U.S. Housing Recovery Tested as Economy Tempers Optimism

U.S. Housing Recovery Tested as Slowing Economy Tempers Optimism
A Toll Brothers Inc. house under construction. Photographer: Daniel Acker/Bloomberg

Rob Gray moved his family of four from Massachusetts to Texas, where he bought a new five-bedroom, five-bath, two-fireplace home built by Toll Brothers Inc.

After completing the deal on July 26 for the $572,000 brick-and-stone house in Allen, about 30 miles (48 kilometers) north of Dallas, Gray and his wife Paula plan to spend about $30,000 on new furniture, appliances, window treatments and an outdoor grill.

“We’re not afraid to roll the dice, to take a leap of faith on the U.S. economy,” Gray, 47, an insurance-company recruiter, said in a telephone interview. “Things are on the rebound, and we need to get off the sidelines.”

As the residential property market climbs back from the worst collapse since the Great Depression, homebuilders need more customers like the Grays for the industry to enter a sustainable recovery and help drive U.S. economic growth. While orders for new homes are rising at the fastest rate in two years and housing may be a net contributor to the economy’s expansion for the first time since 2005, slowing job growth, tight inventories and a backlog of foreclosures threaten to put the brakes on a comeback.

“The gun is cocked with insane affordability,” Stan Humphries, chief economist at property-data provider Zillow Inc., said by telephone from Seattle. “The conundrum is why more people aren’t coming off the fence. Two things are keeping them on the sidelines: economic uncertainty, and the fear of falling home prices. And I think both of those have started to be reduced.”

Breaking Ground

Recent data has been bullish. Builders broke ground on new single-family houses at an annual pace of 539,000 last month, up 4.7 percent from May and the fastest rate since April 2010, the Commerce Department said on July 18. Confidence among U.S. homebuilders increased in July by the most in close to a decade, according to a National Association of Home Builders/Wells Fargo index.

In the three months ended June 30, orders swelled 32 percent at PulteGroup Inc., the largest builder by revenue, and 25 percent at D.R. Horton Inc., the biggest by volume. Shares of U.S. homebuilders are up 48 percent this year.

Home prices in 20 cities fell 0.7 percent in May from a year earlier, the smallest 12-month decline since September 2010, the S&P/Case-Shiller index showed today. Prices increased 0.9 percent from April when adjusted for seasonal variations.

More Affordable

Housing affordability reached a record high in the first quarter, according to the National Association of Realtors. The average rate on a 30-year fixed mortgage dropped last week to 3.49 percent, the lowest since Freddie Mac began keeping records in 1972.

The low rates helped convince Vyonnie Matthews, a retail-store manager in Chicago, to stop renting and buy a home. She opted for a new Pulte house in Yorkville, a suburb south of the city, because the existing homes she looked at were small or in poor condition. Matthews also wanted to escape the city’s high crime rate, she said.

“We started looking to buy based on the interest rates going down,” Matthews said. “People are out there, and they’re saying, ‘Let’s do it.’”

The homeownership rate, which reached a record 69.2 percent in 2004, rose to 65.6 percent in the second quarter from a 15-year low in the prior three months, the Census Bureau said last week.

Slower Growth

Still, the recovery faces significant headwinds. Growth in residential fixed investment, the term economists use for spending on home construction and remodeling, slowed in the second quarter as the U.S. economic expansion decelerated, according to Commerce Department data released July 27.

Residential investment increased at a 9.7 percent annual rate, down from 21.5 percent in the first quarter, and contributed 0.22 percentage point to the gross domestic product’s annualized gain of 1.5 percent. That was down from a 0.43 percentage point contribution to the first quarter’s 2 percent GDP growth.

Residential fixed investment contributed 0.4 percentage points to the 3.1 percent U.S. GDP growth in 2005, the most recent year it was a positive factor in economic growth.

Historical Boost

Since 1947, residential fixed investment has added an average 0.1 percentage point to economic growth as the U.S. GDP grew an average of 3.25 percent annually, according to Daniel McCue, research manager at the Harvard Joint Center for Housing Studies in Cambridge, Massachusetts. Following each of five recessions from 1970 to 2001, residential fixed investment added an average of 0.9 percentage point to an average growth rate of 4.6 percent, he said.

“The contribution of RFI was nine times normal, or 20 percent of GDP growth,” McCue said in a telephone interview. This time around, “I don’t know if housing is set up to lead the economy back because of the fallout from past excesses.”

Working through those past excesses is taking years. Homeowners had $9.18 trillion in mortgage debt at the end of the first quarter, down 19 percent from a September 2007 peak of $11.3 trillion, according to the Federal Reserve.

Home prices have fallen further than the debt. They’re 33 percent below their July 2006 peak, according to the S&P/Case-Shiller index. That’s left owners of 11.4 million homes underwater, or owing more than their properties are worth, as of March 31, according to CoreLogic Inc., a Santa Ana, California-based data company.

Low Rates

Some buyers unburdened by debt are jumping into the housing market. Jenn Zepernick, a property manager in Orlando, Florida, and her husband waited until they had paid off their student debt, felt secure in their jobs and could take advantage of low interest rates before they decided to leave their rental and buy a home.

The Zepernicks are paying about $285,000 for a newly built four-bedroom Pulte house in Windermere, near Orlando, that will have space for their three children as well as high ceilings --a priority for her husband Keil, a stunt actor who is 6 feet, 11 inches (2.1 meters) tall.

“It’s always great to have a new home at a great mortgage rate -- you can’t beat that,” she said. “With the market doing so well, we were like, ‘This was a no-brainer.’”

Petered Out

Home sales picked up for a few months at a time in 2009, in 2010 and last year, spurred by falling unemployment and government incentives such as tax credits. Then the revivals petered out as events including the 2010 Gulf of Mexico oil spill and the March 2011 Japanese earthquake undermined enthusiasm.

This year may bring another repeat, following a weakening of U.S. consumer sentiment and job growth in the second quarter. The unemployment rate held at 8.2 percent last month and hasn’t been below 8 percent since January 2009.

Consumer spending cooled last month even as incomes increased 0.5 percent, the biggest gain in three months, the Commerce Department reported today. Consumer confidence unexpectedly rose in June for the first time in five months, the New York-based Conference Board said.

“Housing demand appears to have hit a soft spot, coinciding with the slowdown in the wider economy,” Paul Diggle, a housing analyst with London-based Capital Economics Ltd., wrote in a July 25 research note. “Nevertheless, the market for new homes is still among the tightest it has been in the previous six years and, on past form, is consistent with rising housing starts.”

Tight Inventory

Along with weak demand, a lack of supply may be holding back sales. There were 144,000 new homes available for sale in June, a 4.9-month supply, down from a peak of 12.2 months in January 2009. The 2.39 million existing homes listed for sale in June -- a 6.6-month supply -- is limiting sales of existing properties and driving some buyers to purchase from homebuilders, according to Lawrence Yun, chief economist for the National Association of Realtors.

“Buyer interest remains strong but fewer home listings mean fewer contract-signing opportunities,” Yun said in a July 26 statement announcing a drop in pending sales. “Housing starts will likely need to double over the next two years to satisfy the pent-up demand for both rentals and ownership.”

While it may be tempering sales, tight inventory is pushing prices higher in Silicon Valley south of San Francisco, Phoenix and other markets where listings are attracting multiple bids. Rising values provide a boost to the economy by lessening negative equity, increasing mobility among homeowners so they can chase jobs, and boosting consumers’ confidence in their finances, making them feel like they can spend more.

Foreclosure Backlog

One threat to a price recovery is a foreclosure backlog. A $25 billion settlement in February with top banks over allegations that they seized homes without proper documentation may open the way to more listings of lower-cost distressed properties.

A probe by state attorneys general, which began in 2010, led to a slowdown in actions against delinquent homeowners. Foreclosure filings rose in almost 60 percent of large U.S. cities in the first half of 2012, indicating that more distressed homes may enter the market later this year, according to Irvine, California-based researcher RealtyTrac Inc.

Lenders seized 60,000 homes from delinquent borrowers in June, compared with 80,000 a year earlier, bringing to about 3.7 million the number of properties lost to foreclosure since September 2008, when Lehman Brothers Holdings Inc. filed the biggest bankruptcy in U.S. history, CoreLogic reported today.

While more buyers are purchasing new homes again, the market needs job growth to accelerate, said Richard Dugas, chief executive officer of PulteGroup, based in Bloomfield Hills, Michigan.

Stronger Economy

“We believe low level of inventory is driving the majority of the good results you are seeing,” he said on a July 26 call with analysts. “Can housing double or triple from these levels just on the backs of low inventory? My guess is no. It probably needs a stronger economy to come along.”

Demand for new homes has been limited because household formation dropped as unemployment rose and incomes fell. The pace of household formation slowed to 810,000 in the second quarter from 1.01 million in the previous three months, according to the Commerce Department.

“Normalized household growth is about 1.2 million, which translates to approximately 1.6 million housing starts,” Stephen East, a homebuilding analyst with International Strategy & Investment Group LLC, a New York-based investment-research firm, wrote in a July 27 research note. “While still at depressed levels, we are well above the trough of 100,000,” the formation pace in the fourth quarter of 2008.

Household Formation

Starts for single- and multifamily residences will have to increase rapidly to keep up with household formation once the economy picks up, according to Ben Herzon, senior economist for Macroeconomic Advisers LLC in St. Louis.

“Pretty soon demographics will take over and people will form households at a normal rate,” Herzon said. “There is considerable pent-up demand.”

The National Association of Home Builders estimates single-family home construction will reach 519,000 units this year, up 19 percent from 2011. The number will rise to 668,000 next year, according to a July 12 presentation by David Crowe, chief economist at the Washington-based association.

Each new single-family home generates three jobs lasting a year, about half of them in construction-related employment, Crowe said in a telephone interview. That means an increase of about 400,000 new single-family homes will reduce the unemployment rate by 1 percentage point, he said.

25% Chance

Crowe’s home-construction projections have been overly optimistic in the past. He forecast that new-home sales would rise 18 percent in 2011, when they ended up falling 5.3 percent to 306,000, the fewest on record.

The possibility of a housing retreat is about 25 percent because of such economic dangers as Europe’s financial crisis, a U.S. “fiscal cliff” threatened by mandatory spending cuts and tax increases at the end of the year, and uncertainty about the future of mortgage companies Fannie Mae and Freddie Mac, Crowe said.

“We don’t even know who’s going to be president,” he said.

Eric Lipar sees the strengths and weaknesses of the new-home market as chief executive officer of LGI Homes Inc., a closely held builder based in Woodlands, Texas, outside Houston. His company sold a record 246 homes in the second quarter and expects to sell 90 units in July, a monthly record. The biggest challenge to increasing sales, especially to first-time buyers, is getting financing for LGI’s homes, which cost an average of $140,000, Lipar said.

Credit Difficulty

“Only 15 percent of the customers who come in our doors to buy have the ability to do it that day,” said Lipar, who sells homes at 12 communities in Texas and Arizona and is shopping for land in Florida. “They have to change their situation --improve their credit, make more money or get someone to co-sign with them.”

Homebuyers need to be careful not to take on unsustainable debt, which helped cause the housing market to crater in 2007 and 2008, said Gray, who bought his Toll Brothers house with a 20 percent down payment.

“We’ve always enjoyed our money,” said Gray, director of recruiting for Liberty National Life Insurance Co. “But we’re spending responsibly, not going crazy into debt.”

Airport Close

Gray, who travels every week for work, chose a house that’s about 45 minutes from Dallas/Fort Worth International Airport. He made the move to Dallas from Boston because of the weather and to be closer to the headquarters of his company, a unit of Torchmark Corp., in McKinney.

Texas is a land of opportunity for his kids, he said. His son Jackson, 16, will attend John Paul II High School, a Catholic school in Plano where he plans to be linebacker on the football team. His daughter, Michaela, 13, hopes to become a cheerleader at Allen High School, which is opening a new $60 million football stadium on Aug. 31, Gray said.

“She’s going to be in one of the premier programs in the country,” he said. “We don’t want the U.S. economy to dictate how we live our life. We want to lead from the front.”

Before it's here, it's on the Bloomberg Terminal. LEARN MORE