Real estate's July report card
Guest perspective: Will housing have a hard or soft landing?
Monday, July 17, 2006
By John Burns
John Burns
The housing market has had four significant downturns in the last
20 years. The current downturn has been swifter than any of the prior
four. The extent of this correction has been similar to the two "soft
landings," but we don't seem to have landed yet.
1988-91: The 1988-1991 period was a hard landing, with many companies
going out of business. The reasons for the severity were primarily:
1) Job losses, particularly in California and Florida; 2) government-induced
wipeout of the savings and loan industry, which was providing most
of the capital to builders; and 3) some speculative price appreciation
that caused affordability problems. The job losses also led to horrendous
consumer confidence.
1993-1995 and 1998-2001: The two soft landings in this cycle were
primarily driven by rising interest rates. The job losses in 2001
were primarily in the Midwest and a few technology-dependent markets.
2005-????: Thus far in the current cycle, we have landed to "typical
soft landing" conditions -- not everywhere, but nationally. Significant
price appreciation from 2002-2005, which was driven by speculative
investors and homeowners, followed by rising interest rates, have
created affordability problems. Thus far, the job market and consumer
confidence are holding up just fine, which leads us to believe that
consumers will return once interest rates stabilize and the investors
have sold their holdings. We don't know how long this will take but
we are fairly certain that there are too many listings for the recovery
to occur sometime this year.
The landing will probably vary by market and even submarket. The landing
is likely to be soft (which we define to be the majority of builders
still making positive profits) because there is nothing wrong with
the economy. However, each market has its own issues that need to
be worked through. These issues include:
New-home supply: In some markets, there is an oversupply of new construction
in the peripheral areas.
Resale supply: In most markets, there is an oversupply of resale listings,
which is likely to be exacerbated by an almost certain increase in
forced sales due to adjustable-rate mortgage resets.
Affordability: In markets that were flooded with speculators, there
are affordability problems that are likely to be with us for many
years to come.
Demand: Job losses in the Midwest and a few other markets are also
a problem, but job growth remains solid in the major housing markets
in the South and West.
The length of time that it will take to work through these issues is impossible to forecast. However, if the Fed can a) maintain positive job growth of 1.5 percent-plus per year and b) keep mortgage rates from rising too much further, most markets will return to normal once resale supply returns to a normal level. Builders who paid high land prices in the peripheral areas are probably going to have the toughest time during this adjustment period.
Our grading system of the economy and the housing market is a "bell curve" model, with statistics at an all-time high receiving an "A," statistics near the long-term average receiving a "C," and the worst times ever receiving an "F." In this grading system, it is OK to be a "C" student.
Here is our current report card:
Economic Growth: C
The U.S. economy is healthy. Economic growth in the first quarter was revised to 5.6 percent. Growth in June was slower than expected but still solid, adding 1.85 million jobs in the last 12 months. The core CPI inflation rose to 2.4 percent, and total inflation was 4.2 percent.
Leading Indicators: C-
The leading indicators declined for the second month, suggesting that economic growth is likely to be more moderate than the pace of the first quarter. The spread between the 2-year and 10-year Treasury was essentially 0 at month-end, which is concerning. The S&P Super Homebuilding Index continues to decline, having fallen 36 percent in the last year and 41 percent since its peak.
Mortgage Rates: B-
Mortgage rates continued to rise in June, with the one-year adjustable mortgage rate 19 basis points higher at 5.82 percent at month-end, while fixed mortgage rates rose to 6.78 percent. The Fed raised its short-term interest-rate target for the 17th consecutive time to 5.25 percent, hinting that at least one more increase is likely.
Consumer Behavior: C+
Consumer confidence rose in June to 105.7, due largely to an improved outlook for the next six months and for the labor market. While consumers may be delaying home purchases because of affordability issues or investment perceptions, they have a confident outlook for the future, which is critical to a housing market recovery.
Existing-Home Market: B
While home-buying activity remains high, rising listings is creating a much more competitive housing market. May sales of existing homes fell to a 6.7 million annual sales rate, down nearly 7 percent from one year ago. The inventory of existing homes continues to rise, rising to 6.5 months of supply, the highest value since July 1997. There are a record number 3.6 million existing homes available for sale.
New-Home Market: B-
May new-home sales rose to a 1.23 million-unit annual rate, higher than many economists expected. New-home sales fell only in the Northeast during the month. The Housing Market Index, which measures builder confidence, dropped another four points to 42, a decline of 42 percent in the last year. Unsold new-home inventory has fallen to 5.5 months of supply, while the supply of completed homes fell slightly to 1.2 months.
Housing Supply: C+
Construction is declining. Housing starts increased to 1.96 million in May from 1.86 million in April, but remain down 4 percent from one year ago. Single-family starts rose to 1.58 million. Permit activity fell for the fourth month in a row to 1.93 million units, more than 8 percent below the permit level in May 2005.
John Burns is the founder of Real Estate Consulting in Irvine, Calif.,
which monitors changes in real estate market conditions and provides
consulting services, including strategic planning, market research
and financial analysis. He can be reached at jbrec@realestateconsulting.com.