The Housing Market: Poised for a Sudden Reversal?

Implications: April's new home sales data showed the largest monthly gain in 14 years.  Could this signal the start of the next housing boom?  Several negative factors indicate otherwise.

Analysis: In the June 11 issue of Business Week, James Cooper’s article, “Is the Housing Recession Starting to Recede?”. poses some interesting statistics which indicate a possible reversal in its long decline. Per the article, “some economists are optimistic that recent positive trends in housing starts, new-home sales and mortgage applications” are good indicators of a housing market turnaround sooner than later. And although sales of new and existing homes “went in opposite directions in April,” the author points out that “there are signs that overall demand (for housing) is stabilizing after last year’s steep decline.”

Can we be comforted by these indicators? Even with April’s 16.2% increase in new home sales (the largest monthly gain in 14 years), the annualized rate of new home construction calculates to 981,000, a dramatic 57 % decline from the 2.265 million units of single and multifamily starts recorded as recently as January 2006.

One major factor could play a negative role in extending the current poor housing market and watering down any enthusiasm. This is the large inventory of both new homes and resales. Whether or not the Fed lowers interest rates has little effect on a home buyer’s decision. Frankly, a 0.25% drop in interest rates only saves the buyer about $30 a month on a $150,000 mortgage. This “savings” isn’t going to positively drive mortgage applications, although it’s a move in the right direction. April’s new home sales “surge” only served to drop inventories to a 6.5 month level, still well above the comfortable 3+ months of inventory seen in “normal” times.

When pondering a decision to make an investment in a new home, potential buyers will be guided by their answers to the following key questions –

• Can they sell their current home and use any appreciation to minimize the mortgage on the new home? Maybe their old home is totally paid off – great!! Or maybe they already took advantage of the low home equity interest rates back in 2005 and used the money to enjoy that long-awaited vacation in Europe. The expectation at that time, of course, was that home values would continue to appreciate.
• How much credit card and other debt they are currently carrying?
• How secure are they in their employment, or is there a concern about downsizing or consolidation and loss of a job?
• Finally, are they a candidate for a mortgage loan, given the banks’ policy on tightening credit regulations after the subprime loan debacle?

There can be one saving factor and possibly two which can get things going in the right direction for the home building industry. The one having the most potential is the large number of baby boomers that may enter the new home market by purchasing some of the current inventory (at reduced prices) or even getting a custom built home at “market” price…a bargain! With the stock market at an all time high, the can benefit from their appreciated portfolio. When they buy a new home, what will they do with the older one they presently live in? Options are to give it to their kids, rent it out or even sell it at a reduced price. The benefit for doing the latter is that they will still realize a handsome profit, assuming they’ve lived in the home for a while.

The second and less likely factor is that a housing spike can be driven by natural disasters which seem to be plaguing the U.S. more frequently nowadays. The latest forecast for damaging hurricanes is not good and the potential for one or more devastating hurricanes as that experienced with Katrina needs to be considered. Ditto with tornados, such as the recent one and the devastation it caused to the community in Greenfield, Kansas.

Unfortunately, without these “events” to boost the housing market, I’m afraid the home building industry will remain in the doldrums for quite some time.