Housing enjoyed an unexpectedly sunny year in 2003. Despite the clouds of war and the threatening skies of a shaky economy, last year builders encountered only scattered showers on their business, which performed beyond all expectations. Even the surprise thunderstorms of accounting problems at Freddie Mac and Fannie Mae failed to dampen builders' yearlong housing picnic.
Even better, the economic weather in 2004 should cooperate with builders' plans, as the job market finds its way, interest rates stay reasonable, and demographics continue to drive demand. Given all those factors, the extended outlook for housing actually looks quite sunny.
Why such optimism in 2004 after so much gloomy economic news in 2003? Part of the answer comes from what one prominent economist called "the perfect policy storm" that hit in late 2003, bringing together low interest rates, government spending and tax cuts, and a rising stock market. "Most of the history of these policies [fiscal, monetary, and financial] is that they conflict with each other," Joel Prakken, chairman of St. Louis-based Macroeconomic Advisers, told listeners at the NAHB economic forecast conference last October. But not this time. These powerful forces all worked together, producing a surge in economic growth (which hit an annual rate of 8.2 percent in 2003's third quarter) that's expected to push the languishing economy into an improving 2004.
As for the upcoming presidential election, most expect the impact to be neutral to positive on housing. "You'd be hard-pressed to see much impact [from presidential elections] historically in terms of the economy," says David Berson, chief economist at Fannie Mae. It certainly doesn't seem to affect home buyers. "In our market, I'm not sure if the election or who's president really matters," says Gary Bowman, COO of Ole South Properties, a builder based in Murfreesboro, outside of Nashville, Tenn. "Buyers just look at the interest rate."
Forecast: Clearing, with patches of fog
Economists have been saying for months that businesses would have to start spending again, increasing their stock and hiring more workers to grow their companies. This time, the businesses may actually have to do it. "Inventories are really low, and final sales are up high," says Ken Matheny, senior economist at Macroeconomic Advisers. "There is tremendous room for inventory rebuilding to take place." Companies that want to stay competitive also are going to have to reinvest in technology, buying new computer hardware and software as their equipment becomes slow, inefficient, and eventually obsolete. "To compete globally, you have to cut costs and invest in new equipment," Berson says. Other positives for business spending: improved profit numbers and a stock market on the upswing. "Stock prices have been turning up, which indicates some confidence in the strength of the expansion and translates into higher equity wealth for stockholders," says Matheny.
Such spending is essential to the economy's full recovery. Business growth has been the missing piece for months, as the economy depended on consumer spending, particularly on housing, to stay afloat. Assuming businesses spend as planned, economists expect the economy, as measured by change in real gross domestic product, to grow in 2004.
The Job Market
The job market, always a lagging indicator of an economy's health, has been a particular straggler this time around. "The general public really doesn't think we are in recovery. Why? Because of the job market," says NAHB chief economist David Seiders. After six consecutive months of job losses in 2003, people began to wonder just how housing could continue to thrive in the absence of job creation. "We're always concerned about the job market," says Larry Webb, CEO of WL Homes, which builds as John Laing Homes in California and Colorado. "In the long run, that and interest rates are the primary drivers for housing."
During the past few years, though, that relationship between job creation and housing demand seems to have faded, at least as super-low mortgage rates provided powerful incentives for homeownership despite poor employment numbers. The weak job market "has been a negative, but not a big negative for housing," says Fannie Mae's Berson, who says the numbers may not have been as they seemed. "Part of the reason why [the job market] seemed so unbelievable in the late '90s was because we remembered the '70s and the '80s. We definitely see things through the prism of recent history."
Many economists agree, arguing that 6 percent unemployment is actually quite low by historical standards and especially for a recession's end. Still, they say if the economy is to fully recover, companies must start hiring workers again. "How long can we maintain economic growth with monetary and fiscal policy?" asks economist Matheny, referring to the low interest rates set by the Fed and the federal government's 2003 tax cuts and increased spending, particularly in defense. "The government has been holding the bag for a while."
He and others expect the employment outlook to improve in the second half of 2004, as businesses gain the confidence to hire permanent, not just temporary, workers to meet increased demand for their products and services. Jobs will be created "steadily, but incrementally," Berson predicts. That's a different picture from 2003, when most companies relied on productivity gains rather than new workers to handle any new business. Wary of expanding in an uncertain economy, they chose instead to fulfill order upticks by extracting additional work from their employees and more efficiencies from all the technology they bought in the 1990s. "All that investment in high-tech didn't immediately result in productivity gains," Matheny observes. "They had to integrate it. They've been digesting it." The result? Surging productivity, which boosts people's incomes in the long run--and results in a lousy job market in the short run. "Unemployment has been very sticky," he admits. "But people who have jobs are enjoying their productivity growth and are spending to show it."
And the numbers may not be quite as bad as they look. The government measures employment in two ways: by asking large companies who is on their payrolls and by asking individual households how much they are working. The household numbers, which include the self-employed and small businesses, have indicated lower unemployment than the payroll numbers. Such statistics support what John Kamin, vice president of sales and marketing for a large Midwestern builder, sees in his market. "The employment picture is getting better," says Kamin, who works for Indianapolis-based Davis Homes. "People who got laid off are working as consultants. We see these people in our sales offices every day."
Interest rates, the superstars of the 2003 housing market, will continue to play a supporting role in 2004. Economists project 30-year, fixed mortgage rates to stay near a very attractive 6 percent for the first quarter of the year, only rising through 2004 as the economy improves. "The Federal Reserve is providing as much support as it can," Matheny says.
Still, after a year of record low interest rates, builders seem resigned to the prospect of increases in 2004. "We're not economists," Webb of WL Homes says, "but we're moving forward with the understanding that if rates go anywhere, they will go up." If the 30-year, fixed rate becomes unappealing, builders say, committed buyers will simply choose other sorts of financing, such as adjustable-rate mortgages. "With interest rates, a lot of people don't realize there are so many products out there today," says Jeffrey Orleans, CEO of Orleans Homebuilders, a fast-growing public builder based in Bensalem, Pa.
What product segments will be affected? Builders' opinions differ. While some believe entry-level is always the safest spot to be, others think entry-level demand will ease in 2004 after its recent strength. "I think we'll see entry-level decline a bit," Kamin says. "Between the low interest rates and the down payment assistance programs, builders have shaken those trees a bit." On the opposite end of the housing spectrum, demand for luxury homes, whose buyers are not as sensitive to interest rates as are entry-level customers, should stay steady. "The upper one-half of 1 percent of buyers will still be able to move up," says Webb, whose company also builds high-end luxury homes in Southern California. "It would be different if we were looking for a bigger absorption or a bigger share" of the market.
Second homes may suffer a bit as the stock market improves and people stop turning to real estate to rebalance their portfolios, but that may also be offset by boomer demand for such residential retreats.
The move-up segment, which has benefited tremendously from both low rates and homeowners' dramatic increases in home equity, remains a question mark. Will they be willing to give up their bargain-basement interest rate to move to a larger home? Fannie Mae's Berson says they will. Families grow, breadwinners get better jobs, and people want to move to different places for jobs, schools, and other reasons, regardless of what's happening in mortgage rates. "Are there people who are captured by their 5 percent mortgage rate? Yes. Is that the majority of the market? No," says Berson.
Kamin agrees, although he believes builders will have to sharpen their product offerings in a higher-rate environment. "If people are turned on and excited about a floor plan, they'll still move," he says. "As an industry, I think we've gotten away from that. People have been buying because of the interest rates. They'll buy anything."
Home Price Appreciation
Forecast: Warm, but cooling
Perhaps the cooling trend in home price appreciation finally will let the air out of the housing bubble story. After years of steep appreciation, home prices are expected to settle down in 2004. They won't drop--according to forecasts by home price experts Case Shiller Weiss, prices should rise nationally 5.9 percent this year--but they won't increase so quickly either. "We're expecting it to slow, but to remain fairly strong," says David Stiff, senior economist at the Cambridge, Mass., firm. Builders have certainly seen the benefits on their own top lines. In the Delaware Valley, where demand is high and land is scarce, Orleans Homebuilders saw its new-home prices rise as much as 10 percent in 2003. Still, many are playing it safe on pricing for 2004. "We're assuming there will be no price increases [in 2004]," says WL Homes' Webb, who admits it's a conservative assumption for his key market. "Historically, California has shown 10 percent appreciation."
In the long run, though, the most powerful support for housing comes not from interest rates or the economy, but from demographics--the inevitable tendency for people to grow up, buy homes, start families, and, eventually, retire, as the nation's baby boomers have begun to do. "The number of trophy houses going up is huge," says demographer Harold Hodgkinson of Hodgkinson & Associates in Alexandria, Va. "I don't see any end to that." Neither does Fannie Mae's Berson, who notes that homeownership peaks at age 70, meaning that the boomers' demand for housing will continue not just in 2004, but for the rest of the decade. At the same time, the boomers' children--the millions of echo boomers--are also reaching adulthood and the promise of renting or owning their own homes. "The echo boomers will affect what will happen in housing," says NAHB economist Michael Carliner.
So will immigrants and minorities. According to numbers recently released by the U.S. Census, the number of immigrants entering the country during the 1990s was significantly higher than expected--as many as 200,000 people higher per year. Such trends have obvious consequences for housing, especially apartments, where immigrants tend to live when they first arrive. (The increased number of immigrants may also explain the higher-than-expected number of new households people have established in the past few years despite the sluggish job market.) But increased immigration will also affect the for-sale housing market, especially in the 10 to 20 years after these new Americans arrive.
The most obvious difference may be in quantity. "If immigration continues, it's not unreasonable to expect an average of over 2 million housing units a year, including manufactured housing," predicts Carliner. But it will also come in quality, the character of homes built for these foreign-born buyers.
"Their first-time house will be a different first-time house than what a 22-year-old will be looking for," observes Berson. These buyers may not respond to the stereotypical American dream house. "Many immigrants have no expectation of a single-family home with a yard, because that's not where most of them came from," Hodgkinson says. But they will probably end up in single-family home territory. Today's immigrants, "rather than coming to the city, are moving into the second-ring suburbs, because that's where their relatives have gone," the demographer says.
Tapping into these immigrant markets will require flexible and nuanced approaches that can be tailored to different ethnic groups. Immigrants from South and Central America, for example, "are sending so much money back home that they don't have the money for a down payment," Hodgkinson says. "People maybe need to start thinking about different arrangements in terms of loans. These people are used to seeing their extended family as a source of services [such as credit], so the criteria lenders generally use may have to be modified for this group."
Forecast: Sunny and warm
Obviously, housing will not collapse in 2004. Boosted by demographics, continued low rates, and a mending economy, the nation's builders are expected to break ground on roughly 1.7 million single-family and multifamily housing units in 2004. Such a performance would come very close to 2003's record-breaking stats. "I think we're somewhere close to sustainability in terms of total housing activity," Seiders says. Builders agree. "Outside of a national disaster, we're pretty bullish on where we're going," says Orleans. He expects his company to generate $500 million for fiscal 2004, closing 1,600 homes in New Jersey, Pennsylvania, Virginia, North Carolina, and Florida.
Builders elsewhere in the country feel similar optimism. For the past year and a half, John Laing Homes in California hasn't had a release that didn't sell out the morning it opened. Late in 2003, its luxury division sold 35 high-end homes in two months, producing $65 million in sales. "We could sell more, but we can't build more," says Webb, who says his company will deliver 1,900 homes for $900 million in revenue in 2004.
He's not the only one. At Ole South Properties, Bowman says business will be strong in 2004, but not as big as in 2003, when the fast-growing Tennessee builder closed more than 700 homes, producing $83 million in revenue. One big reason: land. "The lot inventory is decreasing," he says. "It's hard to supply an inventory of 700 closings."
And, given the expected increase in housing demand over the next decade from echo boomers and baby boomers to immigrants and their children, such land challenges won't get any easier to resolve. "That's the key question" about the next decade's housing needs, Berson says. "Can we meet that demand?"