Although the nation’s economy moved a bit unexpectedly onto shakier ground this summer, housing is likely to continue its slow trudge back to normal, with further improvement next year and more significant gains in 2013, according to economists participating in an Oct. 26 NAHB construction forecast webinar on the housing and economic outlook

Speakers said that a housing recovery has already begun to materialize in many local markets across the country, which will provide some momentum for the overall housing recovery next year. States damaged the most by the housing boom and bust will have the longest wait, but even these places are showing progress in making a comeback.

The European debt crisis and fumbling on the budget process by recalcitrant lawmakers in Washington have created difficult uncertainties for the economy and have significantly raised the odds of the U.S. lapsing into a new recession, the economists acknowledged, but their consensus was that growth would continue, although at a pace unlikely to generate much job growth for a considerable period of time.

While housing continues to face formidable challenges of its own — such as declining home prices, soaring foreclosures and tight lending standards for home buyers and builders — the disappointing performance of the economy itself is undermining prospects for the vigorous housing upturn that normally follows recession but hasn’t occurred this time.

Consumers Guarded

“Slow growth has meant deterioration in the employment market,” said NAHB Chief Economist David Crowe. “Folks aren’t going out and spending a lot of money on a home or other large purchase unless they feel comfortable about their jobs.”

With unemployment lingering around 9%, no better than it was at the start of this year, consumers remain guarded.

Levels of consumer confidence reported in indexes by the Conference Board and the University of Michigan are now below where they were during the recession, he noted, “an indication of discomfort about the current situation and the future.”

Monthly job growth appeared to be picking up earlier this year, heading in the first quarter towards the 200,000 rate needed to start filling the enormous gap left by the recession, but the upward trend stalled out by mid-year, cutting job generation in half.

Prospective buyers who do venture into the housing market will find that home prices and interest rates are favorable.

Home prices nationwide have returned to a healthy average of about three times household income, compared to the unsustainable five times predominating at the height of the boom, and the NAHB/Wells Fargo Housing Opportunity Index for the second quarter found that more than 70% of all new and existing homes sold were affordable for median-income families.

Mortgage interest rates have also been in record low territory, and although they will begin creeping up, Crowe predicted they would remain below 6% at the end of 2013.

Household Formations

An eventual pick-up in household formations is the “magic powder” that will ignite housing demand, Crowe suggested, with the large cohort of children of the baby boomers — “the echo boom” — now in their 20s and 30s “coming forward at the perfect time to form households” and poised to enter the housing market relatively soon.

Economic hardship drove down household formations during the recession from a typical yearly pace of 1.25 million, he said, as younger people postponed establishing homes of their own and doubled up with families and friends.

As a result, “there are as many as 2 million households out there waiting” to form, he said. “They will be the first ones out of the box as soon as they feel comfortable with their employment situation,” and their entry into the housing market will initially be concentrated in rentals.

Renters today account for about one-third of households, and with a reversal beginning in the second half of the previous decade in rising homeownership rates, their ranks are now climbing.

Sales and Starts

For the third consecutive year, Crowe said, new-home sales will fall to a record low, coming in at not much above 300,000, which is “one reason builders aren’t starting new homes.”

Sales of existing homes will fare better than new home sales in 2011 because of the large number of sales of distressed properties, but both new and existing sales are expected to soon begin registering more significant ongoing improvement.

Crowe forecasted “eventual curing in 2012 and better curing in 2013 on new home sales,” stoking demand for new construction.

Single-family production is also expected to set a new low this year in records dating back some 50 years, slumping to 422,000 units.

Single-family home building will hit a “flat spot” for a couple quarters before heading up, he said, rising to 495,000 units in 2012 and 723,000 in 2013.

Next year’s gains will be led by smaller, scattered markets, he said, such as those that have been appearing in the new NAHB/First American Improving Markets Index.

To appear on the index, markets must show increases in single-family permits, home prices and employment for a consecutive six-month period. So far, Pittsburgh and New Orleans are the only larger metropolitan areas to meet these criteria.

Multifamily is on a faster upward trajectory, with starts forecasted to progress from 164,000 units this year, to 186,000 in 2012 and 212,000 in 2013, he said. Even so, a full recovery to the 350,000-unit long-term trend for this sector remains “a long way off.”

Overall, “the housing recovery is going to be spotty,” Crowe said, which is “one of the reasons that the overall national numbers will be spotty, with some states growing faster than others and other states lagging behind.”

Elevated Recession Risks

Delving into the economic forces that housing will be contending with in the next two years, Joel Prakken, senior managing director and co-founder of Macroeconomic Advisers, LLC, projected growth in the gross domestic product at 1.5% this year and about 2.5% in 2012.

While this is slightly above the consensus of forecasters on growth, “these numbers are hardly buoyant,” he said, “in the middle of a period of slow growth with recession risks quite elevated.”

The labor markets will remain very weak, he said, with no decline in the current 9% unemployment rate until the end of next year and only a modest decline to 8.5% by the end of 2013.

To the extent that the housing recovery depends on robust employment growth, the jobs outlook is not encouraging, he said.

In Prakken’s view, “inflation will remain well contained,” at less than 2% this year and 1.5% next year — excluding volatile food and energy — which is also slightly better than the consensus forecast.

Weak economic growth, high unemployment and low inflation are all conducive to “no monetary tightening any time soon,” he said, with even more easing from the Federal Reserve possible.

“The environment for the next year or two will be characterized by extremely low interest rates,” he said.

“Mortgage rates for the next year or two will be low historically,” Prakken said. “That’s good news for the housing sector, which needs this support as a precondition for its eventual recovery.”

Not until 2013 will real GDP growth be moving up into the range of 3% to 4%, close to the historic average. “We are now in an unprecedentedly weak period,” he said.

Fiscal Drag

Prakken said his forecast is subject to revision, “depending on how the legislative winds blow in Washington” as the federal government grapples with new fiscal spending and tax policies aimed at reducing the debt.

He is assuming that the current payroll tax holiday will not be extended by Congress for 2012, which would impose a $120 billion tax increase on the middle class in the coming year and put a drag on growth.

If he is wrong and the tax holiday is extended, GDP growth projections would be revised up by about 0.5%.

Prakken also expects the congressional supercommittee established in August at the time of the “debt ceiling debacle” to fulfill its mandate of lining up $1.5 trillion worth of deficit reduction over the next 10 years and to backload the plan so that it does not place a tremendous burden on the budget in 2013 and 2014.

If the committee fails in its mission, then automatic cuts will take effect, in which case he would double to 0.8% the 0.4% that would be subtracted from growth as a result of tighter fiscal policy.

“2013 is a period of extreme uncertainty surrounding fiscal policy,” he added, with all of the tax cuts instituted by President Bush set to sunset, representing a $400 billion tax increase for “an economy that will still be struggling.”

How this plays out will have a pronounced impact on the state of the economy, he said.

Facing Uncertainty

“Clearly, we are lurching into a period of fairly dramatic fiscal restraint. It would be better to have a stimulative fiscal policy” until the economy recovers.

Adding to uncertainties is the outlook for spotty growth in the Eurozone, which along with ongoing “flip-flopping” in U.S. fiscal policies is reducing asset values and damaging confidence in hiring and spending.

“Housing is the biggest drag on the economy right now, but Europe is the biggest risk,” he said. If Europe fails to fix its financial system, it could result in global turmoil and unnerve the financial markets.

A prerequisite for an upturn in housing is an upturn in housing prices, he said. “It is critical for construction activity because nobody wants to build or buy if prices are expected to fall.”

On the lending side, based on the Federal Reserve’s surveys of senior bank officers on lending practices, credit conditions “are easing on all fronts for consumers, mortgages and businesses, but the cumulative easing has been far less than cumulative tightening during the recession,” Prakken said, leaving housing, particularly, “a long way from anything approaching normalcy.”

Conditions Vary by State

Looking at various state statistics behind the national numbers, Robert Denk, NAHB’s assistant vice president for forecasting and analysis, noted a range of conditions across the country and differences among the states in the amount of distress suffered during the recession and the headway that is being made in recovering.

Housing nationwide bottomed out at an average 28% of normal production, which he defines as the residential building that occurred in 2000 to 2003, before the housing boom.

The hardest hit states — such as California, Florida, Nevada and Arizona — bottomed out at 10%-20% of normal, while better states, in sharp contrast, declined to 50% of normal production.

Denk said that housing prices are drifting back to near-normal in many states. The number of states where house prices now exceed their historic trend are continuing to recede, joining the states where prices are in the normal range.

Some states, however, have seen an overcorrection of boom prices — such as Nevada, where prices soared to more than 200% of their trend level and have now fallen to 90% of trend.

What’s happening with prices, he said, is an important issue, one that will be “a key driver of fundamentals in what’s going to happen.”

Most states saw their foreclosure rates double from an average of 0.5% during the period before the boom to a peak of 1.0% in the third quarter of 2009, but there were those — such as California, Arizona, Florida and Nevada — where foreclosures increased by a factor of four, five or six times normal.

While foreclosures remain a problem in most markets, they are at crisis proportions in only a few, he said. He added that Texas and Florida have the same number of mortgages, but Florida has four times as many foreclosures.

Smaller Markets Running Ahead

The protracted housing recovery now underway will bring housing starts to 42% of normal production by the fourth quarter of next year and 61% of normal by the end of 2013.

Getting back to normal considerably faster will be oil states Texas and Oklahoma; coal and natural-gas producing Wyoming and Montana; and Iowa, supported by agricultural commodities.

In another way of looking at the long road back to normal, by the end of 2013 the top 20% of the states will be at an average 76% of normal production, compared to the bottom 20%, which will still be below 51%.

Most markets on a state basis will be performing better than national statistics in the two years ahead, he said, because some of the largest states in terms of housing production — such as California — are also the most distressed.

The five hardest-hit states account for 27% of building activity, he said.