January 29, 2004

Doom for Home Sales?

I'd be remiss to not comment on the home sales report yesterday. It's not the starting gun for a free fall in home building stocks or in mortgage activity. But it may be more like a rolling start. The good news, if you're looking to flip your house and buy a new one, is that 2003 was a record year. New home sales were up 11% and over 1 million units were sold. The bad news is that December sales were down 5%. Inventories--supply of new homes--were up too. There were 374,000 new homes in the market in December...about 4.3 months supply given current sales rates. That's the highest inventory level since 1989...suggesting that supplies are growing just as demand as falling...the classic signs of a "capacity build out." Of course the key in all of this is sales rates. Homebuilders are going to keep building if they think buyers will keep buying. And buyers probably WILL keep buying...as long as money is cheap. And on THAT score, the fact that mortgage requests were down last week--demand for new loans--isn't good news for homebuilders. The higher rates grow, the lower demand for new homes will be. You can't read too much into week-over-week changes in mortgage demand. The big question is what demand will look like two or three years out...and that will affect both individual home buyers and the GSEs, who make their living buying up new mortgages. The MBA published it's Macroeconomic and Housing Finance Outlook for 2004-2006 l ast week. Here were some of its conclusions (emphasis added is mine): +"Mortgage interest rates will follow Treasuries but will not rise as far as Treasuries because the drop-off in refinance volume brings an increase in competition, thus narrowing spreads. The Federal Reserve will remain on the sidelines until late 2004. Mortgage rates will likely end 2004 in the 6.3 to 6.5 percent range with an increase to slightly over 7 percent by year-end 2005." + "Mortgage origination volume, which hit an all-time record in 2003 at $3.8 trillion, will decline to $1.9 trillion in 2004 which will be the 5th largest year on record. Volumes will register slight decline to $1.7 trillion in 2005 and another $1.7 trillion in 2006." +"The volume of loans originated for home purchases will increase annually across the three-year forecast period. The refinance share of originations will fall from 66 percent in 2003 to 34 percent in 2004, to 22 percent in 2005 and to 19 percent in 2006." These forecasts prompt some obvious questions... 1) If mortgage rates rise to 7% by 2005, what effect will it have on recent buyers? And if rising rates slow down the pace of new buyers, will home prices fall...leaving many new buyers owning homes whose mortgage value exceeds its market value? 2) If mortgage originantion falls by 50% in 2004, as the MBA projects, how will it affect the financing of Fannie Mae and Freddie Mac? 3) If refinancings as a percentage of originations fall by 50% this year, will a huge prop to consumer spending be kicked out from under the barely recovering economy? I'm not aiming to answer all these questions at once, or even today. We just don't know how it all will play out...and how vulnerable Americans are to falling home values. But I think we'll find out soon... And in the meantime...the important investment implication is that a marginal increase in interest rates is going to lead to much slower growth in mortgage activity and new home buying. Even if this didn't signal that something was broke in the homebuilding market, it would still be bad news for homebuilders. It means the cheap money that's driven demand is a thing of the past. And that inventories of supply (new homes) are likely to get larger. You saw a foretaste of what that does to homebuilding stocks early this month. And you saw more of it yesterday, when the Philly Homebuilding Index (HGX) fell 3.5% on the slower December sales news. Home prices might not collapse all at once. But stocks of homebuilders, which are thinking of the future, might very well do just that.


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