Hold Your Houses

Editor’s Note: The following feature is an edited excerpt from an economic forecast focusing on single-family housing construction written by Portland Cement Association Chief Economist Ed Sullivan.

The Portland Cement Association (PCA) believes the residential sector’s adverse impact on cement consumption has run its course.

PCA’s fall forecast projects a 14.4 percent increase in housing starts during 2010 compared with extremely depressed 2009 levels. This reflects a 20 percent increase in single-family starts and a 5.7 percent decline in multi-family starts compared with 2009 levels. These projections lie well below the consensus of construction economists’ expectations.

PCA continues to believe that several significant hindrances specific to the housing sector will remain in play throughout 2010, leading to a delay and more muted improvement in the residential sector compared with the consensus averages. In our view, it is likely that 2011 will be characterized by a dynamic recovery in residential building.

Conditions Required for a Broad-based Recovery in Single Family Construction. Homebuilders are unlikely to accelerate construction activity until two critical conditions are met: (1) low levels in inventory of unsold new homes reflecting no higher than five months supply, and (2) stable or rising home prices. Both conditions are likely to be required to ensure an adequate ROI for homebuilders to spur an increase in building activity.

At the start of 2010, the single-family housing market is characterized by excess new home inventories. Nationally, new home inventories stand at 235,000 units, or roughly 7.9 months’ supply.

In addition, according to the National Association of Realtors, new home prices stand nearly 24 percent below October 2005 peak levels. More importantly, however, the small month-over-month price changes that suggest new home prices may be nearing a turning point have materialized in the context of federal homebuyer support programs as well as private and public foreclosure moratoriums – neither of these can necessarily be counted upon to ensure sustained price increases.

Reasons Why a Delayed Recovery in Single-family Building May Materialize. A reduction in new home inventories and stabilization in new home prices must occur in an environment characterized by weak economic growth, high unemployment, likely increases in foreclosure activity, fire sale pricing of bank possessed properties and the continuation of tight lending standards. Combined, this environment is hostile to any significant near-term improvement in the fundamentals leading to an increase in starts activity.
Consider the following PCA assessments:

1. Weak labor markets will hinder a significant and sustained increase in 2010 new home building. The recovery in the U.S. housing market cannot be sustained without stabilization in labor markets and job creation. 
PCA expects job losses will stop in the first quarter of 2010, followed by a saddle point quarter characterized by minor monthly losses/gains, essentially leaving quarterly job losses at zero. Early in the third quarter job gains are expected to materialize, followed by successive strengthening in labor markets. This period of strengthening yields between 350,000 to 500,000 new jobs created in 2010.

2. Homebuyer tax credits may result in a payback in sales during the second half of 2010, moderating perceived momentum. The accelerated sales pace that materialized during the 4th quarter of 2009, may owe a substantial amount of credit to the home buyer tax credit and its planned expiration in November. During the three months leading up to the expiration of the program, home sales averaged more than a 5.3 million at a seasonally adjusted annual rate – roughly 17 percent higher than the 2009 pace preceding that period.

3. Foreclosure activity is likely to accelerate during the first half of 2010 - adding to inventories. PCA expects foreclosure activity is likely to increase during the first half of 2010. This assessment is based on three key factors including; labor market conditions, the end of foreclosure moratoriums and a work-through of bank backlogs and a continuation of weak home price conditions.

4. Increases in bank possessed properties will hinder an improvement in new home prices. It is likely that the bank possession rate per foreclosure will exceed depressed 2009 levels and probably even 2008 levels.
Banks are not in the realty business – they are in finance. Banks offer substantial discounts below prevailing market prices to remove the financial liabilities of possessed homes from their books. These homes, some nearly new, compete directly with new homes for the homebuyer – putting downward pressure on new home prices. The potential of increased foreclosure activity and higher bank possession rates during 2010 suggests that the downward price pressures arising from bank possessed properties may accelerate during the first half of 2010.

5. Lending conditions are likely to remain a hindrance during much of 2010. The critical issue facing the economy is not the level of capital available, but rather the access to the capital by business and consumers. It is likely that banks’ aversion toward risk will diminish only after charge-offs for loans show a sustained pattern of decline. Unfortunately, loan charge-offs are expected to accelerate as unemployment increases. PCA expects an easing in lending standards will begin to materialize roughly six to nine months after the U.S. labor markets become stabilized.

6. Trigger points may be delayed – suggesting less upside risk compared to consensus. Clearly, PCA has pessimistic assessments compared to other forecasters. Upon review of the structural factors needed for recovery, there may be reason to lean against the wind of consensus.
Compared to consensus, the potential for slower than expected sales, higher than expected inventories and a weaker than expected pricing environment suggest the potential for a delay in homebuilders reaching the trigger point signal to accelerate single-family home building. C&DR