The housing market downturn looks rougher than the soft landing housing analysts had been expecting, but some economists are saying the downswing will unlikely lead the economy into recession.
Historically low interest rates, an overall economy that is still pushing forward, and efforts by the nation’s home builders to control their unsold inventories will keep the real estate slowdown from causing a recession, according to economists participating in a teleconference last week hosted by the National Association of Home Builders trade group.
NAHB Chief Economist David Seiders said that he is forecasting an 11.5 percent decline in housing starts this year, followed by another 11.7 percent drop in 2007. Housing should hit bottom by the middle of next year, and will be approaching a demographically based trend production level of about 2 million units in 2008 (including manufactured homes).
Following an unsustainable boom in housing starts, sales and price appreciation in 2004 and 2005, “we need a period of below-trend performance to work off excess inventory and improve housing affordability,” said Seiders. “Mortgage rates are dropping; builders and sellers are offering all sorts of incentives and upgrades, energy costs are retreating and the national economy is moving ahead, making it a very good time to buy a home.”
Seiders said he is assuming that rates on 30-year mortgages will average about 6.5 percent for some time, pointing out that long-term interest rates have been “performing beautifully” since mid-year. He expects the Federal Reserve to hold the federal funds rate at the current 5.25 percent into the first half of next year, and likely move it down to 5 percent by mid-2007.
Noting that housing is now a major source of weakness for the economy, Nariman Behravesh, chief economist for Global Insight, said that the “good news is that other sectors are doing reasonably well and will continue” to do so. Corporate cash flow is at record levels, and that capital will be used to invest in equipment and structures and create some new jobs, he said.
Although a soft landing is “no longer in the cards” for housing, Behravesh said that type of outcome most likely awaits the U.S. economy, with the gross domestic product growing 3.4 percent for this year, 2.2 percent next year and possibly slipping below 2 percent for a few quarters ahead. He agreed with other teleconference participants that a slowdown, or even a decline, in home price appreciation will reduce the wealth effects from home equity, but the impact on consumer spending and the spillover to the rest of the economy should be relatively modest.
During the recent boom, inflation-adjusted housing prices rose to record levels, and the market is paying the price for that rapid ascent now, with “prices coming down off their own weight,” Behravesh said. The current housing downturn “was not triggered by a substantial increase in mortgage rates, which didn’t go up that much and are down now and low by historic standards, putting a floor on the housing market.”
Looking at fundamentals such as demographics and income growth, housing prices in 70 of the 300 metro areas that his company and National City Bank survey quarterly are overvalued, Behravesh said, by an average of 30 to 35 percent. Located primarily in the Northeast, Florida and California, these markets can expect to see some downward price adjustments. In Boston, for example, prices could drop 15 percent over the next year or two. At the same time, such cities as Chicago or Houston, where the large run-up in home prices didn’t occur, might see continued appreciation at low levels.
Behravesh predicted that prices could drop 5 percent nationally over the next year. “To bring the markets back into equilibrium,” he said, “we need sluggish growth in prices for three, four, five years. We have to have home prices rising less than the rate of inflation to get things back into equilibrium. In the last boom and bust, overvalued markets generally were in the same place and it took them the better part of the decade of the 1990s to see real prices get back to levels that preceded the boom years.”
Behravesh said that housing starts will fall into the 1.5 to 1.6 million-unit range as the downturn progresses, “but nothing worse than that.” Seiders is looking for a bottom of 1.6 million in mid-2007.
Jim Glassman, managing director for JPMorgan Chase, said that the current housing downswing could proceed faster than expected, and “things could bottom out faster than you see in the numbers. A rapid adjustment in prices and the rapid adjustment builders are making in production” could reverse the speculative excesses of the boom market. Annual “housing starts shouldn’t go below 1.75 million for long,” he said, “and the long-run trend for housing production is about 2 million units per year.”
Strong global economies, record levels of corporate profits in the U.S., a healthy stock market, unraveling energy prices, and falling interest rates are among the “safety nets” for housing during the adjustment period, he said. “Don’t be surprised if 30-year mortgages fall back to the 5.75 percent level,” he added.
“Most of us will be grateful if housing prices flatten out for a couple of years. … This is not your classic interest-rate story, so it won’t be long before we work though this, recognizing that we are in a transition now.”
Mike Moran, chief economist for Daiwa Securities America, complained about how the news media are portraying housing market conditions as the industry is “going through a correction that’s badly needed. The key issue is whether the correction is orderly or disorderly, and the correction looks orderly even though it’s portrayed as a catastrophe in the press.”
New-home sales are “right in line with where we were in 2003, which was then a record year for housing,” he said, “and we have squeezed out the exuberance that was in place in 2004 and 2005.”
Taking a look at single-family housing starts compared to new-home sales, Moran pointed out that the former are slowing more sharply than the latter, another indication that the industry will adjust fairly quickly. “We are in line with the 2003 average for sales, but far below that average for starts,” he said, “showing that builders are taking the steps they need to take in order to get inventories under control.”
