Treasury yield did not transfer fully to the prime fixed-rate mortgage (FRM) yield. This yield spread widened amidst reports from a major mortgage lender that credit quality is eroding in the prime mortgage market.
The reported erosion was concentrated in second mortgages that had been layered on top of prime first mortgages and in payment-option ARMs where combinations of rising loan balances (via negative amortization) and eroding house values were pulling some of these “nontraditional” first mortgages under water. Although these types of problems hardly characterize the entire prime mortgage market, the frenzied flight to quality promises to elevate the FRM-Treasury spread for some time.
Look Toward Mid-2008 for the Bottom of the Housing Production Cycle
The recent downbeat news on home sales and housing demand, the near record excess supply of vacant housing units at mid-2007, the moderate process of home price adjustments and the recent broad-based setbacks in the housing finance system have prompted yet another trim to NAHB’s forecast for housing production in the second half of this year and 2008. We now expect housing starts to trail downward through the first quarter of 2008 before embarking on a gradual recovery process that should run for several years.
On a year-over-year basis, we now expect total housing starts to be down by 23% in 2007 and another 1% in 2008. We now expect RFI to be down by 14% in 2007 and 1% in 2008; on a quarterly basis, we expect RFI to bottom out in the first quarter of next year before embarking on a systematic recovery path.
As in previous forecasts, the single-family market bears the brunt of the balance of the projected housing correction. In this regard, projected single-family starts fall by 40% from the peak in the first quarter of 2006 through the first quarter of 2008 and the single-family component of RFI contracts by a similar percentage over this two-year period.
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 Aug. 1 edition. To subscribe to “Eye on the Economy,” click here.
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