Housing Not Out of the Woods Despite Growing Economy
It’s a pretty safe guess that the U.S. economy is now on the road to recovery, according to economists participating in NAHB’s Fall Construction Forecast Conference in Washington, D.C. on Oct. 21. But the end of the recession, they said, doesn’t necessarily mean that troubles for the housing industry are over.
Housing appears to have stabilized, with both single-family home sales and production activity heading for higher ground, they said, with the multifamily sector trailing behind. The severity of the downturn from which the nation is now emerging, however, has made it more difficult to know exactly what to expect in the period ahead.
As a result, housing could improve faster than is generally expected, or it could hobble along without reaching healthy levels until far into 2011. What happens to housing prices is crucial in determining the strength of industry performance, the analysts said. While prices have shown signs of stabilizing in recent months, they could suffer a relapse in the face of rising unemployment, which in turn is increasing the number of home owners who can no longer afford to make their mortgage payments.
On at least one point the panelists were in agreement: failure to extend the home buyer tax credit, which is set to expire on Nov. 30, would be a setback for the first-time buyer market that was driving sales this summer.
“This will not be the kind of robust recovery you usually see given the depths we are coming out of,” said NAHB Chief Economist David Crowe.
Not a Robust Recovery
A big negative for the economy, he said, is the continuing wave of joblessness, which is expected to crest around 10% and improve modestly early next year but not improve significantly before 2011. “Not adding to jobs feeds back into dampening housing demand,” he said.
With households recovering from home equity and retirement savings losses and still facing an unsettling outlook for jobs, “it’s hard to get consumers believing that things have improved enough that it’s time for them to come back full force into the market,” Crowe said.
The sales expectations of home builders surveyed in the NAHB/Wells Fargo Housing Market Index have weakened for the past two months, he noted, largely over concerns that the home buyer tax credit was coming to an end. July was about the latest that builders could break ground on a new home and have it completed in time for the buyer to close on the sale by Nov. 30 to qualify for the popular tax incentive.
A monthly survey of actual net sales among large home builders based on a seasonally adjusted three-month moving average showed an upturn early this year, Crowe added, but those sales have tapered off a bit recently as a result of the fading tax credit and declining first-time buyer demand. “That’s a concerning indicator of where we may be going,” he said.
New home sales bottomed out at a seasonally adjusted annual rate of 329,000 in January, Crowe said, and climbed 30% by August, to 429,000. The percentage increase may look impressive, but it is from an exceedingly low number and it will take an extended period of time for the market to return to normal, Crowe said. NAHB is forecasting that sales will total 389,000 this year and rise to 525,000 in 2010 and 806,000 in 2011.
The inventory of new homes has dropped from a 12-month supply, he said, to nearly a seven-month supply, which is closer to the five-month supply that is considered average. However, “the absolute level of new homes on the market is extremely low” — the lowest since 1992 — and “the existing home inventory is the problem,” he said.
There are currently about two million vacant homes for sale, Crowe said, about one million more than are needed. “Additional foreclosures are feeding into this,” he said, along with unemployment, “which is the primary driver now.”
With some hesitancy, single-family starts have also been moving up, he said, from an annual rate of 357,000 in January to 479,000 in August, a 34% gain. The NAHB forecast projects 600,000 single-family starts next year and 894,000 in 2011. Multifamily production, on the other hand, will continue to slide — from 126,000 this year to 116,000 in 2010 — and rise to 165,000 units in 2011.
The availability of acquisition, development and construction (AD&C) financing remains a serious concern as the industry moves forward, Crowe said. As of now, “the banks are simply saying no to real estate,” he said.
Crowe said that in this year’s second quarter less than 20% of the builders surveyed by NAHB were seeking new AD&C loans, down from roughly 75% when times were booming in 2005, because “they don’t have enough production and they realize conditions are that bad, so why bother.”
In this year’s third quarter, about three-quarters of the builders polled by NAHB reported that the availability of AD&C credit had worsened since the previous quarter. “This is one of the single largest issues even in markets where the stress was never felt and sales are still occurring at least slowly,” he said.
Appraisals are another ongoing impediment to a full-scale housing recovery. In recent NAHB surveys of builders, 59% responded that they had received appraisals below a home’s selling price; of those, 56% said appraisals had come in below the cost of building the home and 26% said they had lost sales because of low-ball appraisals.
While the short-range outlook may be a mixed bag for builders, Crowe said that the opposite was true for the longer term when looking at the age distribution of the U.S. population. Not counting new immigrants, there will be 83 million Americans in the 25 to 44 age bracket, which are the prime years for home buying and household formations. “That’s a huge demand for housing,” he said.
Crowe also discussed the recent decline in the average size of new homes, which has dropped from just over 2,300 square feet in 2007 to below 2,100 square feet currently.
“That’s not unusual in a recession,” he said, “as first-time buyers account for a larger share of the market.” However, following past recessions, the size has tended to go back up. “It might be different this time,” he said, because first-timers may continue to account for a disproportionate share of the market, households remain concerned about reducing their energy expenditures and home buyers aren’t as concerned about maximizing their investment in housing because they don’t expect prices do go up as rapidly as before.
Robust, But Sub-Par Growth
Like his co-panelists, Joel Prakken, chairman of Macroeconomic Advisers, said that the recession is over and the economy is heading into a sub-par recovery, but he was decidedly more bullish about prospects for growth and housing even under less than stellar conditions.
He attributed support from the Federal Reserve and government stimulus policies for today’s “dwindling downside risks” to the economy. Growth for the third quarter will come in around 3.5%, he said, and rise to a relatively “robust” 4.1% in 2010 and 4.2% in 2011, which sounds good compared to a Blue Chip consensus of 2.8% for next year, but is decidedly slow for the early phase of a recovery from a deep recession.
Looking at history, which suggests that the deeper the contraction the faster the recovery should be, the current upturn normally would be expected to yield growth pushing 10%, he said.
Among the factors that might suppress growth: the securitization markets still aren’t working, there are potential commercial real estate lending problems; bank lending to consumers and others remains “stingy;” home prices could erode further, dragging housing lower; the recovery in equities could falter; energy prices increases could be a drag on growth; and foreign demand for dollar assets could fall short, exerting downward pressure on the value of the dollar and pushing up interest rates.
Prakken said he expected unemployment to reach a peak of around 10% later this year and decline to 9.1% in the fourth quarter of 2010 and 7.7% by the end of 2011.
Inflation No Big Concern for Now
Because there is so much slack in the economy, he projected that core inflation would fall from 1.4% this year to 0.8% in 2010 and 2011, comfortably below where the Federal Reserve doesn’t want to see it. “Core inflation falls most in the early phases of recovery,” he added.
For the time being, Prakken dismissed the possible inflationary impact of ballooning federal deficits. “The fiscal stimulus is working for now to help the economy through this period,” he said, and discussions about reducing the deficit will be delayed “until we get out of these economic woods.”
Core inflation will also feel downward pressure from “the stunning performance of productivity growth,” he said, which was running at 7% in the second quarter and could be 6% in the third quarter. Just moving out of a recession, it would be far more typical to see declining productivity, he said.
“Inflation is not something we’re very concerned about,” he said, conceding that there are those who are worried about inflation arising from expanding federal balance sheets.
Among the factors Prakken expects to contribute to above-trend GDP growth are: a rebound in motor-vehicle production; a sharp slowdown in inventory liquidation; an improvement in broader financing conditions; an improvement in household balance sheets that will help stabilize and lift consumer spending; the Administration’s stimulus package, which is providing two percentage points of the annualized growth occurring in the second half of this year and in early 2010; and a faster-than-expected global recovery thanks to the performance of China and India.
An Economic Boost From Housing
Housing will also boost the economy, he said, with starts rising to the 1.4 million range by the end of 2011. Contributions of residential investment to GDP growth will rise to one-half of a percentage point during the second half of this year, 0.8 points in 2010 and 0.7 points in 2011, he said.
Prakken conservatively projected 1.3 million to 1.4 million net annual household growth over the next four to five years and estimated yearly housing demand at 1.5 million to 1.6 million during this period.
“We overbuilt by about four or five million homes” during the boom, he said, and it is assumed that there can be “no rebound until you completely get rid of this. But that’s not how it works. The upturn in housing has always begun before all the excess inventory was worked off.”
The excess existing home inventory has been reducing new construction by about 350,000 to 400,000 units, he estimated, “but it is a slow process.”
The housing market will gain impetus as the economy improves and incomes stop falling and begin to rise. The end to falling home prices will also significantly lower the user cost of housing, he said, producing a significant decline in the real mortgage rate and offsetting the drag from the inventory overhang.
The Day of Reckoning
Mark Vitner, managing director and senior economist for Wells Fargo Securities, said there is “no debate” and “incredible unanimity among economists that the recession ended this summer,” with as much as 3.7% GDP growth in the third quarter, resulting in large part from a doubling of output in auto production.
“But we see structural issues as being a little bit larger this time,” Vitner said. “The day of reckoning has come” for an economy based on too much spending and borrowing and too little savings. As a result, he forecasted a substantial deceleration in growth next year and prospects for 2% GDP growth “for quite some time.”
“We have had incredible job destruction and are on pace to lose nine million jobs,” he said. If those jobs start being added back next June at the same pace as jobs were created following the last two recessions, it would take until 2015 for them to be fully restored, he said.
Even new jobs will be slow to stimulate strong consumer demand, he said, because workers have been employed for a long period of time — with 20% to 25% out of a job for six months or longer — depleting their savings and other financial resources and getting by the best they can. “If they get a job tomorrow they won’t be in a position to go out and make major purchases for quite some time.”
Even workers who have managed to stay employed will be cutting down on consumption, Vitner said, because their earnings from work are down a cumulative 25%, although retail sales have seen the worst of their downturn.
Looking at the ups and downs of GDP “hasn’t given an accurate portrayal of actual conditions in the economy,” he said, which is still recovering from burst bubbles in housing, consumer spending, the financial sector, commercial real estate lending and trade.
Retail businesses stopped opening stores and then started closing them to bring their inventories in line with plummeting demand, he said, and the massive business liquidations that occurred in the first half of this year are expected to proceed, although at a slower pace, for several more quarters, he said.
“The trade deficit has unwound quickly because we are importing less,” he said. Also, “a large proportion of what goes into a home is imported, so the housing slowdown slowed imports. The improvements in the balance of trade aren’t the result of rising U.S. exports, he said; “they’re a sign of weakness, not a badge of honor.”
With growth as weak as it is, the economy remains vulnerable to an unexpected shock, Vitner cautioned. “It wouldn’t take much to bring us down.
Further Housing Price Decline Ahead
Vitner projected that total housing production would rise slowly, hitting one million units at the tail end of 2011 and 1.2 million at the end of 2012.
While intervention by the Federal Reserve in the mortgage backed securities market has pushed mortgage interest rates sharply lower — below 5% for 30-year, fixed-rate loans — that process is now winding down “and we haven’t seen the healing we need in the financial sector to get investors buying securities,” he said, citing “a very limited appetite” for them among foreign investors.
Household wealth is experiencing some improvement from a rising stock market and stability in measured housing prices, he said.
However, he noted that there can be 20% variations in house price movements within a given metro area.
Also, Vitner warned, there have been so few transactions in the jumbo mortgage market, that there has been an insufficient correction in the prices of homes at the high end.
“When we do see transactions in the jumbo market,” he said, “measured house prices will come down.” Consequently, he is expecting a resumption in price declines in the next quarter. While “the decline is behind us for the most part,” Wells Fargo is forecasting another 4.5% to go.
Photos by Morris Semiatin