June, 2006

NAHB Forecast: Soft landing for housing market

Demand dips 10% in first quarter; market expected to level out in 2007

By Staff Report

After soaring to record levels for three consecutive years, the single-family housing market is gliding toward a soft landing in 2006, as rising interest rates, affordability and a reduced role for investors/speculators contribute to a softening demand, according to economists at the National Association of Home Builders (NAHB) Construction Forecast Conference in Washington, D.C., on April 27.

“After topping out in the third quarter of last year, it is pretty clear that the housing sector is in a period of transition,” said NAHB Chief Economist David Seiders. “Sales and starts are trending lower toward more sustainable levels.” Even so, he added, the slowing housing market is not likely to derail the expansion, as housing yields its position as the economy’s major growth engine to other sectors.

Looking to the future, Seiders said that new home sales in the first quarter of this year were down 10% from the fourth quarter in 2005, and that he expects them to ease further in the coming months before leveling off in 2007.

NAHB is forecasting that new home sales will hit 1.13 million units in 2006, down 12% from last year’s all-time high of 1.28 million units, and then move down slightly in 2007 to 1.09 million.

“Hopefully, most of this decline will be due to investors and speculators stepping out of the market,” said Seiders. “What we don’t want to see is investors dumping homes on the market.”

After posting a record 1.716 million single-family starts in 2005, NAHB predicts that new home construction will level off to 1.595 million units in 2006 and 1.488 million in 2007, which would still rank high by historical standards.

Commenting on the dramatic home price increases in many markets in recent years, Seiders said home price appreciation is expected to fall from an average 12% in 2005 to about 4% in 2007, and that mortgage rates should move up to 6.7% later this year.

Regional Outlook

Looking at housing on a more localized level, Bernard Markstein, NAHB’s director of forecasting, said that the forces driving housing demand vary significantly by region. Among these forces are home prices, population growth, household formation and growth in employment opportunities. Other factors that can greatly affect demand include immigration and migration, energy prices, large-scale natural disasters such as Hurricane Katrina and an area’s appeal as a second-home location.

Mark Zandi, chief economist for Moody’s Economy.com, said that “builders have done a pretty good job of matching supply and demand” and that “nationally, house prices and supply will go flat in 2006, 2007 and 2008.” This implies that there will be some price declines in key markets, he said, but the markets are going to “correct, not crash.” 

Markets where Zandi anticipates significant corrections—defined as more than a 10% peak-to-trough

decline—are in the Northeast, the Mid-Atlantic, Florida, California, parts of Arizona and Las Vegas.

“Any fundamental rise in interest rates will bite hard,” Zandi said. “The rise will lock out two key groups that are important to local/regional markets: first-time home buyers and investors (investors include second-home buyers and other buyers in it for the long term, not just those in the market with the intent to flip and get out).

“The Bubble” Revisited

Addressing a question that has generated endless speculation in recent years, Thomas Lawler, a housing and mortgage market consultant who worked for Fannie Mae for 22 years, said “Was there a national bubble? Nationwide, no, but in some regions, absolutely.”

Lawler, who spoke on house prices and local dynamics, noted that in some areas, “all of the signs of a bubble were present: a surge in speculative investing, a surge in innovative financing, easy credit and loose underwriting, home inspection waivers, and home purchases sight unseen. You had to be ‘on something’ not to see a bubble in some areas.”

Housing Finance

With interest rates on the rise, housing finance was a major topic at the conference.

“Housing is the most interest-rate-sensitive industry in the country,” said Frank Nothaft, vice president and chief economist of Freddie Mac. “Mortgage interest rates, home prices and family incomes—these are the three ingredients that families think about when deciding to buy a home.

“We expect mortgage interest rates to rise slowly through the end of 2006, but they’ll still remain well below historical norms,” Nothaft said. “The affordability problem is a function of increases in home prices.”

He pointed out that among families with prime mortgages, 87% of the loans are fixed-rate. “So even if the Federal Reserve continues to raise interest rates, most American families will be insulated because they have fixed-rate mortgages.”

The major tailwinds that have driven loan originations in recent years have swung 180 degrees and could be major headwinds in the coming years, said Scott Anderson, senior economist for Wells Fargo & Company. These include rising interest rates, weakening demographics, increasing housing inventories, and less investor demand—especially if the stock market picks up.

“The Federal Reserve is doing its best to take away the punch bowl,” Anderson said. “It should be no surprise that the housing market is going to slow down.”