Seiders on Housing

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 The wealth effect will materialize whether or not housing equity is “withdrawn” via cash-out refis or home equity loans.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.

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.