A fellow builder I know shrugged his shoulders about how bad things are, but he drew comfort in predicting that things will improve in six months. Clearly, he's not paying attention.
Housing's key drivers–macroeconomic, job growth, supply, credit availability, affordability, and buyer psychology–continue to trend downward. Back in 2004 and 2005, these drivers were strongly positive. By 2006, two had lost steam. The supply of finished homes and all homes available for sale skyrocketed, and buyer psychology soured. Still, job growth, interest rates, and the availability of financing remained positive.
Since then, two more drivers have succumbed to negative forces in the past six months. Financing's availability has taken a huge hit a result of the collapse of sub-prime lending. The impact has been far-reaching, as Alt A and A lending has tighten reducing the number of customers who can qualify for mortgages at all levels.
To add insult to injury, interest rates are moving higher and most likely will continue to do so the result of forces outside of our country. Although home building may be a local business, interest rates are global.
The 10-year Treasury is now above 5 percent for the first time in 11 months and is nearly 100 basis points above the 4.2 percent level from February 2005. A 30-year fixed rate mortgage has moved higher, to over 6.65 percent. Why are interest rates moving higher when housing is dragging down economic growth in the United States? Economic growth was anemic in the 1Q2007, as the U.S. gross domestic product trickled along at 0.6 percent growth.
As interest rates in China and Europe increase, investors who purchase bonds tend to move their money into higher-yielding opportunities overseas. Because the United States needs to compete in attracting investors to buy its bonds to finance the country's deficit, U.S. interest rates need to rise accordingly. So, despite slower growth here, there's pressure on U.S. rates, which makes money more expensive all around. As central banks in China and Europe raise their interest rates, the benchmark 10-year Treasury, which directly correlates to mortgage rates, has also been notching upward.
Inventory of finished homes in the largest home-sale markets continues to rise, increasing by 5 percent in May. The meltdown among sub-prime lenders has made residential financing more difficult. Now, interest rates are on the rise, putting up a barrier to affordability. Buyer psychology is strongly negative. So how is it that a builder could think things will get better in six months? Because he's not paying attention to the realities of the market.
Builders need to anticipate the worst; it's okay to hope for the best as long as you don't bet on it. The mortgage market will stabilize, but it won't happen immediately. Interest rates will most likely continue to rise modestly, fueled by global growth. Inventories will stabilize and begin to decline, but not in the near future. And finally, buyer psychology will moderate, but not the day after tomorrow.
We need to develop business plans and strategies that take into account that home building will likely not regain momentum until latter 2008 at the earliest. Assuming any other likelihood would be reckless.
–Jamie M. Pirrello is the CEO and president of Vision Homes USA, a Fort Myers, Florida?based home builder. E-mail: firstname.lastname@example.org