Housing Rebound? Not So Fast

Has the housing bust hit bottom yet?

The latest encouraging data came on May 4, when the National Assn. of Realtors said its index of pending home sales rose 3.2% from February to March. That sent shares of homebuilders surging, with KB Home (KBH) up 11% and Lennar (LEN) up 9%. But just how good an indicator of a housing recovery are those pending sales numbers? And what do those and other recent sales reports mean for homebuilders?

First of all, remember what pending means. These are homes that have gone under contract—but have not actually sold. The Realtors' association says that based on historical data, the pending sales numbers do closely track future sales. But the correlation is much stronger in the year-over-year data than it is in the month-over-month numbers. The increase over March 2008 was much more modest, just 1.1%.

Historical context may mean nothing in this downturn. Despite what big banks are telling Congress, it's very difficult to get a loan these days. Buyers who have been pre-qualified by lenders often find it's a different story when they actually request the money. The down payment or interest rate required could be larger—or the money might not be there at all. The volume of paperwork required to get a loan has also surged, creating more opportunities for buyers to be disqualified. "We're hearing anecdotally that lenders are backing out of funding," says Jim Gaines, a professor of real estate studies at Texas A&M University. "They're only going to give you the money if you don't need it."

Cheaper Homes Selling Well

Another reason for caution is that the home sales recovery—if you can call it that—isn't nationwide. Pending sales in the Northeast fell 5.7% from February to March. Meanwhile, much of the market—more than 40% of all sales nationally—is being driven by banks unloading foreclosed homes at distressed prices. Higher-end homes are not selling anywhere near as well as cheaper homes. That's not an indicator of a truly healthy housing market.

Also, keep in mind that the index of pending sales tracks purchases of existing homes. Foreclosures continue to be a huge drag on new-home builders. KB Home Chief Executive Jeffrey Mezger has said his biggest competition nowadays is foreclosed homes on the market at fire-sale prices. There may be more home-sales news in weeks to come that gives a broader sense that housing demand is picking up. But as long as buying activity is focused so much on foreclosures, it's bad news for builders.

For now, many smart people in the home-finance business are worrying not about whether the housing market has recovered but whether it could still get worse. At the Milken Institute's Global Conference last week in Los Angeles, leveraged-buyout king Thomas Lee pointed to a slide showing the large number of "Alt-a" adjustable-rate loans due to reset in coming months. These loans—made to buyers with decent credit but who were required to show less documentation of their income—could default in larger numbers, to the extent that they reset at higher rates.

Another 10% to Go?

Donald Brownstein, chief investment officer for money manager Structured Portfolio Management, told Milken conference attendees that his internal calculations show home prices have to fall about 40% off their peak before hitting bottom. The latest Standard & Poors/Case-Shiller home price index numbers showed a 30% decline from the peak in the summer of 2006, meaning we still may have a ways to go.

Low interest rates and tax credits such as the $8,000 federal credit for first-time home buyers do seem to be luring buyers back. But even National Assn. of Realtors Chief Economist Lawrence Yun expressed caution at the pending sales data. "We need several months of sustained growth to demonstrate a recovery in housing," Yun said. Existing-home sales for April will be released on May 27. Those data track actual, completed sales. So they should give a better picture of whether the housing market is really recovering.

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