How We Got To This Point in the Housing Market

Wednesday, August 23, 2006 | 08:48 AM

"Every time we've gone into a downturn in the home-building industry, they've always been longer and deeper than we've all imagined. So we're preparing for the worst, and we think this one will be longer and deeper than just the last six months." -Donald Tomnitz, chief executive, D.R. Horton, the nation's largest home builder


As we wait for Existing Homes Sales data today, and New Home Sales tomorrow, we thought it was an opportune time to review how we got to where we are in the housing market.

Its been exactly one year since we announced in this space that "Real Estate Begins to Cool."

To review what we said last August 2005: 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.

It turns out that call was correct; Real Estate has slowly faded, as the rates rose, the Home Affordability Index hit 15 year lows, and a measure of Builder's Sentiment dropped to levels not seen in decades. Indeed, we can even mark the peak in the Housing boom around that same time.

Housing_hard_landing_1 What has been so astonishing about the housing boom is how totally misunderstood its been by people who should have known better, real estate agents, mortgage brokers, developers, and economists. To reiterate our views, half century low interest rates, combined with an investor class burned by the stock market crash, Wall Street scandals and corporate malfeasance on a grand scale saw Housing as a better place to park their dollars.

Mean reversion apparently is not understood by many real-estate professionals. From brokers to lenders to developers and home builders, there was a irrational expectation that the "soaring property market eventually would glide to a soft landing."  It makes little sense to assume that after home prices more than doubled between 2000 and 2005, they would then mean nicely revert to a normalized gain 5% or 6% a year.

That's the equivalent of stocks reverting to a 10% annual gains after the 1995-2000 run up. In case you forgot, lots of cheerleaders predicted that would happen. Remember, it was a new paradigm, and eyeballs and sticky pages counted much more than revenues and profits.

Of course, the market crashed in 2000, with the Nasdaq -- home to the hottest market sectors of tech, telecom and internet -- getting hit the most. It dropped 78%.

So too, will the hottest sectors of Real Estate get hit the hardest in the slowdown. That means the Coastal Northeast, (NY, Boston). California, South Florida and Las Vegas along with a few other hot areas will feel the burn more than the sleepy parts of the country where home prices ares till relatively reasonable. I don't expect real estate prices to crash 78% in these markets, but a healthy retracement of recent gains is very likely in the cards.

I expect to see a reverse of what occured when rates were slashed. As more and more potential buyers are priced out of the market, many homes will sit for sale longer, and some will have to be discounted aggressively to sell.

Bad news for Housing is good news is for apartment building owners: Marginalized buyers will be come renters. This is a large part of the reason we have seen rents rise lately. The New York Times reports that "in the metropolitan area covering New York, Long Island and Northern New Jersey, annual increases in rent surpassed 5 percent in the second half of last year for the first time since 1990, according to government statistics. And brokers and landlords in the city speak of even sharper rises lately."

They write:

In the early years of this decade, low interest rates and rising home prices prompted more Americans to buy, both because of the lure of a healthy profit and the fear of being left out of the game. As a consequence, demand for rental properties shrank — pushing up vacancy rates and pulling down rents.

By the fourth quarter of 2004, rental vacancy rates had risen to 10.4 percent, the highest level since the government started tracking them in 1960. Overall rent gains slowed to a modest 2.5 percent through early 2004, their slowest since the mid- 1990’s. And in the bigger rental complexes, according to the National Association of Realtors, rents fell nationally in 2002 and 2003 and inched up only marginally in 2004.

We have a combination of falling sales and rising rentals. And sales may be falling even faster than has been recently reported. Today's WSJ observes:

"Nationwide, the median sale price of previously occupied homes in June was 0.9% higher than it was a year earlier, the smallest year-to-year increase since May 1995, according to the National Association of Realtors. Over the next few months, the median price may decline from year-earlier periods, a spokesman for the association says, something that hasn't happened since February 1993.

The market may be weaker than the Realtors' widely followed monthly reports suggest. The group's data don't reflect the latest transactions. Its report on July home sales, for instance, due today, will mainly reflect sales that were agreed upon in May or June and closed in July. Moreover, when the market turns down, many home sellers initially let their homes sit instead of cutting prices enough to entice buyers.

The bottom line remains that real estate will no longer drive the economy the way it has over the past 5 years. And nothing else has risen to take its place as a key driver of consumer spending, or creator of jobs.

If that remains the case, its hard to see how a dramatic economic slowdown -- or even  a recession -- can be avoided . . .


Housing Slump Proves Painful For Some Owners and Builders
'Hard Landing' on the Coasts Jolts Those Who Must Sell;
August 23, 2006; Page A1

Rents Are Rising Rapidly After Long Lull
NYTimes, August 19, 2006

Builders sour on condos, love apartments
Affordablity falls to record low in second quarter
MarketWatch, August 22, 2006 3:14 p.m.

Wednesday, August 23, 2006 | 08:48 AM | Permalink | Comments (52) | TrackBack (0) add to | digg digg this! | technorati add to technorati | email email this post



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Soft landings are for dimwits and nimrods. The perma bears finally have their day. It's the single one item which has changed my opinion to expect more than a midcycle correction. Consumer credit, mortgage debt, savings rates, blah, blah, blah. It's all about housing.

Posted by: BDG123 | Aug 23, 2006 9:02:48 AM

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