The downturn in the housing market could extend into 2008 if a recession develops before the housing market bottoms out, according to analysts at Fitch Ratings who track the home-building industry.
In a new report, Fitch analysts say home builders will continue to produce new housing at a reduced rate into next year as the U.S. housing market continues a multiyear contraction.
Although the 106-page report is focused on new home construction, it details a broad range of factors affecting the real estate industry, such as housing supply, housing affordability, population trends, interest rates, lending practices, government regulations, and economic factors such as employment and income.
Housing affordability, excess supply and “a negative psychology (among buyers) that seems to have become pervasive” are the biggest factors in the current downturn in the housing market, the report concludes.
The existing-home supply has steadily risen to 7.5 months in August, compared with 4.7 months at the same time last year. A 5.5- to 6-month supply is considered a better equilibrium.
“The excess of supply is troubling,” the report says, noting a National Association of Realtors analysis that investors represented a large portion of home buyers in 2005. The “absence (of investors) as buyers in 2006 and the dumping of their housing on the market has caused considerable pain,” Fitch analysts said.
Compounding the problem is the “expectation or fear (among buyers) that home prices have peaked and buying now would be a mistake.” That’s especially true for people in the market for “trade-up” or second homes, who can be flexible about when they buy. The likelihood that national home prices will continue “slight to moderate declines” in coming months could reinforce the negative psychology among buyers, the report speculates.
While housing starts, new-home sales and existing-home sales are moderately weaker than Fitch analysts expected at the beginning of the year, the economy “continues to generate solid, if not robust growth.” Fitch expects home builders to prosper during the coming decade, but within a cyclical context.
The 1990s “produced surprisingly positive results” in housing because of unexpected demographic trends such as immigration and better-than-expected housing affordability due to low mortgage rates, the report noted. If inflation remains in check, demographics may again provide a “surprising upside” for housing in the first decade of the new millennium, Fitch analysts say.
But a recession could derail a recovery in the housing market, and another worry is delinquencies and mortgage defaults. If there’s a spike in bad loans, lenders could be pressured to tighten underwriting standards.
Investors who purchase home mortgages in the secondary market may demand that lenders be more selective, “and the loan originators, as in the past, could likely overtighten mortgage standards,” the report warns.
Nationwide, 4.4 percent of home loans were delinquent in the second quarter of 2006, compared with the record delinquency rate of 6.1 percent in 1985.
Fitch analysts say overall delinquencies and foreclosures “are not yet at troubling levels,” but they “remain cautious” about consumer credit quality, as “consumers are fully leveraged, yielding little wiggle room — especially for the subprime borrower — to cope with the possibility of a more rapid increase in interest rates.”
In 2006, more than $400 billion worth of hybrid adjustable-rate mortgages will readjust for the first time, and $1 trillion will adjust in 2007, the report noted.
While some see the increasing popularity of adjustable-rate mortgages as a sign of deteriorating creditworthiness, Fitch analysts say the problem appears to have been overstated, since many affluent home buyers opt for ARMs.
Credit may also get tighter if the Federal Reserve’s Open Market Committee raises the federal funds rate. Fitch analysts expect a final 25-basis-point increase in the short-term benchmark to 5.5 percent this year, before the Fed retreats on interest rates later in 2007.
“The Fed is trying to balance the risks of slower growth ahead with the deterioration in recent months in most core inflation indicators,” the report said. The decision not to raise interest rates at the committee’s two most recent meetings has been justified on the grounds that slowing growth, a cooling housing market and the ongoing effect of recent interest rate hikes are moderating inflation pressures. “However, the door has been left open to further rises in light of remaining inflation risks.”
Fitch forecasts that new-home sales will fall almost 14 percent to 1.08 million in 2006. The previous forecast was for a 12 percent decrease.
Total housing starts are expected to decline by 11.5 percent to 12.5 percent, to between 1.81 million and 1.83 million.
Fitch’s preliminary 2007 forecast predicts total housing starts will be down 9.5 percent to 10.5 percent, that new single-family home sales will slip 6 percent to 7 percent, and that existing-home sales will be down 6.5 percent to 7.5 percent.
The boom in housing construction that began in the 1990s produced 1.5 million to 2 million new housing starts in 11 of the past 12 years. But the report argues that there is still considerable unmet demand for housing — especially affordable housing — in the intermediate and long term.
The household count grew by 3.5 million in 2001, 1.09 million in 2002, 1.98 million in 2003, 720,000 in 2004, and 1.68 million in calendar 2005, “generally solid numbers by historical standards.”
For a decade, rental production has been concentrated on mid-priced and luxury apartment rentals and single-family homes, while rentals affordable to low-income families have become harder to find. Restrictions on land development and exclusionary zoning practices are likely to continue that trend.
While the home-ownership rate has reached record highs, “it will be increasingly challenging to raise ownership much above the 70 percent level,” the report found.
For eight years in a row ending in 2001, housing prices outstripped inflation, and now affordability issues could dampen housing demand. The average new home price rose 95.1 percent between 1990 and 2005, from $149,800 to $292,200.
Government-sponsored mortgage repurchasers Freddie Mac and Fannie Mae may be motivated to increase programs for low-income buyers to deflect calls for more government oversight of their operations, the report notes.
Affordability is likely to be a greater problem for minority households, which have lower average incomes and wealth than other segments of the population, the report said.
Minorities may make up 29 percent of households in 2010, up from 25 percent in 2000. The growth in minority and younger households could boost the demand for entry-level housing, the report said.
The report, “U.S. Homebuilding: The Chalk Line — Quarterly Update: Fall 2006” is available on the Fitch Ratings Web site at www.fitchratings.com in the “Corporates” sector page under “Special Reports.”