Seiders on Housing

Builders Have Not Lost Touch With Demand

The demand for single-family homes and condo units peaked during the second half of last year and has moved downward since then. This change of direction has occurred as record-high house prices and rising mortgage rates have taken a heavy toll on affordability. Eroding expectations of future house price appreciation may also be contributing to the erosion of demand, particularly among investors/speculators.

On the supply side, we see that total housing starts averaged 2.21 million units (annual rate) for the January-February period, higher than any quarterly average for the entire expansion period, and the same can be said for the single-family component which averaged 1.82 million for the first two months of this year. The strong forward momentum of housing starts kept residential construction put-in-place on a strong upward trend through February, particularly for new single-family units.

Maintenance of strong production in the face of eroding final demand for homes has resulted in record levels of unsold new-home inventories and a large increase in the months’ supply--from 4.1 last July to 6.3 in February. Furthermore, these inventories don’t include homes handed back to builders when sales contracts are cancelled!

Our surveys show that builders are well aware of the downshift in housing demand as well as the recent upshift in cancellations, and many builders are offering special incentives to maintain sales volume and limit cancellations. At this point, I’m attributing the overly exuberant housing starts of early 2006 largely to unseasonably good weather, and I expect the starts pace to fall back in the near future. Having said that, it’s clear that many larger builders have large backlogs of home sold but not yet started (largely because of land-use and regulatory delays) and I expect starts to hold up better than new sales in 2006.

A Soft Landing for Housing Still is in the Cards

The supply-demand balance in housing markets obviously has changed dramatically since mid-2005, and further increases in mortgage interest rates are bound to take an additional toll on the demand for single-family homes and condo units. I’m also looking for a modest slowdown in job and income growth later this year and in 2007 as the Fed guides the economy onto a more sustainable growth path, and that’s another negative for demand.

The recent buildup of unsold new single-family homes poses a real threat to the housing market, but a lot of that buildup represents temporary weather-related factors. Thus, I’m still projecting a “soft landing” for the single-family market in 2006, following three years of rapid expansion to unsustainable levels in 2005. Some further erosion is likely in 2007 before the markets stabilize in the latter part of the year.

The condo component of the multifamily market figures to weaken even more than the single-family market, while the rental component may well post an increase following years of erosion. I definitely expect another year of positive real (inflation-adjusted) growth for residential remodeling, supported by a record level of homeowner equity (more than $11 trillion at the end of 2005). Everything included, the residential fixed investment component of GDP should top out in the first quarter of this year and then recede gradually during most of the 2006 - 2007 forecast period.

Although home sales and housing production will be waning, ongoing increases in household wealth generated by positive (albeit slower) rates of house price appreciation will continue to provide solid support to consumer spending. The wealth effect will materialize whether or not housing equity is “withdrawn” via cash-out refis or home equity loans.

Households Will Not Retrench in 2006

Spending by households on consumer goods and services, as well as on homes, has been the backbone of the U.S. economy throughout the economic expansion that began four years ago. Indeed, personal consumption expenditures (PCE) and residential fixed investment (RFI) have combined to account for nearly nine-tenths of overall GDP growth during this expansion period.

NAHB’s forecast shows a modest slowdown in GDP growth from 2005 to 2006, with some slowing of both PCE and RFI. But a loud chorus of analysts is contending that a overextended consumer poses a huge risk to the economic outlook for 2006. This chorus is focusing on a negative personal saving rate, record household debt burdens, and heavy reliance on inflated real estate values to support consumer spending.

It’s true that impressive growth of household net worth has permitted negative saving rates as well as accumulation of record debt burdens, and recent data from the Federal Reserve show that household balance sheet foundations are now stronger than ever. But those analysts who fear a serious retrenchment of household spending in 2006 worry about two things: first, rising interest rates that could slow the turnover of the housing stock and discourage borrowing against equity by homeowners; second, an interest-rate related contraction of house values that could seriously erode the equity base, pulling the rug from under debt-financed personal outlays.

These are legitimate concerns in a rising interest rate environment. However, realization of the type of interest rate outlook in the current Blue Chip consensus forecast, or in NAHB’s forecast, will not seriously damage house values or cause a major cutback in consumer spending. Indeed, Fed Chairman Greenspan has pointed out that housing equity is now so large that most households could easily absorb a moderate setback (if it occurs). Furthermore, housing equity will continue to support consumer spending even if higher interest rates cut into housing turnover, home equity loans and cash-out refinancings. Believe it or not, housing equity does not actually have to be “extracted” (to coin a Greenspan term) with debt in order to support household spending. Credible research shows that the accrual of capital gains is a lot more important than the “realization” of gains through borrowing, and the accrual has already occurred.

The Bush Tax Panel Delivers A Bomb

The report delivered on November 1 by the President’s Advisory Panel on Federal Tax Reform is a bomb that’s going nowhere but down. That’s good news for the housing sector!

The only real driver of fundamental change in the tax code is persistent encroachment by the alternative minimum tax (AMT), away from the original super-high-income parties that paid no taxes into the middle income classes where people pay plenty of taxes. Indeed, the Tax Reform Panel says that the AMT, if left alone, will increase taxes for more than 21 million taxpayers in 2006 and 52 million taxpayers by 2015 -- and the AMT will raise about $1.2 trillion over that 10-year period.

So why not just fix or eliminate the AMT? It’s because scaling back or eliminating the AMT creates a huge revenue “hole” that, as such, violates the President’s mandate that the tax reform package must be “revenue neutral,” i.e., must raise as much tax revenue as the current system would over the next 10 years. So it’s insistence on revenue neutrality that makes no sense when you’re starting out with a tax system that is deeply flawed. If the White House is so concerned about “protecting” the currently projected federal budget deficits, it would make more sense to just fix the AMT and make cuts to domestic discretionary spending.

The Tax Reform Panel may not be ultimately responsible for the ridiculous tax-increase exercise mandated by the twin requirements of AMT elimination and revenue neutrality. But the Panel had no mandate to strip economic and social policy from the tax code, under the guise that an economically neutralized tax code would lead to a more efficient use of economic resources--a refrain we’ve heard many times before. Congress justifiably will squawk that policy decisions made on Capitol Hill over many years cannot be neutralized away by some appointed tax panel.

Cuts of housing preferences in the current tax code are proposed by the Tax Reform Panel as a major step back to revenue neutrality--once AMT is eliminated. These cuts are “justified” on the grounds that current tax law directs too much capital into housing, particularly to the higher end of the market. Congress will justifiably take issue with this proposition, and there’s already a chorus of credible voices screaming that the Tax Panel’s proposals would cause major house price declines and damage the financial system and the overall economy. And there’s no way to write transition rules to forestall the price effect.

Housing Will Converge to Trend

The housing sector has provided an unprecedented degree of support to the U.S. economy during the past year, but things are about to change.  The very success of housing will soon provoke a slowdown, and a rising interest rate structure will seal the deal.

The housing sector obviously has feasted on the low and falling long-term interest rates of recent years and the Fed’s hikes in short-term rates after mid-2004 did little damage to the adjustable-rate mortgage market as most lenders discounted initial rates on ARMs and many issued highly aggressive forms of ARMs -- the “exotic” types that concern Fed Chairman Greenspan.  These types of loans fueled speculative purchases of single-family homes and condo units, and those purchases helped fuel the double-digit increases in home prices recorded in recent times.

Our housing forecast depicts a changing balance in the markets, largely because of  affordability problems caused by the accumulation of large price increases as well by evolving conditions in housing finance.  We believe that home sales and housing starts have been toying with cyclical highs in recent months and that a fade in market activity is about to develop.  The forecast shows modest declines in housing production in both 2006 and 2007, despite rebuilding activity in the wake of Katrina and Rita.

It seems clear that recent housing production and recent rates of house price appreciation have been unsustainable, and the production level we’re forecasting for 2007 is back within the long-term forecast range we’ve established for this decade.  That range is based on estimates of demographics, net replacements and vacancies (including second homes) -- the trend factors that eventually win out.

There Is Nothing Wrong with Homeowners' Finances

Anti-housing forces, including many in the media, have been insisting that heavy borrowing against housing equity has been pushing homeowner finances to the brink of disaster.  And yes, Federal Reserve Chairman Alan Greenspan has just unveiled Fed research showing home equity “extraction” of about $600 billion in 2004, and borrowing against equity should be even bigger this year.

These are staggering numbers, of course, but they don’t actually mean that something has gone wrong. Indeed, the Fed’s own national balance sheets show that homeowner equity grew to $10.5 trillion by mid-2005, up by 18 percent from a year earlier. Furthermore, the aggregate housing debt-to-value ratio stood at 43 percent at mid-year, lower than at any time in recent years.

It's also clear that mortgage debt repayment is not placing an undue burden on the income of America’s homeowners -- partly because mortgage debt has been substituting for a lot of shorter-term, higher-cost, consumer debt. Indeed, the Fed’s Financial Obligations Ratio for homeowners was only 16.37 percent in the second quarter, compared with 28.87 percent for renter households.

While the media may be able to find and highlight debt-strapped homeowners, the overall picture shows remarkably healthy current homeowner finances and a housing equity nest egg that could withstand very large unforeseen shocks. Even Chairman Greenspan concedes these points.

Now What Do We Do?

S. Robert Kaufman’s comment on my contention that it’s “Time to Applaud Rather Than Condemn Greenspan’s Housing Boom” places some blame for rapid house price increases on the shoulders of builders and asks what builders should do when aggressive price appreciation seems to be peaking out. 

It’s important to note that most local housing markets are highly competitive, with prices determined at any moment by the supply of and demand for units on the market -- new and existing homes combined. In recent times, price appreciation has been driven by robust demand coupled with regulatory constraints on the supply of land for development. It may seem that builders have been able to push up prices all they want, but it’s primarily been a demand-pull situation.

At some point, soaring house prices take a real toll on affordability at the margin, particularly when mortgage rates stop falling. That’s the situation Mr. Kaufman senses in the D.C. area, and we’ve seen affordability indexes weaken substantially in regions where price increases have been relatively strong -- such as the West and Northeast.

A survey of builders around the country, conducted by NAHB in early September, identified growing buyer resistance to home prices. Nearly seventy percent of builders in the survey noticed some price resistance in their market areas, and close to 10 percent characterized the resistance as “significant.”

So what’s a builder to do when price resistance gets serious? We actually asked that question in our September survey. One-fourth of the builders were trimming prices, thirty percent were shifting their production mix toward lower-priced models, and about forty percent were strengthening non-price sales incentives -- such as free amenities or payment of closing costs.

These types of builder reactions should help promote the kind of “simmering down” process that Chairman Greenspan predicted. There’s no reason to expect the sky to fall.

Time to Applaud Rather Than Condemn Greenspan's "Housing Boom"

On August 26, Federal Reserve Chairman Alan Greenspan characterized the current "housing boom" as one of America's major "economic imbalances." The Chairman blamed the housing boom for everything from a low national savings rate to a burgeoning trade deficit, and he obviously wants the boom to end before long.

Greenspan's perspective are hard to fathom. The housing sector has been the brightest star in the economic skies and that star is still shining. For years, home sales and housing production have powered both GDP and job growth, and house price increases have created large amounts of wealth for America's homeowners-- fueling consumer spending in the process. Everything considered, housing has been responsible for as much as half of U.S. economic growth in an era when other components of the economy have turned in lackluster performances.

Chairman Greenspan once applauded housing's dramatic contributions to the economy and he steadfastly argued against charges of price "bubbles" in the U.S. housing markets. Maybe the Chairman has just become frustrated by the Fed's inability to raise long-term interest rates and take the starch out of housing despite more than a year of monetary tightening. Whatever the reason, perhaps the Chairman should take a step backward and recognize yet another benefit to be reaped by the "housing boom."

Hurricane Katrina seriously damaged the energy production and transmission infrastructure in the Gulf region, all but promising historically high energy costs for the foreseeable future. At a time like this, large amounts of housing equity-- created by those dratted price increases-- is a Godsend, providing a buffer to household finances and helping the economy weather the storm.