I'm calling a RE top - again - for xth time in as many years - time will tell, but this is probably not a real good time to be purchasing RE - unless you are purchasing land with extremely limited and beautiful beachfront/lake access. Anyway, I saw this article posted on Mish's thread:
morganstanley.com
U.S.: Housing -- Bubbly?
Richard Berner (New York)
Most macro forecasters — crystal ball gazers all — have eaten a lot of ground glass trying to call a top in housing activity in the past two years, including yours truly. Likewise, home prices have defied all calls, including mine, for a peak in appreciation, not to mention the bears’ forecasts of a sharp decline.
Undaunted, I’m taking a stand: Housing fundamentals, in my view, are as good as they get, and activity is likely to decline over 2005 and 2006. Among the reasons: Previously favorable demographics are turning less supportive, much pent-up demand seems to have been satisfied, soaring housing prices have made purchase less affordable, interest rates are gradually rising, and starts are slightly out of line with sales.
Importantly, however, a precipitous decline is unlikely: Stronger job and income growth should underpin new and replacement demand. Indeed, the combination of strong job growth and rising rates should also be good news for apartment owners, as newly employed would-be buyers get priced out of the single family market. And home prices? I stick to my view that prices henceforth are likely to rust, not bust.
What are the key forces behind this long-awaited peaking in housing? First, favorable demographics contributed strongly to pent-up demand for housing in the 1900s, but those trends are starting to cool. Most important, an unprecedented wave of immigration into the United States in the last three decades, especially in the 1990s, became the dominant factor in U.S. population growth. For example, the 13.2 million immigrants who arrived in the 1990s and the 7 million births to immigrant women accounted for at least 60% of U.S. population growth over that decade. Immigrants, many in diverse ethnic groups, accounted for more than one-third of household formation in the 1990s. In addition, the 1990s economic boom brought many minorities into the labor force. Thus, minorities accounted for two in five net new homeowners from 1994 through 2003, according to the Harvard Joint Center for Housing Studies. Likewise, the growth in households of traditional prime homebuying age (30–44)was 7.8% and thus underpinned housing demand in the 1990s. Partly as a result, the homeownership rate soared from 63.8% in 1993 to 69.2% at the end of 2004, amounting to an 11 million increase in households owning their own home. However, the immigration boom has cooled since 9/11, and the growth of prime-age households has also slowed in the past five years. The result will likely be slower growth in housing demand.
A second key force: Improved affordability helped to unleash that pent-up demand, underpinning it through 2004. But the combination of soaring home prices and the coming rise in rates will be a one-two punch reducing housing affordability in the next two years. The 48.5% jump in home prices over the past five years has begun to make housing less affordable, especially for the first-time homebuyer. While the rise has not been ubiquitous in every region, bicoastal increases have reduced affordability for a large part of the population. For example, of nine Census regions, Pacific region (Washington, Oregon, and California) average home prices measured by the Office of Federal Housing Enterprise Oversight (OFHEO) jumped by 79.1% in the past five years; by comparison, they rose just 25.1% in the West South Central region (Oklahoma, Arkansas, Louisiana, and Texas). In contrast, stable mortgage rates have helped to keep housing affordable, at least so far. In my view, that is set to change: 15–30-year rates may back up 75–100 basis points, and rates on one-year adjustable-rate mortgages may rise by 150 bp over the next year.
Moreover, there may be a brewing inventory problem in single-family homebuilding. One-family housing starts soared to a record 1.76 million in January 2005, suggesting unbridled strength. But starts are likely getting a little ahead of sales, which have slipped steadily from their peaks of early 2004. Existing home sales, although still at high levels in January, have declined 3.7% from their peak, while sales of new homes had in December slipped 9.2% from their highs early in 2004. That sales have slipped as rates came back down over the summer of 2004 strongly hints that pent-up demand has faded. And even if demand stabilized, inventories of unsold new homes have risen 15.6% from a year ago, so there could be a minor problem realigning starts and sales.
And what about home prices? The pace of home price appreciation is unsustainable, at 13% from a year ago in the third quarter, measured by the OFHEO nationwide price index. But neither the pace nor the level of prices is prima facie evidence of a bubble. As I see it, nationwide housing ‘valuations’ are only back to neutral from being undervalued, consistent with my thesis that home prices will rust, not bust, for the next few years. My valuation metric — a crude ‘price-earnings’ ratio for housing — corroborates that view (for details, see “Bubble Trouble?” Global Economic Forum, June 4, 2004).
Of course, that does not mean that home prices will be unaffected by rising interest rates; far from it. Waning pent-up housing demand and rising rates suggest that both housing demand and prices will likely cool significantly. And that does mean more limited opportunities for home equity extraction, significantly lower mortgage originations, and deterioration in mortgage credit quality even though income and job growth are improving. Far from obsessing about the macroeconomic implications for the American consumer, therefore, investors should regard these developments as a yellow flag for those who lend to consumers.
Finally, what should equity investors do about housing stocks? The homebuilders’ stocks have been on a tear, with the Philadelphia Stock Exchange Housing Index (HGX) more than doubling over the past two years and up 37.4% since mid-October. Bulls claim that the homebuilders are cheap, trading at 8–10x forward-looking earnings. I’m skeptical: While I’ve long thought that homebuilders are more disciplined and rational than in the 1980s and 1990s, it’s still a cyclical business, and next year’s earnings could be down. Thus, just as fading demographics and rising rates will curb housing demand and house prices, they may also be a double whammy for homebuilders’ stocks in the next several months.
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