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The housing market is being cleaned out, not wiped out. The purge of the market's excesses—especially in areas where price growth has been strongest during the past few years—will probably last until next spring. Talk of a nationwide housing bust is overblown, despite price-slashing by sellers in some once-hot regions and mounting order cancellations seen by home builders.
The conditions for a widespread housing crash simply aren't developing. Mortgage rates, the most important influence on the market's health, won't head high enough to throw housing sales and home construction into tailspins. The average interest rate on the popular 30-year fixed mortgage will peak at about 7% by fall—well below the 8% threshold that real estate agents consider to be the red flag for prospective buyers. What's more, signs of easing inflation and economic growth later this year will probably send mortgage rates lower again. In addition, job growth, though slowing down, will remain strong enough to sustain a large pool of potential home buyers and prevent a big jump in mortgage foreclosures. Still, interest rate hikes on variable-rate loans will pinch a small percentage of homeowners.
The supply overhang also doesn't seem as bad as in previous housing downturns. The nationwide inventory of unsold homes is equivalent to a bit less than six months of sales, compared with 10 months in the early 1990s. And home builders are adjusting their output to softer demand more quickly than they have in the past. The industry is increasingly dominated by big, nationally active companies quick to pick up on market trends and act accordingly. Their faster reaction to cooler demand lowers the risk of more-abrupt price declines down the road. That said, builders will bear the brunt of the cooling. They'll have to offer more inducements to potential buyers to clinch sales, throwing in finished basements or upgrades in kitchens and baths, while swallowing higher costs for their materials.
Look for home sales to be flat next year after a 6% drop this year to about 7.8 million. New-home sales, about 20% of the market, will shrink slightly as sales of existing homes post a modest gain. We expect housing starts to run roughly 1.8 million a year for several years before ticking up as two key demographic waves—aging baby boomers seeking second homes, and their offspring, the echo boomers, reaching the prime age range for first-time home buyers—converge, spurring demand.
But remodeling is poised for another good year—about a 6% increase in spending—keeping demand strong for appliances, flooring and other such goods. There'll be fewer mortgage refinancings, of course. But lots of cash tapped in the refinancing boom of the past few years remains available to buoy consumer spending on makeovers.
Nationwide, expect about a 3% increase in median home prices both this year and next, compared with last year's 12% gain. But local performance will vary wildly. Investors are exploring lower-profile areas bypassed by the boom: Nashville, Tenn., Kansas City, Mo., and Cincinnati, for example. Albuquerque, N.M., Seattle and others that came late to the party and still have strong potential for price gains are also attractive. Areas at the greatest risk of big drops are those that are heavy on condos: Miami, Las Vegas, Chicago and San Diego, for example. Investors there are cashing out before prices fall further.
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