Housing Hasn't Hit Its Ceiling

With mortgage rates still low and signs of economic improvement, S&P thinks the home boom has more room to run

By Michael Jaffe

While the torrid pace of new home sales may leave some observers wondering if a significant slowdown may be in the offing, we at Standard & Poor's expect them to remain strong through the end of 2004. We base that forecast on the belief that mortgage rates will remain accommodating through the period, and that an improving economy will leave consumers comfortable about taking the plunge to buy an expensive asset such as a home, even if interest rates move up modestly. Despite the uptick over the past couple of months, rates remain very low, though our opinion would change if rates move much higher.

Overall, we expect sales of new single-family homes to rise in 2003 at a percentage rate in the mid-single digits -- reaching an all-time high of more than 1 million units -- and to remain relatively steady in 2004. Sales in the first six months of 2003 were up 11%, to 554,000.

In recent years, housing markets have been buoyed by historically low interest rates, which bolstered the U.S. market throughout most of 2001 and 2002 and through the first half of 2003, despite economic recession, terrorist attacks, and the war against Iraq.


  Although 30-year conventional mortgage rates had moved up some 110 basis points, to 6.4%, since reaching a 45-year plus low of 5.3% in late June, S&P believed that 30-year conventional mortgage rates would stay in check through 2004. As of mid-August, 2003, we were projecting average 30-year mortgage rates of 6.0% to 6.2% in the second half of the year and 6.3% in 2004.

The upturn seen in 30-year conventional rates since late June has knocked down affordability slightly. However, as long as our mortgage-rate forecast is relatively accurate, we don't expect homes to get much less affordable through the end of 2004. Other factors influencing new home sales are employment trends, consumer confidence levels, and housing prices. The amount of inventory and the fluctuations of the housing cycle also affect industry performance.

The sluggish job market is one of the possible obstacles to home sales over the next year. Since the early part of 2001, companies have actively reduced their payrolls, and the June, 2003, the unemployment rate of 6.4% marked the highest level seen in over nine years. Although job losses have slowed since early 2002, net job creation seems unlikely before 2004. This could discourage a number of individuals from buying new homes.


  Builders are doing their part to ensure that there are plenty of homes in the pipeline. During 2002, the total number of new homes under construction gained 6.4% on the prior year's total, reaching 1.705 million, according to the Commerce Dept. Gains of 6.7% in single-family starts and 5.1% in multifamily starts were recorded. For the first half of 2003, total starts managed a 2.2% gain, with a 4.2% rise in single-family starts outweighing a 6.1% drop in multifamily.

For the multifamily segment of the market, we expect the softer trends seen in the early part of 2003 to continue. We base that forecast on the higher affordability of homes, with historically low mortgage rates enabling more individuals to buy single-family homes instead of renting apartments.

Our top stock selections in the homebuilding group are Lennar (LEN ) and DR Horton (DHI ), each of which is ranked 5 STARS (buy).

Analyst Jaffe follows homebuilding stocks for Standard & Poor's

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