More Housing Gloom

Hopes of a rebound next year are fading fast. And home builders face more bad news on the cost side.

By Jim Ostroff, Associate Editor, The Kiplinger Letter

Jerome Idaszak, Associate Editor, The Kiplinger Letter

September 28, 2007

Forget about a noticeable pickup in the housing sector next year. Recent figures point to a huge overhang of unsold inventory -- equivalent to nearly 10 months' of sales for existing homes at the current pace and about eight months for new homes. There hasn't been this much slack in the market since just before the last big housing slump in the early 1990s.

What's more, indicators of pending home sales show a paltry amount of deals in the pipeline. And the most recent survey of home builders by an industry group shows that they expect business to look worse in six months than it does now.

Despite all the bad tidings, we still think housing activity is likely to bottom out around mid-2008. However, the subsequent recovery will probably be so painfully slow as to be nearly imperceptible. The level of unsold inventories won't return to normal levels until about mid-2009, and maybe even a bit later than that.

We see housing starts slumping to 1.25 million next year, down 100,000 from this year. That'll be the slowest rate of home building since 1992. Sales of existing homes will slip by 400,000 or so to 5.3 million, while sales of new homes should fall to about 825,000, down 55,000.

House prices will decline 5% on average after a 4% fall this year. But expect drops of as much as 20% in areas that led the housing boom and where lots of potential buyers need jumbo loans to make a purchase. These locations include much of California and Florida, suburban Washington, D.C., and the New York City metropolitan area. Average rates on jumbos, which are loans worth more than $417,000, have risen a percentage point since early August, whereas rates on lower-value conforming loans have fallen a tad.

The problem with jumbos lies in the secondary mortgage market, where financial firms acquire loans from mortgage lenders and repackage them to sell as securities to investors. Fannie Mae and Freddie Mac, the biggest players in the secondary market, buy conforming loans and have continued to do so despite turmoil in the credit markets. But other financial firms have shied away from purchasing jumbo loans, prompting banks to jack up interest rates on jumbos to cover their increased risk exposure.

Meanwhile, builders' tabs for construction materials are headed higher, threatening to further squeeze the already-diminished profit margins of the likes of KB Homes and Lennar Corp. An industry-tracked market basket of about 20 commonly used building supplies is likely to show a 6% gain next year after advancing about 5% this year. That may seem surprising, given that home builders in the U.S. are drastically reducing their output and commercial construction is also easing a bit. But there are bigger forces at work here.

Higher prices are a global phenomenon for a wide variety of building materials, including steel, concrete and copper piping. As long as economic growth blazes ahead in places such as China and India -- and we see no reason why it won't, at least through next year -- demand for construction supplies will remain brisk. High energy prices are also contributing to upward price pressure, particularly for asphalt, which is very energy-intensive to produce, and for plastic items.

Here's what to expect in various product categories: Wholesale prices of concrete products -- ready-mix, blocks and bricks -- will rise about 6% on average next year, while steel mill items advance 7%. The latter is bad news for builders of office towers, roads, bridges and pipelines who use a lot of beams, steel plates, rebar and steel tubing. U.S. steel mills will have the most pricing power in specialty stainless steel products.

The costs of metal plumbing fixtures are likely to climb an average of 6% in 2008, slowing a bit from this year. Gypsum, heavily used in house construction, will be a relative bargain as its average price falls about 5%. However, prices for lumber -- also in great demand worldwide -- will hold up fairly well. We see the cost of widely used oriented strand board holding flat after a 15% plunge this year. Overall, lumber prices should advance about 4% next year, but the gains will come mainly in the second half of 2008, once housing begins to stabilize.

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