THE HOUSING SECTOR HAS PROVIDED AN UNPRECEDENTED degree of support to the U.S. economy in recent years, but things are about to change. The very success of housing will soon provoke a slowdown, and a rising interest rate structure will help seal the deal. The good news: The slowdown should constitute an orderly adjustment toward sustainability, not the beginning of a wrenching cyclical contraction.
HOUSE PRICES Rising home prices have a positive effect on housing demand by demonstrating the positive investment aspects of homeownership. But persistently strong house price increases inevitably have a negative impact, as well, by moving home buying beyond the reach of more and more potential purchasers. Indeed, standard measures of affordability have come down quite a bit as house prices have ratcheted up to ever-higher records in many parts of the country.
NAHB surveys show builder recognition of a rising tide of buyer resistance to elevated prices as well as builder reactions to this development. In a nationwide survey of about 500 builders conducted in September, 60 percent of respondents said they had noticed “some” buyer resistance to new-home prices in their market areas, and an additional 8 percent said the resistance was “significant.” Nearly 20 percent of builders encountering price resistance were trimming prices to maintain sales volume, 30 percent were slanting their production mix toward lower-priced models, and nearly 60 percent were offering nonprice sales incentives—most commonly including optional items in homes at no charge or paying closing costs for buyers.
HOUSING FINANCE For quite a while, falling mortgage interest rates neutralized the negative effects of rising house prices on affordability, but the interest rate factor recently has turned against housing as well. The Federal Reserve is engaged in a process of monetary tightening that will continue to raise short-term interest rates, and the cost of ARMs is on the way up. Furthermore, financial regulators and rating agencies have exposed the risks of various “exotic” ARM formulations (an Alan Greenspan term) that have fueled buying by owner–occupants as well as by investors/speculators.
The support to housing demand from historically low long-term interest rates is waning as well, partly because of the central bank's determined march toward monetary policy “neutrality.” Long-term rates should continue to firm up in 2006, taking an inevitable toll on housing affordability.
THE GLIDE PATH Recent levels of home sales as well as recent rates of house price appreciation certainly have challenged sustainability, partly because of extra fuel on the fire from those “exotic” ARMs and the elevated role of investors/speculators. But the inexorable pressures on affordability from rising house prices and interest rates, together with a likely retreat by ARM lenders and investors/speculators, should conspire to cool down the market before long.
The NAHB's forecast shows an orderly slowdown in home sales and housing production in 2006 and 2007, combined with a deceleration of national house price appreciation toward historical norms (around 5 percent).
The production level we're forecasting for 2007 is at the midpoint of the long-term forecast range we've established for this decade—an average of 2 million new housing units per year (including manufactured home shipments). That range is based on estimates of demographics, net replacements, and vacancies (including second homes)—the trend factors that will eventually win out.
Chief Economist, NAHB Washington, D.C.