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Wednesday, May 20, 2009

Is A Housing Recovery Underway?
Business Week Reads The Tea Leaves

Hopes are high that the deeply troubled U.S. housing sector has finally seen the worst of the recession and financial crisis.

But new data on May 19 raised questions about that optimism. U.S. housing starts hit a record low, dropping 12.8% in April, to an annual pace of 458,000. Housing starts are down 79.8% from their peak in January 2006.

A sharp drop in construction of multifamily dwellings drove the reading, with single-family starts actually up 2.8%.

However, the overall record low disappointed economists and investors, who had seen signs in recent months that housing might have hit bottom.

With housing starts at a record low, "it's early to pop the cork," says Michael R. Englund, chief economist for Action Economics. Yet, Englund and other economists told BusinessWeek, the data don't contradict hopes that housing might be near a bottom.

"in the process of bottoming out"

A drop in construction activity is certainly troubling for the overall economy and for unemployment trends. But a drop in housing starts might actually be good news for the sector's eventual rebound, says Gary Wolfer, chief economist at Univest Wealth Management (UVSP).

One of the housing market's main problems is a glut of supply—too many homes for sale. Idle homebuilders mean fewer new homes coming onto the market, thus hastening a bottom for the market. "We're getting there in a brutal fashion," Wolfer says, but at least we're "in the process of bottoming out."

Keith Hembre, chief economist at First American Funds, worries that further home foreclosures could continue to drive the proliferation of "for sale" signs across the country.

However, he does see reasons to hope for a revival in demand. The government is helping: Low interest rates make mortgages more easily affordable (if you can qualify for one) and the federal government is providing an $8,000 tax credit in 2009 for first-time home buyers. "The signs are there that demand has generally hit bottom," Hembre says—and it may even be improving somewhat.

A recovery start for homebuilders?

First-quarter earnings reports from homebuilders have bolstered the case for guarded optimism.

"For the homebuilding industry, we think that probably the worst is over," says Kenneth Leon, a Standard & Poor's equity analyst who covers the homebuilders. Key metrics seemed to improve in the homebuilders' first-quarter earnings reports, Leon says, including net orders, backlog, and the pace of homebuilder write-offs.

Still, industry players continue to post quarterly losses.

Investors had a mixed reaction to the April housing starts data. Though the record decline was cited by some market observers as a troubling sign for the overall economy, shares of the largest homebuilders were mixed.

On May 19, Pulte Homes (PHM) dropped 2.6%, to 10.03, but Toll Brothers (TOL) slipped just 0.7%, to 19.51, and D.R. Horton (DHI) gained 1.8%, to 9.96.

Homebuilders: Not out of the woods

After two very difficult years, homebuilders are trading solidly higher so far this year. The S&P Homebuilding index rose almost 19% in the first four months of 2009.

S&P's Leon doesn't expect "a full sustained recovery" for the housing sector until the end of 2010. And several factors could derail or delay the housing market's recovery, experts say.

Fresh foreclosures could flood the market with supply, even as homebuilders cancel new projects. Credit troubles could make it hard for buyers to get mortgages. Right now, "affordability is very attractive—if you can qualify and get a mortgage," Leon says.

Even if activity returns to the housing sector, home prices could continue to fall for some time.

"While we are well into the housing bottoming process, we are a long way from recovery," Stifel Nicolaus (SF) analyst Michael R. Widner wrote May 19. "Our math suggests we have a couple years to go before excess inventory clears and paves the way for significant housing sector improvement," he added.

Watch "the broader financial crisis"

Englund of Action Economics warns that there may be too much focus on foreclosures, government incentives, or individual data points.

Those aren't the key drivers of a revival for housing, he says. As demonstrated by the "roller coaster of the last 2 1/2 years," he says: "It's the broader financial crisis that [is] really driving this process."

While worries linger about the next potential financial disaster or an unforeseen economic meltdown, many home buyers are reluctant to take a risk on a major home purchase. "No one wants to jump headlong into this environment," Englund says.

In other words, no matter what the data say from month to month, it's hard to imagine the housing sector bouncing back until the big picture significantly improves.