What's Haunting The Housing Industry

Charles Rutenberg can hardly wait for the end of the Super Bowl. The Florida-based homebuilder laments that "the football playoffs and Super Bowl are death to home selling," since many would-be buyers spend weekends in front of their television sets instead of searching for a new home.

Competition from football, however, is the least of the problems facing homebuilders. True, housing is in an upswing, but the recovery is so muted that some developers haven't noticed. The lowest mortgage rates in 18 years have lifted refinancings to new highs, yet they are spurring little demand for new housing.

Homebuilding began to climb out of the cellar about a year ago. But even so, 1991 was the worst year for housing in the postwar era. With an annual rate of 1.1. million homes started in December, new construction for 1991 stood at about 1 million, down 17% from 1990. Starts aren't expected to rise much over 1.1 million this year and to only 1.2 million in 1993 (chart). Builders were much busier after the last two severe recessions, in 1973-75 and 1981-82. Both times, housing starts soared at an annual rate of 30% in the first two years of recovery.

What's gumming up housing's prospects? Fewer new households are being formed, credit remains tight, and developed land is in short supply. Add to that the glut of apartment buildings, plus consumer worries about incomes and jobs, and it isn't hard to see why the new-housing market is soft.

"Demographics make a powerful argument against a housing recovery," says David H. Resler, chief economist of Nomura Securities International Inc. He points out that the U.S. adult population isn't growing as fast as in the previous two decades. In the 1970s, the first wave of baby boomers became adults, raising the number of new household formations to 1.7 million a year. And in the 1980s, household formation averaged a solid 1.3 million a year. But only about 1.1 million new households will be created this year, a middling growth rate that will continue for most of the 1990s.

And these members of the so-called baby-bust generation face a housing market that is out of reach for many. The National Association of Realtors' index of housing affordability stands at its highest level since 1974. But the NAR uses the national median family income of $36,500. For those in their late 20s, who make up the bulk of first-time home buyers, earnings are only $27,394.

At the same time, the Federal Housing Administration--a source of mortgages for lower-income families--has tightened its lending standards, so buyers need more cash up front. The 1990 move was in response to losses in the FHA insurance fund. Falling prices meant that some borrowers owed more on their home than the home was worth. So, many people defaulted on their mortgages. Under the new FHA rules, buyers must pay 43% of their closing costs, which on average means an extra $800. Previously, they could fold those costs into the mortgage. Also, if the buyer has a small downpayment, the FHA charges a higher mortgage-insurance premium than in past years.

For buyers who go the private-financing route, the upfront costs are even more daunting. Using the rule of thumb that closing costs and points equal 6% of a mortgage, first-time home buyers who want to put a 20% downpayment on a new home with the median price of $117,400 need $30,000 in cash even before selecting their furniture and color scheme.

CASH POOR. The current low mortgage rates also won't sway consumers who are worried about layoffs. "With uncertainties on the job front, people are not willing to take the risk of buying a home, even if [a lower rate] means saving a few hundred dollars a month," says David F. Seiders, chief economist of the National Association of Home Builders.

Builders have their own money woes. The credit crunch--the difficulty in getting bank loans--affected small companies more than large corporations. And since homebuilders are mostly small companies, they have felt the impact more than most industries. "Certainly, there has been a tightening of credit standards," notes the NAHB's Seiders, "and I think it will stick." Lending is tightest in New England, Florida, and California, Seiders says.

Developer Rutenberg knows the credit crunch firsthand. "We cannot get good loans," complains the builder. He says his company must build "out of pocket," selling a few homes and then using that cash to build more houses. He does admit that this abridged homebuilding has a silver lining. "We're selling fewer homes, but we get a better return because we can pocket the financing costs [that the bank would have collected]."

But for others, the lending vise has squeezed them out of the business. The NAHB reports that its membership has slipped by about 4% in the past year. And economists and others in the housing industry expect more builders to pack up their tools. Despite the falloff in housing activity over the past decade, the number of those employed in residential construction--about 500,000 workers--has hardly dropped at all. By one estimate, one-third of homebuilders could call it quits without hampering construction in coming years.

In addition to scarce credit, builders also face a paucity of land. Because of last year's credit crunch, land developers--companies that put roads and sewage and water systems on undeveloped land--also had problems getting money. As a result, the NAHB says there is a shortage of finished lots.

MULTIVACANCY. There is no shortage of apartment buildings, however, and that also clouds the outlook for builders. "Multifamily construction has been slaughtered by overbuilding," says Roger Brinner of DRI/McGraw-Hill. Tax breaks and easy financing in the 1980s boosted apartment construction, Brinner says. And now, some of those projects stand empty. In the third quarter of 1991, the vacancy rate of rental units--mostly apartments and condominiums--was 7.6%, up from 7.2% a year earlier. The biggest overhang is in the South, where the vacancy rate is 8.8%.

Certainly, the mid-January pop in long-term rates offers no solace to the construction sector. The average rate on a 30-year fixed mortgage jumped by 0.2% in one week, to 8.53%, according to HSH Associates. Although economists expect rates to resume falling, the volatility adds to uncertainty in the industry.

The Washington proposal of a $5,000 tax credit for first-time home buyers will help in the long run, but such a tax break could backfire in the first half of this year. "If you tell people that it may happen, you may discourage activity in the short run," warns Neil M. Soss, chief economist at First Boston Corp., because consumers would wait to take the credit.

That's sorry news for builders facing an uncertain winter. And if the economy doesn't pick up in the spring as expected, even this modest housing recovery could soon fizzle out.

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