The Sullivan Group Market Observer
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The housing market has crashed, right? The bubble has burst, correct? All is lost, affirmative?
The answers to all three questions? Absolutely not.
The housing market, however, is facing a correction – one that has resulted from ignoring the basic tenets of economics and its driving force of supply and demand.
That's one of the reasons I love the housing industry. While it is driven by a consumer that does not always behave rationally, the housing industry itself is truly an organic being with highs and lows, sunsets and sunrises, and like any organic being, it needs to rest after periods of major activity (think of how you feel after Thanksgiving dinner).
As housing has just come out of its largest expansion period ever, we are now in that period of cooling that follows any protracted exertion. Consider a few of the national trends as 2006 comes to a close:
• We will finally see a drop in building permits in 2006 compared to 2005 after nearly 12 years of sustained growth. Before this frenzy, there had never been more than four years of consecutive increases.
• New home sales will drop at least 10 percent in 2006 from 2005 after experiencing nearly 10 years of consistent increases. Going back to 1960, our economy's best streak was a mere four years, not unlike building permits.
• Unsold home supply (per the US Census) finally increased after seven years of stability at three months supply. Given that the average since 1960 has been around six months of supply, and prior to 1997, we had not had more than three years without an increase in supply, this has been a long time coming.
So this must mean the bubble has burst, right? Again, not at all. Our economy is relatively solid. But for the first time in 20 years, the housing industry is going through a correction, while the overall economy remains quite sound. Consider the following economic indicators:
• Thirty-year fixed rate interest rates have actually dropped in the last six months. This is the upside to a softening economy. The Fed is closely watching the housing market as perhaps its most important indicator of the economy's resilience.
• Gross Domestic Product (GDP) is still solid at 2.0 percent. While we believe housing may erode that growth rate a little (remember that housing and its related industries represent as much as 20 percent of GDP), it should still stay above the 2.0 percent growth rate that defines a stable economy.
• Job growth has been quite good nationwide (at over 1 percent) and this is key to housing. It is interesting to note that two of the weakest housing markets are Las Vegas and Phoenix, but together they should generate over 120,000 jobs in 2007 and represent over 10 percent of the nation's job expansion.
What we are experiencing can best be defined as a "Supply Hangover". We have too much supply and have to burn through it to get back to market equilibrium. We went too far too fast and, in the early 2000s, we effectively ate up some of the demand that should have taken place in 2007 to 2010. During this correction, prices are being reduced and while we have not seen land prices drop considerably yet, we anticipate some reduction in land prices in 2007.
Today the buzzword is normalcy and stability. But keep an eye on supply, as it will be a key indicator for any recovery. And as we look forward to some level of improvement in the coming year, remember that the basic tenets of economics reign supreme over irrational buying.
Volume 5
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The graph illustrates the correlation between increasing prices and increasing inventory in the United States.
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