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Real Estate Begins to Cool

Two major themes we have been discussing for quite some time appear to be coming together:

A) Real Estate, though not a bubble, is an extended asset class overdue to retrace;
B) RE has been the dominant sector in the US economy since the recession ended.

Those themes lead us to following: 5 key factors suggest to us that Real Estate has finally begun to cool:

1. Inventory
2. Prices paid
3. time on the market
4. relative strength of Condo sales
5. Mortgage rates

Mortgage rates have ticked upwards to 6% on the decoupling of the Chinese Yuan from the Dollar and the reintroduction of the 30-year Treasury bond.

Given Real Estate’s contribution to economic growth, this is quite significant. Despite recent data to the contrary, the Real Estate complex has been the most robust economic growth engine in the US. We credit half-century low interest rates, demographic trends, disenchantment with equities, and the decreasing availability of buildable plots of land for this phenomenon.

We spoke with Real Estate Agents in the NY area, and they have all noted a pronounced shift. Bidding for Houses is far less furious than it was a few months ago. Sellers who were inflexible on price wait much longer to sell, as Buyers have become more selective. Even the credit worthiness of some bidders is not as strong as it was prior. Anecdotal evidence, combined with quantitative data, suggest that we are now in the latter stages of the housing boom.

As the sector begins to further cool, we foresee several significant elements coming into play: 1) Housing related employment slows and reverses. Think real estate agents, mortgage brokers, durable goods manufacturers, home-builders and retailers. They could move from a hiring mode to laying off sometime over the next 18 months; 2) Major retailers (Home Depot, Lowes, Sears, Bed Bath & Beyond) will feel the pinch, as revenue and profits begin to slow; 3) Home builders, still cheap on a P/E basis, will begin to throttle back growth.

How the builders handle the slowdown will be a function of their prior positioning. Those with little debt, prime locations and a strong back order will likely see only a modest slowdown. However, Jeff Matthews notes that some homebuilders are engaging in speculation; He specific cites Toll Brothers as “playing the spot market.”

The silver lining is that slowing Real Estate gives the Fed the excuse it needs to stop tightening, assuming their motivation was to let some air before a real bubble got too far out of hand.

Given the significance of this sector and the relative modest strength of the rest of the economy, we suspect the Fed will fail in their attempt to engineer a soft landing.

We expect a recession in the 2006-07 time frame.

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UPDATE August 10, 2005 6:47am

The NAR noted on Tuesday that they too expect Real Estate to cool off into 2006:

A runaway real estate market this year has many economists – and even Fed Chairman Alan Greenspan – fretting about the housing bubble. But the people who sell real estate for a living predict a soft landing for the red-hot market, not a crash that could wipe out homeowners' gains of the last three years.

The Federal Reserve raised short-term interest rates for the 10th consecutive time today, lifting its short-term rate target to 3.5% from 3.25% and signaling that more increases are to come. The Fed ist rying to deal with strengthening economic growth, a slightly less favorable inflation picture and still-low long-term interest rates.

“The housing market is probably close to a peak right now in terms of sales activity, but there is tremendous momentum," said David Lereah, chief economist for the National Association of Realtors. "Sales are expected to coast at historically high levels into next year, but they will trend slightly downward.

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Source:
Realtors See Market Coasting For The Rest Of The Year
August 9, 2005
http://www.consumeraffairs.com/news04/2005/housing_realtors.html

Monday, August 08, 2005 | 01:30 PM | Permalink | Comments (23) | TrackBack (6)
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Comments

Seems like you're missing a big factor here: increases in rents have not kept pace with house prices. That indicates that there isn't a shortage of housing, but only of one type of housing for which a ready substitute is available. At some point, most people don't buy houses if they can rent one for much less money.

Posted by: royce | Aug 8, 2005 1:58:48 PM