Housing Still Correcting in 2007 with Likely Growth in 2008

Affordability the culprit in housing downturn, economists say
Washington, DC—None of the economists at the National Association of Home Builders’ annual fall forecast conference suggested a quick and easy recovery from the current housing slump, but most believe the correction will be orderly through 2007 and the start of 2008.

“Clearly we’re not on a soft landing—we’re past that—but I wouldn’t call it a hard landing,” said Bernard Markstein, director of forecasting for NAHB. “Maybe a bumpy landing.”

“The housing market correction is now a little over a year old and I think we have another 6 to 12 months left,” said Mark Zandi, chief economist for Moody’s Investor Service’s Economy.com.

Although the panelists had some varying opinions on when exactly the market would turn the corner and housing would start posting positive growth—as well as what levels the housing market might achieve in the coming years—they agreed that the U.S. economy is strong enough to survive the residential housing slowdown.

Further, the picture doesn’t look as scary when taken in the context of historical data, most pointed out. After unsustainable growth rates in 2004 and 2005, the percentage rate of growth has finally settled to below-trend, said David Wyss, chief economist, Standard & Poor’s. “By historical standards, this is still pretty darn good, and for the foreseeable future, it’s going to stay that way,” he added.

CONTINUED DROPS IN 2007?
NAHB Chief Economist David Seiders kicked off the October 25th conference by suggesting that a sustainable level for single-family housing starts is 1.5 million units per year. Starts in 2004 and 2005 were well above this threshold, resulting in an eventual drop and correction in the market (Fig. 1). He forecasts a continued drop in housing starts in the early part of 2007, a leveling-off through the mid- and end of the year, and some eventual upward growth as we head into 2008. “I’ve got [housing starts] retreating through the middle of next year, which means we’re through the worst of it,” he said.

“We need to see below-trend single-family and multi-family housing for the next couple of years” to match supply with demand, Zandi said. Single-family housing prices, which have increased significantly in recent years, will grow at a substantially lower rate and even see decreases in certain areas of the country. “In ’07, I expect and outright decline in house price growth,” he said. “It’ll be the first decline since the Great Depression.”

David Berson, vice president and chief economist of Fannie Mae, said excess housing inventory needs to be burned off for housing prices to stabilize. “Inventories are essentially at record levels,” he pointed out. “Starts need to slow or the inventory will continue to climb. There are just a lot of homes out there to be sold…and that’s putting downward pressure on prices.”

UNDERSTANDING WHAT HAPPENED
Seiders also reviewed how the residential construction has reached its current state. He, and the panelists who followed, pointed to plummeting affordability rates as one of the primary culprits behind the sluggish housing market. Seiders referred to the National Association of Realtor’s composite housing affordability index (Fig. 2) to show how affordability has reached record-low levels. While the chart shows slight up-ticks in certain months of 2005 and 2006, the numbers are still far below historical trends. “It’s the decline in affordability that’s behind this housing decline,” he asserted. “And I don’t know [referring to the affordability index] whether this baby has hit bottom or not.”

A spike in the number of “flippers,” or short-term investors, in the real estate market has contributed to declining affordability, according to Seiders. Home prices have been artificially driven up by investors in certain markets of the country—a condition which must be remedied as the correction plays out, he noted. “The result of all the investing for normal people is that it ruined affordability,” he said. “The housing price topic is so central to how this housing adjustment is going to play out.”

Zandi contends that creative lending also contributed to the current housing market’s woes. The Fed’s attempt at tightening monetary policy was delayed as lenders turned to alternative mortgages to keep buyers—especially first-time buyers—entering the market. “That circumvented the Fed’s attempt to slow the housing market and regulate the economy,” he pointed out.

Ultimately, the Fed won out with consecutive interest rate hikes, but that too may need some corrective action in the coming years, he noted.

Wyss agreed with Zandi, pointing out that what the Fed does today affects the economy 12 to 18 months down the road. After 17 hikes in a row (until last week when the Fed announced no change in rates), the governing body may have to reverse course and adjust as it moves into the future. “Even a mule gets the idea after being hit in the head 17 times with a 2x4 to slow down,” he joked.

REGIONAL ADJUSTMENTS
Most metropolitan areas in the country will see a significant decline—in some areas as much as 20 percent, Zandi pointed out. “The only areas that will hold up reasonably well are Texas and the Pacific Northwest,” he said.

As mentioned by Seiders, many of the major metropolitan markets in the U.S. have been affected in recent years by an influx of real estate investors. Zandi estimated that out of 379 metropolitan areas, nearly 100 are overvalued, “meaning there’s froth in these markets from speculators.” Florida, California and Nevada, in particular, are “investor infected” and are still suffering from high housing prices because investors are hoping these markets will bounce back, he said. “We still need another 9 to 12 months to ring out investors, especially in Florida, California and Nevada,” he said.

Looking at the multi-family segment, Seiders predicted it would follow a similar curve as single-family, but it would not see as dramatic a drop and recovery. He expects recent levels of about 350,000 starts to dip down to around 300,000 in 2007 before turning around in 2008.

In his multi-family construction outlook, Ron Witten, president of Witten Advisors, noted that the national rental market has been in a “nice upswing” in the last 18 months because of the challenges with homeownership. “2005 and 2006 have been gangbusters for leasing,” he noted. “Home buying, which was competition in 2001, 2002 and 2003 is now, frankly, a good friend to the rental market today because home buying is so expensive.”

To review the speakers’ presentations in their entirety, click here to visit NAHB’s Web site.