The most challenging issue for housing markets is likely to be excess inventory, analysts at Fitch Ratings said as they issued more dire projections for declines in housing starts and sales in the second half of the year.

Fitch now forecasts sales of existing single-family homes will fall 10 percent, to 5.83 million, in 2007, while sales of new homes will be off 23.5 percent, to 812,000. Total housing starts are projected to be 1.3 million, or 28 percent lower than 2006.

That compares to a previous forecast in Fitch’s Summer 2007 Chalkline report predicting existing-home sales of 6.09 million, new-home sales of 902,000, and 1.46 million total housing starts.

Housing production is being cut back at a faster rate than the decline in sales, but, Fitch analysts expect the supply of homes “to still be excessive entering 2008.”

“Perhaps, the most challenging issue for housing, both new and existing, is excess inventory,” Fitch analysts said in summarizing their new ratings and outlooks for home builders.

Houses for sale rose above 500,000 during the past 21 months, a level “that has often presaged major industry downturns.” There was a 7.5-month supply of new homes on the market in July, and enough existing homes to handle 9.6 months of demand, when 5.5 to six months of supply represents equilibrium of supply and demand.

Fitch analysts blamed inflated home prices and problems in mortgage lending for the growth in inventory, saying sellers have been reluctant to lower prices even as many loans that helped buyers afford more expensive homes have disappeared.

The average new-home price will fall 2.5 percent in 2007, Fitch projects, while the median new-home price slips 1.5 percent — estimates that don’t include sales incentives that don’t show up in transaction prices.

“Unfortunately, home prices have not yet reached market-clearing levels in most places,” Fitch analysts noted. “Home prices (especially existing-home prices) definitely have been ‘sticky’ on the downside. This pattern is similar to price behavior exhibited in earlier major housing corrections.”

Although rates on 30-year fixed mortgages are low by historical standards, the market for subprime loans has “essentially disappeared,” and lenders making reduced-documentation Alt-A loans are only able to sell “prime-like Alt-A loans” in the secondary market, Fitch analysts said.

“Fitch’s forecast for the housing sector in 2007 has become more bearish,” the report concluded. “This is principally due to the impact from even tighter credit standards for home buyers and the effect of disruptions in the secondary markets for subprime, Alt-A and jumbo mortgages.”

Most potential home buyers, “absent any real urgency to buy, are deferring the purchase decision, concerned that selling their existing home at a fair price may be challenging, and fearing that real home prices might decline further as builders increase the level of incentives being offered to the advantage of those who wait to buy.”

A stronger economy would help housing markets in 2008, “but will probably not be robust enough to counter continuing negative buyer psychology, and tight credit qualification standards,” Fitch analysts warned.

Fitch said it was lowering its ratings on the debt of most publicly traded home builders, saying there is “a high probability” that their revenues and profits will fall further in 2008.

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