U.S. Housing Outlook Is Complicated

The Second Homebuyers' Tax Credit—Up too Now—Is Having Minimal Effects. Mortgage applications to buy homes tumbled to their lowest level in 13 years during November, according to the Mortgage Bankers Association, and February's reading is on track to be lower than November's. We still believe that the effects of the second homebuyers' tax credit will kick in soon. But time is getting short, since buyers have until April 30 to sign the contract and June 30 to close the deal.

Builders Remain Pessimistic, But Are Nonetheless Ramping Up Production. Single-family permits posted solid, broad-based gains in both November and December, and were up again in January. Indeed, seasonally adjusted permits have picked up in most states, even in those where foreclosure rates are high.

How can one reconcile these numbers with the latest NAHB/Wells Fargo Housing Market Index reading, which shows builder confidence near all-time lows? One explanation is the larger builders are seeing a pickup in demand, while the more numerous smaller builders are not. In the NAHB index, the responses of large and small builders carry the same weight. It is also possible, however, that builders have temporarily ramped up production in anticipation of a small demand surge from the second tax credit.

January's new home sales figures, which come out on February 24, will shed light on the state of demand in the market for new homes. New home sales were down 9.3% in November and 7.6% in December—a third straight drop in sales could spell trouble for the housing market in 2010.

Foreclosures Are Still a Problem. The foreclosure inventory rate at the end of 2009 was at an all-time high of 4.58%, according to the Mortgage Banker's Association (MBA). An encouraging sign, though, was that delinquency rates were down slightly during the fourth quarter of 2009.

During normal times, homeowners stop making payments on their home because of a life-changing event—a death, a divorce, or a job loss. The current wave of defaults is being driven by job losses and falling home prices. Housing prices have stabilized recently and the unemployment rate inched down to 9.7% in January, from 10.1% in October 2009. It is tempting to conclude that the wave of foreclosures is near a peak—or that the worst may be behind. Indeed, the MBA's press release suggests that "we are seeing the beginning of the end."

But a possible surge in strategic defaults complicates the outlook. A strategic default occurs when a homeowner who is able to make payments on his or her mortgage opts to walk away because the value of the home is so deeply under water. According to First American CoreLogic, the number of homes that are 25% underwater will surpass the 5-million mark this year. In the past, the number of homeowners who walked away was small, partly because most homeowners felt morally bound to live up to the "spirit" of the mortgage contract. But social attitudes are changing. The big unknown, therefore, is whether another surge in foreclosures is in the cards because of strategic defaults.

Glut of Unsold Homes Is Still Near All-Time Highs. The homeowner's vacancy rate, which measures the proportion of homes that are vacant and for sale, ended last year at 2.7%. Because this estimate is sample based, it is not statistically different from the all-time high of 2.9% reached at the end of 2008, according to the Census Bureau.

The Census numbers raise a key question about the size of inventories of unsold homes. According to the National Association of Realtors (NAR), the number of homes for sale has dropped to 3.289-million units, or a 7.2-months supply at the end of December 2009. This is down from the July 2008 peak of 4.57 million (11-months supply). The NAR numbers, however, do not include the "shadow inventory," which mainly consists of foreclosed homes not listed with realtors. The Census numbers imply that the shadow inventory of single-family homes is huge.

The Outlook for Multi-Family Construction Keeps Getting Worse. In January, multi-family permits sank back to the rock-bottom levels plumbed in early 2009. The good news is that activity has stabilized and is more likely to go up than down hereafter. The bad news is that the recovery could take years.

This sector has been hit on several fronts, including a national recession and near-record-high rental vacancy rates. The biggest obstacle to putting up new units, however, is financing. On February 10, the Congressional Oversight Panel released a report concluding that conditions in the commercial real estate loan market are unlikely to improve over the next four years. According to the report, "Between 2010 and 2014, about $1.4 trillion in commercial real estate loans will reach the end of their terms." Presently, nearly half are underwater—that is, the borrower owes more than the underlying property is currently worth.

Weather Is Complicating the Short-Term Outlook. October ranked as the third coolest and the all-time wettest October in the 115-year period of record keeping, according to the National Climatic Data Center. November, however, was extremely mild (third warmest and 18th driest), while December was again miserable (14th coldest and 11th wettest). January's weather was seasonable. But two powerful snowstorms swept through populated areas in the Midwest and Northeast during February.

Unusual weather patterns corrupt housing data, especially the starts statistics. Generally, it takes two straight months of "normal" weather to get a good reading. So we may not have a clear idea of how the housing market is "really doing" until May, when the April data come out—assuming, of course, that weather patterns get back to normal.