Housing Hasn't Hit the Roof Yet

Strong demand and tight supply are proving to be a sturdy foundation for the market, even though rates will likely tick up and home prices slip

After three straight years of record sales, it's understandable that the red-hot housing market, which has been the wobbly economy's pillar of strength, would start to cool from its torrid pace. But anyone who doubts that housing still has legs should just ask D.R. Horton (DHI ). On Apr. 16, the Arlington (Tex.)-based homebuilder racked up another quarter of record double-digit sales and profit gains. Net income shot up 44%, to $127.8 million, on $1.9 billion in sales, up 19% over the year-ago quarter.

D.R. Horton also hiked its earnings outlook for 2003 by 4.2%. And it logged a 32% increase in its order backlog, reflecting robust revenue two or three quarters down the line. "We're in a very strong position," says CEO Donald J. Tomnitz. "At the end of March, we had either closed or sold 87% of the 35,000 units we told Wall Street we would sell this year."


  The housing boom that began three years ago -- and continues to help prop up the economy -- is still chugging along. All across the country, homebuilders are chalking up record sales and profits, and many are raising earnings projections for the rest of 2003. While sales of existing homes, reported on Apr. 25, dipped in March, following gains the first two months of the year, realtors and economists say that likely was a lull brought on by lousy weather and war-related jitters. With fears of sustained conflict in Iraq receding, new home sales jumped 7.3% in April.

Low mortgage rates have been the primary driving force behind the continued strength in home buying. As the economic recovery picks up steam, they'll inevitably will rise, knocking potential buyers out of the market and putting a lid on the big gains housing has racked up in recent years.

However, don't expect housing to crater under the weight of climbing mortgage rates. Historically low rates may be a big reason for continued strength in the sector, but in recent years housing has also been buoyed by poor investment alternatives, tight home supply, and changing demographics. The sector has had a history of boom and bust cycles, many experts say, but it appears to be on solid ground and doesn't look poised for a bust anytime soon.


  Will those other underlying strengths keep the housing market buoyant if a second-half rebound materializes, as many, including Federal Reserve Chairman Alan Greenspan, expect? Is the housing market, after several stronger-than-expected years, heading for a major correction? The short answer, according to most economists: No.

While sales of new and existing homes are expected to be relatively flat in 2003, they'll remain at near-record highs. "When people see strength in housing, they don't believe it. It's easy to assume a bubble," says Smith Barney analyst Stephen Kim, who estimates a conservative 15% jump in earnings this year for homebuilders. But "you won't see a cratering or a popping of the bubble because there is no bubble."

To many, the bubble fears are real. Over the past few years, home prices have continued to appreciate -- at alarming rates in some regions. The Mortgage Bankers Association of America (MBA) expects prices to jump again in 2003. It's estimating that the median price of an existing home will climb 4.5% this year over 2002, to $165,000, while the median price of a new home will jump 2%, to $188,700. But as the sector cools, so will home prices, analysts predict -- and rather sharply in areas where prices have risen substantially in recent years, such as Boston, New York, and Silicon Valley.


  A key component of past housing bubbles -- overbuilding -- isn't a problem this time. Land continues to be in short supply, and municipalities keep imposing tough restrictions on building permits. "Land is a zero-sum game. The supply side is continuing to be tight in a lot of markets without a lot of land to build on," says Richard J. Dugas Jr., chief operating officer of Pulte Homes (PHM ). In addition, he says "the processing time for land has doubled in just about every market we do business in over the past couple of years."

Even with the boom times builders have enjoyed in recent years, they're more cautious than in the past. Inventories of new homes are at some of the lowest levels on record. At the current rate of new-home sales, it would take 4.1 months to sell all available houses on the market nationwide vs. 9 months in 1991, when the economy was in recession.

"Both lenders and builders have learned from past mistakes," says C. Kent Conine, National Association of Home Builders' president. "There are not so many homes being built that we have to worry about excess inventory causing problems," adds economist Joel L. Naroff of Naroff Economic Advisors in Holland, Pa.


  Where's the housing demand coming from? Not from $2 million-plus high-end luxury homes, which have been hit by the stock-market lull and the collapse of the telecom and dot-com bubbles. "Higher-end properties sit on the market for an average of 8.7 months, up from around 3 months 3 years ago," says Ilona Kuphal, a senior vice-president with Coldwell Banker in Boston.

Homes priced below $500,000 are moving well, with the hottest segment being starter homes that sell for $200,000 or less in most markets. Those are being snapped up mostly by immigrants. That segment has helped boost sales for realtors like Tal Kramer in Atlanta. "Homes are selling on average in less than 90 days," says Kramer. "We've had more sales this year than any year I know of -- and I've been in the business 20 years."

Atlanta, Boston, and Las Vegas are still among the hottest markets for builders, while Austin, Dallas, and Denver -- which have all been hurt by problems in the technology and telecom industries -- have softened.


  Another key factor in housing's strength -- refinancing -- is still looking robust despite the threat of higher rates. The MBA estimates that the lending industry will rack up $2.6 trillion worth of new loans, up marginally from last year. Of those, the group says 60% will be refinancing, up from 59% in 2002. Much of that borrowed money goes into buying new furnishings, remodeling, and even new cars.

Countrywide Financial (CFC ), the nation's largest mortgage broker, on Apr. 29, reported a 95% jump in earnings for the first quarter. "The big trend is the repeat refinancing -- two, maybe three, times within three years," says Doug Perry, first vice-president for consumer markets at Countrywide in Calabasa, Calif.

Others agree. Says Arlen W. Gelbard, chief banking officer at E*Trade Group (ET ): "There are still a lot of people who haven't refinanced or haven't refinanced in a while. You see people who do it over and over again. We're going to have at least one, if not two, more mini-booms of refinancings, assuming the Fed cuts rates again."


  That assumption may be a bit too optimistic. As the economy improves, the central bank is unlikely to see the need to cut rates any more this year. Observers say, however, that even when rates do increase, they'll remain well below historical levels. For example, a 30-year fixed mortgage hovers around 5.7%, among the lowest in 40 years. The rate will average 6% this year, vs. 6.5% in 2002 and 7% in 2001, estimates the MBA.

And many homeowners may rush to purchase or refinance as they see rates rising, giving another boost to the sector. "If rates are going up, it's because the economy is getting better," says Laurence E. Hirsch, chairman and CEO of homebuilder Centex (CTX ). "That's a better situation than having lower rates." Adds Robert Toll, chairman and CEO of builder Toll Brothers (TOL ): "I'll take 7% [mortgage rates] with a good economy vs. 5% in a bad economy any day." And likely so would many homebuyers.

By Stephanie Anderson Forest in Dallas, with Amy Barrett in Philadelphia, Charles Haddad in Atlanta, Christopher Palmeri in Los Angeles, Faith Keenan in Boston, Louise Lee in San Mateo and bureau reports

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