Headwinds Await Housing Recovery

During this “irregular recovery” of the housing sector, there will be periods where the market sees some months of backtracking, especially after the tax credit expires and the demand from first-time homebuyers decreases.

The concern is that with the environment somewhat uncertain, builders will commit too much money to purchases of land requiring a lot of development spending, according to Robert Curran, managing director and lead homebuilding analyst at Fitch Ratings.

“The recovery is slower and less robust than normal. A lot of the private builders have at least for now been forced out of business,” said Curran during a conference call to discuss the fourth quarter of 2009 as well as Fitch’s 2010 housing outlook. “Build-up is much smaller today. Not as many people are taking slices from the pie. That is advantageous for the bigger builders, especially because of their access to capital.”

The rate of price improvements may accelerate in 2010 but still be below the historic trend line in recovery at 12 to 24 months off of a bottom. “Part of that is one, some expectation is the economy isn’t going to be so much more robust next year. And two, there is the issue of delinquencies translating into foreclosures. That continues to be fairly meaningful next year as well that adds to access inventory and is certainly going to be competitive pressure for all next year as it is this year.” In its quarterly update, Fitch said during the first 12 to 15 months off the bottom, the recovery appears “jaw-toothed” as substantial foreclosures now in the pipeline present as distressed sales and as meaningful new foreclosures arise from alt-A and option ARM resets.

High unemployment rates and the tightening of certain FHA loan standards will be notable headwinds early in the upcycle, noted Curran.

For certain builders, including Meritage Homes Corp., Hovnanian Enterprises, Lennar Corp., M/I Homes and Beazer Homes, cash flow has been enhanced by recent debt offerings, large land sales, tax refunds and even some public equity offerings.

If banks do not price land more attractively in order to move it off of their books, Curran said builders are likely see a dip in the type of return they are willing to accept. “In general, there is some enthusiasm that 2011 could be a better year on a macro sense than how 2010 is currently shaping up.”

New single-family home sales were down 17.2% year-over-year in February 2010. On a year-to-date basis, new-home sales are 13.4% lower than in 2009. The national average home price was $282,600, 9.3% higher than a year earlier. In February the median sales price of $220,500 rose 5.2% year-over-year.

At the end of the fourth quarter of 2009, unit backlog was higher for seven of the builders Fitch tracks. On average, unit backlog was up 17% (up 4% excluding Pulte, which has absorbed Centex) and the value of backlog was 15.2% greater than one year ago (up 4% excluding Pulte).

With the Fed terminating its MBS purchase program at the end of March, the concern about possible sharply rising mortgage rates is more widespread, according to Fitch’s Chalk Line report. Rising rates affect affordability, as well as home prices and financing terms, influence the decision to buy a home, including demographics, pent-up demand, rising income and improving consumer confidence.

“When rates rise because of an improving economy, which should also stimulate job growth, and when there is a lower-cost alternative in ARMs, the effect of higher financing is likely to be somewhat muted. So the key questions when rates increase become: Why are rates going up, how high do rates rise, how quickly do they increase, and from what level are they rising?” the report said.