More Woes For Housing

The rough ride is far from over for homeowners and builders. We don't expect sharp drops in home building and sales to bottom out until spring 2008.

By Jerome Idaszak, Associate Editor, The Kiplinger Letter

June 29, 2007

Forget about a housing recovery later this year. In fact, odds are that the residential property slump will extend into 2008, as beleaguered homebuilders slowly unload a mountain of unsold houses and prospective buyers continue to face affordability challenges.

Those dismal home sales figures for May weren't an aberration -- the housing market's fundamentals clearly stink. On the supply side, the amount of unsold residences in May was equal to a hefty nine months' worth of sales at the current pace, and seven months for new homes, forcing builders to slash prices or offer lucrative freebies if they want to move any property.

Surveys of homebuilders show them as pessimistic as they were in 1991, during the last big housing slump. They will break ground on approximately 1.35 million new homes this year, 100,000 fewer than what was previously expected before the mortgage rates jumped. The pullback is bad news for a variety of housing-dependent industries, such as plumbers, drywall hangers, landscapers and insulators. Next year, housing starts should creep up to 1.5 million or so. Nicholas Retsinas, the director of the Joint Center for Housing Studies at Harvard University, says, "It's going to take into 2008 to work out the oversupply. It will be a while before there's a rebound."

Average home prices are likely to fall about 4% to 5% this year, and will probably give up another 1% next year before they stabilize. In principle, this should spur demand. But the recent spike in mortgage interest rates has instead pushed many potential customers to the sidelines. The average rate on the popular 30-year fixed mortgage will probably stay close to its current 6.7% for the remainder of the year, which is up about a half percentage point from May.

As a result, we expect home sales to total about 6.82 million this year -- 5.9 million existing homes and 920,000 newly built ones -- down nearly 10% from last year. Look for only a modest improvement in 2007, with 6 million existing homes and 940,000 new homes purchased.

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Higher mortgage rates are one of the housing market's recent unwelcome guests. They'll compound ongoing drags on demand caused by the meltdown in subprime mortgage lending, which led to tougher standards imposed on all types of mortgage applicants.

Loftier mortgage rates will also accelerate the pace of foreclosures as homeowners with adjustable-rate mortgages see their payments increase. Mortgage defaults -- the first stage of the foreclosure process -- will hit around 1.25 million both this year and next, up from 900,000 last year and 800,000 in 2005.

Note that foreclosures are geographically concentrated. One cluster includes Michigan, Ohio and Indiana, where cutbacks by U.S. automakers are taking a toll. Another consists of the former boom areas in California, Florida, Nevada and Arizona, where get-rich-quick investors have long since abandoned such markets, leaving large amounts of unsold properties in their wake. Homeowners in these areas face the additional burden of still-high property taxes, which have yet to adjust to a cooler market. The bulk of tax assessments in the once-hot regions were done when the boom was in full force. Douglas Duncan, chief economist with the Mortgage Bankers Association, says, "As prices decline and payments rise, it doesn't take much for investors to dump homes back on the market."

Housing is doing better in some parts of the country than in others. Brighter spots include Charlotte and Raleigh, North Carolina, Nashville, Tennessee, and Seattle. One real estate agent in a suburb near Chicago says he's having his second-best May in the past seven years. The bottom line is that housing remains largely a localized phenomenon, even if big trends such as higher mortgage rates or tighter mortgage lending standards have national impact.

And in the longer term, demographic factors will support housing demand once the current correction from the boom period ends. Immigrants will play a big role on the demand side, even if Congress decides to stem the flow of illegal aliens from Mexico and elsewhere soon. Those immigrants already here as well as their children will buy thousands of starter homes over the next decade, creating a firm foundation for the market. Retsinas says, "If we closed the [borders] now, it would take about 10 to 15 years to feel the effects."

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