Housing Challenges for 2009

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Housing Challenges

Housing across America is healing. National Builders such as KB Homes (NYSE: KBH) and Toll Brothers (NYSE: TOL) are experiencing stronger traffic throughout their developments, and an increase in new sales was particularly evident in the June and July time frames. Sales of existing homes are gradually improving, and as Sandy Young, managing Broker for Realty Executives in Phoenix, Arizona states "it is not unusual to generate 5-8 offers on almost all REO inventory."

The supply of Foreclosures has dropped from a high of 6-months inventory to less than 30 days. There is a widespread perception that lenders are managing the supply of foreclosures and limiting the availability of discounted properties. The markets of Phoenix and Las Vegas are normalizing with the supplies of homes available at less than 4 months. The Phoenix MSA has closed over 80,000 properties through the end of July, compared to a total of 59,000 closed for all of 2008. With a current 12,732 homes pending closing, projections are for over 110,000 sales.

Vacant condos in Miami are experiencing the same scenario; sales are brisk. There were estimates of as many as 25,000 vacant condo units at the beginning of the year, but that heavy stock has moved to as little as 9,000 condos currently. Aggressive pricing, with discounts of up to 50% is being credited for buyers returning to the market. The basics of supply and demand are at work. It is still a historic buying opportunity.

Although housing appears to be recovering, many problems still remain. The greatest factor affecting the housing market is supply. In the lower price ranges, which qualify for government financing, particularly FHA financing, the supply has dwindled to the point where it is becoming a seller's market, with multiple offers and rising prices. Unknown to all is the "Phantom Inventory" held off the market by lenders. Should the lenders flood the housing market with foreclosed homes, prices may soften. Should the stream of homes released by lenders remain at current levels, prices will rise and may rise dramatically as many homes are being sold at or below replacement pricing.

Bidding wars reminiscent of 2005-2006 are becoming common with some prices settling 15-20% over asking, although asking prices are severely discounted. The price action suggests a potential jump in values. In price ranges above Fannie Mae (NYSE: FNM) or Freddie Mac (NYSE: FRE) lending limits, prices continue to soften, but at a lower rate. The luxury market is still declining, but again at a lower rate, suggesting a bottoming process. The housing market viewed in total suggests a recovery is starting, though should REO's flood the economy, it could be a "false start." My indicators are pointing to a genuine upturn however, and I believe the fourth quarter of 2010 will mark the end of the Housing Crisis.

Value investors and first time buyers have entered the housing market en masse, and are affecting rental rates. Vacancy rates have increased as tenants vacate their rental units to become homeowners, and investor purchases add to the supply. Although construction of apartments has been severely curtailed, the supply of rental homes has increased here in Phoenix from the March 2008 low of 7800 units, to over 9300 current units available. This has had the unwanted affect of lowering per unit rental rates by 10-15%. I expect these extra units will be absorbed within 12- 18 months as population growth and job growth return to normal. Unemployment always expands vacancy rates, as children leave their apartments and return to their parents' homes. Thus, some households expand to include more people per unit, also lowering housing demand.

I expect the demographic growth of the US will shortly absorb available housing, and there exists a scenario for a future housing shortage. Some economists are concerned that the recovery could be aborted or develop into a double-dip recession. If this plays out, household compression would accelerate and rental rates would decline further. Most economists currently are not forecasting a return to recession; some, including myself, believe the US will rapidly enter a new business cycle, and recovery will be swift.

As economic activity strengthens, interest rates could rise and slow the recovery; rising rates would be a normal characteristic of recovery, however. The Federal Reserve has indicated a willingness to pursue a policy of low interest rates, pursuant to the Fed's target of price stability and asset appreciation. This policy of extended low rates should effectively abort the negative impact of "Option Arm Loans" scheduled to reset in the next 12-15 months. The affect of lower rates should thus substantially increase the strength of the recovery.

In conclusion, there are several issues that may negatively impact housing; some have the potential to severely retard the growth of the new business cycle. However, it is very typical in the beginning of an upturn for unease and concern regarding future growth. This cycle is just beginning, and will likely grow immensely in the next 36-48 months. The trillions of dollars earmarked for the recovery have just begun to trickle into the economy; most agree only 15-20% of the funds are in the system. Let me say it clearly: the recovery has started and there are trillions of dollars of government funds coming. There are estimates of $3.6 trillion in US money markets alone. When the system is full, this money will begin to move, velocity will increase, and activity will soar.

I believe that anyone with investment capital should look hard at their local housing markets and encourage their children to buy; in a few short years, the historic housing affordability enjoyed now may be vastly different. I suggest you buy your second home; buy a home near your child's university; buy a home for your grandchildren; or treat yourself well and buy a luxury home. But buy your properties soon!


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