Home sales apparently stabilized around the end of last year, in both gross and net terms, at least on a national basis. Moreover, the outlook for mortgage rates as well as prospects for employment and household income are reasonably positive for 2007. Even so, this will be quite a challenging year for the industry as home builders face a number of strong headwinds in the aftermath of the 2004–2005 housing boom.
THE 2006 “CORRECTION” The housing boom of 2004–2005 was driven by highly stimulative financing conditions and related surges in home buying by investors/speculators. Home sales, house price appreciation, and housing production all soared into unsustainable ranges during the boom, decimating affordability conditions and setting the stage for development of a major inventory overhang.
The housing “correction” of 2006 was a recoil from earlier excesses and involved an abrupt decline in home sales, an abrupt upswing in sales cancellations, and a substantial slowdown in house price appreciation (going negative in some areas). As demand weakened and inventories climbed, builders reacted by cutting housing starts and permit issuance while trimming asking prices and rolling out time-tested nonprice sales incentives —a process that gained momentum as the year progressed.
As 2006 drew to a close, gross sales volume appeared to be stabilizing and sales cancellations appeared to be topping out. Furthermore, inventories of unsold homes (as conventionally measured) stopped rising and even showed a bit of improvement in the final months of the year.
HEADWINDS FOR 2007 Despite the 2006 correction process, builders still face a number of headwinds that will hold back the incipient housing recovery for some time. In a nutshell, housing affordability must be rebuilt further and housing inventories must be reduced further before starts of new homes can move upward on a sustained basis.
Measures of housing affordability improved to some degree in the latter months of 2006, but a lot still needs to be done to bolster sales for owner occupancy (purchases by investors/speculators are bound to continue downward). However, mortgage rates are not likely to move down this year, and mortgage-lending standards are bound to tighten in the wake of the financing excesses during the boom (particularly in the subprime and adjustable-rate mortgage markets). It's true that employment will be growing and that gains in household income will be providing some boost to affordability, but further cuts in house prices along with aggressive use of nonprice sales incentives most likely will be needed to get home sales on a meaningful upswing this year.
On the inventory front, it must be recognized that the current overhang is heavier than it looks and that the true overhang may actually rise further. Homes left with builders when sales contracts are cancelled are not in the government's estimates of the new-home inventory, and an abnormally large portion of previously owned homes for sale are standing vacant—a legacy of the investor/speculator buying binge that compounds the seriousness of the current inventory situation. And then there's that “phantom supply,” made up of an unknown number of homes that will be put back on the market by investors/speculators that grow weary of carrying them in down markets.
MESSAGES FOR BUILDERS Despite the market corrections made last year, builders in many areas still are operating in unbalanced markets characterized by historically low levels of affordability and historically high inventory overhangs. Builders should do everything possible to move inventory this year, even at the expense of margins. Fundamentally positive underlying demand forces (primarily demographics trends) can be relied upon to support production as balance is restored to the markets.
David F. Seiders, Chief Economist, NAHB Washington, D.C.
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