Eye on the Economy - 02/03/2010 (Plain Text Version)

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Housing Struggles as the Economy Slowly Grows

The Bureau of Economic Analysis (BEA) at the end of January estimated that growth of the gross domestic product (GDP) jumped to a seasonally adjusted annual rate of 5.7% in the fourth quarter of 2009, up from 2.2% growth in the third quarter, suggesting that the economy now has established a firm footing on the recovery path.

Unfortunately, that’s not the end of the story. For housing, for the extremely high levels of the unemployed and underemployed and for consumers, convalescence from the worst recession in generations will be slow.

Things are getting better, but maybe not fast enough to entirely ease the pain.

If the economy continued growing at a 5.7% rate, that would raise some genuine cause for celebration. Unfortunately, growth of that magnitude at this point is generally considered unsustainable. The economy will continue to move forward over the coming year, but at a relatively modest pace that should at least arouse a feeling of gratitude that we have endured the worst and can now prepare for better times ahead.

Inventory replacement made a major contribution to the fourth quarter growth spurt as businesses scrambled to replenish their supplies. Once those inventories have been rebuilt, the question is how soon they will need to be replaced again.

While cash registers will be seeing more action than they did when the economy was still falling off a cliff, goods won’t be flying off the shelves, so inventory replacement won’t be as potent a force behind growth in the period ahead. At the same time, personal expenditures by consumers in the fourth quarter slowed to a growth rate of 2.0%, down from 2.8% in the third quarter.

The most fortifying news for home builders is that after three-and-a-half straight years of reducing GDP growth by an average annual rate of roughly 1%, residential construction is no longer a drag on the economy. Residential fixed investment, which is housing’s share of GDP, grew a robust 18.9% in the third quarter and continued at a healthy clip of 5.7% in the final three months of 2009. Of course, it should also be kept in mind that the first GDP numbers we see for any quarter are advance estimates that are subject to revisions, sometimes substantial, as more data become available.

To gain an even more realistic perspective on the robust-appearing advances that recently have been registered in the general economy and residential construction, it also must be acknowledged that these improvements are coming off extremely low levels of activity.

By many measures, at the bottom of the recession housing production reached its lowest levels since the 1940s, and a couple quarters of positive news have hardly restored it to full health. Meanwhile, nonresidential construction, which held up fairly well through most of the recession, has now fallen for six straight quarters, tumbling at a rate of 18.4% in last year’s third quarter and 15.4% in the fourth.

This can’t be good for the stability of the financial institutions that have been making nonresidential loans, and unfortunately these tend to be many of the same lenders home builders have relied upon for the credit they need to develop and build their projects.

Home Sales Fall

While most observers now believe that housing is heading slowly but surely to higher ground, in the early stages of the upturn the ascent has not been entirely smooth, and that has been complicated by the availability of the tax credit for first-time home buyers.

Although the tax credit was extended into 2010 and expanded to include repeat home buyers in early November (see www.FederalHousingTaxCredit.com for details), it is unlikely that many December existing home sales were generated by the credit. After three months of steady improvement, existing single-family home sales fell dramatically in December. After rising to a seasonally adjusted annual rate of 5.76 million in November, their highest level since April 2006, sales dipped 16.8% in December to 4.79 million.

Based on settlements, existing sales actually reflect sales agreements from earlier months rather than capturing new contracts for purchases of existing homes. This makes it likely that the November sales were inflated by buyers who were rushing to qualify for the credit by meeting the closing deadline at the end of the month, at the expense of sales that otherwise would have occurred in the following month, not knowing that Congress was about to extend and expand the credit. As for the longer term trend, existing single-family homes sales were up 12.7% from one year earlier.

The home buyer tax credit similarly obscured the longer-term upward trajectory of new home sales in December, but for a somewhat different reason. New home sales, which are based on signed contracts with a deposit, fell in December to a seasonally adjusted annual rate of 342,000 their lowest level since March 2009. That was down 7.6% from November’s 370,000 and 8.6% from the year-earlier pace of 374,000.

Although the extended and expanded home buyer tax credit was safely in place by December, prospective buyers were under no immediate pressure to race back into the market, given deadlines of April 30 to sign a contract and June 30 to close.

Ongoing uncertainty over the strength of the economy and job market was probably another contributing factor behind the reluctance of households to make the major financial commitment of signing a contract for a new home.

Even as the market remained anemic, builders continued to reduce the inventory of new homes for sale, which has dwindled to 231,000 houses, its lowest level since April 1971, despite an 80% increase in the number of U.S. households since that time. [return to top]

Single-Family Housing Starts Fall

The housing recovery has also remained erratic on the production side, with single-family housing starts falling to an average annual rate of 456,000 in December, down from 490,000 in November, when many builders may have decided to rebuild their inventory of lower priced homes to continue to take advantage of the tax credit.

While it was clear that the positive effects of the credit had yet to be felt in December in any significant way, there is the general expectation that it will once again bolster sales into mid-year, giving the economy more time to gather strength and gradually provide the momentum that housing needs to mount a full-scale recovery.

Rising single-family building permits in November and December suggest a growing sense of optimism among builders as they look further out. Permits climbed 8.3% in December to a seasonally adjusted annual rate of 508,000, which was their highest since September 2008. But builders surveyed in January for the NAHB/Wells Fargo Housing Market Index (HMI) remained guarded in their hopes for the future and not entirely convinced that the economy was yet strong enough to support a major resurgence in housing.

Those misgivings nudged the index down from readings of 17 in November and 16 in December to 15 last month, back to where it stood last June. Any reading below 50 is negative territory for the HMI, so builders will need a considerable amount of cheering up before they are able to extricate themselves from their current doldrums.

The component of the index gauging future sales is where builders are pinning their hopes, looking forward perhaps to a livelier home buying season this spring, and that part of the index held steady in January. Current sales and the current traffic of prospective buyers remained disappointing, however, pushing those parts of the index down.

Further evidence of a generally slow, steady improvement in single-family residential construction is provided in the Census Bureau’s numbers on the value of construction put in place, which is a barometer of the effects of ongoing construction. This series has been on an upswing for the past seven months (June through December), though the improvement in December was a scant 0.6% and the measure was still down 17.6% from a year earlier.

Meanwhile, Census data on the value of multifamily construction put in place portrays a dramatic slowdown, with declines in 14 of the last 15 months. In seven of those months, the declines were 5% or more. This measure fell 4.4% in both November and December, and on a year-over-year basis, it was down 45% in December 2009 from December 2008.

On a decidedly slower recovery track than single-family housing, no quick turnaround is anticipated for multifamily production, which has been on the decline on a quarterly basis since the second half of 2008 and deteriorated over the course of 2009.

Multifamily starts in last year’s first quarter averaged a seasonally adjusted annual rate of 169,000, about half the level of a good year, and tumbled to a meager 81,000 by the fourth quarter. Multifamily starts in 2009 totaled a dismal 110,000 units, compared to 283,000 in 2008, 309,000 in 2007 and an average of 342,000 for the 10 years from 1997 through 2006.

Multifamily quarterly building permits have been careening down a similar path since the second half of 2008, with one notable difference — an uptick from a yearly rate of 113,000 in the third quarter of 2009 to 122,000 in the final quarter, suggesting that this sector has also seen the worst and is prepared to make some headway this year and increasingly in 2011. Even so, NAHB is forecasting only 150,000 multifamily starts for 2011, less than half the average starts for the 1997-2006 period. [return to top]

Housing Prices Continue to Inch Up

The S&P/Case-Shiller 20-city price index has now risen for six consecutive months (July through November). Although the measure in November 2009 was down 5.3% from November 2008, the year-over-year rate of decline had slowed in each of the preceding eight months (April through November). Further, the year-over-year decline for September through November dropped below the double-digit declines that characterized the index for more than a year and a half.

The other major price index, published by the Federal Housing Finance Agency (FHFA), also pointed to further stabilization of home prices, which rose in the second quarter of last year and again in the third quarter to only 3.7% below the third quarter of 2008.

The first-time home buyer tax credit can be credited with helping arrest the free fall in house prices that was gnawing at the core strength of the U.S. economy, and in its extended and expanded phase the credit should work to further shore up home prices, inspiring confidence in prospective buyers that this is an optimal time to re-enter the market. According to the S&P/Case-Shiller price index, house prices are back to around their fall 2003 levels.

In the many states and metropolitan areas where home prices and inventories have settled back to their long-term trend levels or below and supply and demand are in equilibrium, the marketplace has been primed for sustainable growth in housing production going forward, with the next phase depending on a restoration of consumer confidence.

In localities still struggling with excess inventory, however, house prices will remain soft and further declines are possible. While the problem of oversupplied areas will subside as the recovery picks up steam, the most distressed markets are large and their drag on housing nationally will just about equal the bounce from returning home sales in stabilizing markets.

As a result, NAHB is forecasting that house prices will remain flat on a national level through the second quarter of 2010. [return to top]

Housing Still Faces Significant Headwinds

Although the economic outlook for housing in 2010 is reasonably positive and the extended and expanded home buyer tax credit will provide a much-needed boost, the housing market continues to face significant challenges that could slow or even derail the recovery.

The job market, though mending, remains weak. Would-be home buyers still need large downpayments and/or nearly stellar credit to obtain a reasonable mortgage.

With traditional lenders moving to the sidelines and placing restrictions on residential development, builders face extreme difficulty in obtaining acquisition, development and construction (AD&C) loans for new projects and in working out viable plans to restructure existing loans that have become problematic in a down market.

Builders have seen lenders reduce their lines of credit, demand increased equity for outstanding loans and, in some cases, demand full repayment. It has not been uncommon for these increased requirements to transform a performing loan into a non-performing loan.

Inaccurate appraisals are also hindering a faster recovery for housing. These occur when an appraiser (often from outside the area being appraised) uses sales from a dissimilar neighborhood as a comparison or uses a foreclosure or short sale as a comparison without making proper adjustment for differences in the condition of the house.

Foreclosures are yet another drag on numerous housing markets. Many of the foreclosures and past due mortgages are concentrated in the formerly hot markets — parts of California, Las Vegas, Phoenix and southern Florida — and economically distressed markets, primarily in the Great Lakes region of the upper Midwest.

Based on data from the Mortgage Bankers Association, in the third quarter, the five states with the highest rate of foreclosures started were, in order, Nevada, Florida, Arizona, California, and Michigan. These five states accounted for almost half (48%) of all foreclosures started in the U.S. These same five states (in the same order) also had the highest rate of mortgages 90 days past due (generally a sign that most of them are headed to foreclosure).

Even with an improving economy and the home buyer tax credit, foreclosures will be fed by the weak employment market and are likely to continue to rise into the first part of 2010, especially in these areas. [return to top]

Want to Know the Housing Starts Forecast Through 2017?

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